Jill Peters - SVP, IR Jeff Mezger - President and Chief Executive Officer Jeff Kaminski - Executive Vice President and Chief Financial Officer.

Alan Ratner - Zelman & Associates Stephen East - Wells Fargo Mike Dahl - RBC Capital Markets John Lovallo - Bank of America Merrill Lynch Nishu Sood - Deutsche Bank Trey Morrish - Evercore ISI Jay McCanless - Wedbush Securities.

Good afternoon. My name is Devon and I'll be your conference operator for today. I would like to welcome everyone to the KB Home 2018 Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the Company's opening remarks, we will open the lines for questions.

Today's conference call is being recorded and will be available for replay at the Company's website, kbhome.com for 30 days. Now, I would now like to turn the call over to Jill Peters, Senior Vice President, Investor Relations. Jill, you may begin..

Thank you, Devon. Good afternoon, everyone. And thank you for joining us today to review our results for the third quarter of fiscal 2018.

With me are Jeff Mezger, Chairman, President, and Chief Executive Officer; Jeff Kaminski, Executive Vice President and Chief Financial Officer; Matt Mandino, Executive Vice President and Chief Operating Officer; Bill Hollinger, Senior Vice President and Chief Accounting Officer; and Thad Johnson, Senior Vice President and Treasurer.

Before we begin, let me note that during this call, items will be discussed that are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future results and the Company does not undertake any obligation to update them.

Due to factors outside of the Company's control, including those detailed in today's press release and in filings with the Securities and Exchange Commission, actual results could be materially different from those stated or implied in the forward-looking statements.

In addition, a reconciliation of the non-GAAP measures referenced during today's discussion to their most directly comparable GAAP measures can be found in today's press release and/or on the Investor Relations page of our website at kbhome.com. And with that, I will turn the call over the Jeff Mezger..

Thank you, Jill, and good afternoon. The third quarter marked another quarter of consistent execution on our returns focused growth plan, driving considerable improvement in our key financial metrics.

A principal component of this plan is growing both our scale and profitability and our results for the quarter reflect our ongoing progress toward becoming larger and increasingly profitable business.

Looking at the specifics of the third quarter, we grew total revenues by 7% to $1.2 billion, and increased earnings per share by more than 70% to $0.87.

We produced significant year-over-year gross profit margin improvement through our consistent focus and optimizing our assets, a continued rotation in the higher margin communities, and an increasing benefit from lower interest amortization.

Our gross margin this quarter was also helped by a geographic mix shift in deliveries toward higher margin communities. In the third quarter, we expanded our gross margin by 180 basis points to 18.7% excluding inventory related charges.

We also continued to effectively manage overhead cost, while increasing scale which resulted in a record low third quarter SG&A ratio. Taken together, our operating income margin was up 190 basis points to 9.3%.

Looking at our operating income on a per unit basis, we generated approximately $38,000 per delivery in the third quarter of 2018, an improvement of more than 25% as compared to the prior year quarter. Market conditions remain favorable as the key drivers that fuel housing demand are still in place. The economy is healthy and growing.

Consumer confidence is at an 18-year high. We are at or near full employment with wage growth now accelerating, and household formation is continuing at a steady pace.

At the same time, the supply of both new and existing inventory remains insufficient to satisfy this demand, underscoring the opportunity for higher levels of new construction to bridge the gap. Taken together, these dynamics continue to support solid market conditions for the foreseeable future.

Home buyers are demonstrating a preference for choice, fueling strong demand for a built-to-order product. Once again this quarter, we effectively balance pace and price to capitalize on this demand, maintaining among the highest absorption rates in the industry.

Our net orders per community grew 11% in the third quarter to 4.1 per month with increases in each of our four regions. This marked the first time in many years where our third quarter absorption pace was above four per month. We accomplished this improvement in pace while opportunistically capturing price, helping to offset cost increases.

We were able to raise prices in over 60% of our communities and still maintain accessible price points for first-time buyers.

We are well-positioned from an ASP standpoint as our long-standing approach of offering our products and pricing our homes to be attainable for the median household income of each sub market, allow us to remain affordable and also competitive with resale, our biggest competitor.

As we anticipated, our average community counts declined by 7% during the quarter, yet we still produced a 3% increase in net orders. Our $2 billion backlog provides visibility on deliveries for the remainder of this year, supporting our 2018 expectations including housing revenues that are at the low end of our previous guidance range.

Although we are pleased with our year-over-year absorption pace increase in the third quarter, we now recognize in retrospect that our full year revenue guidance from last quarter was too aggressive based on the timing of getting our communities open and establishing our targeted pace to support projected fourth-quarter deliveries.

In addition, with our backlog currently weighted outside of California, we're lowering our ASP expectations from our previous guidance, reflecting our third quarter backlog ASP that is down 4% year-over-year, which will also impact our revenues.

Managing the business for the balance of 2018, we made the decision to maintain our pace price discipline and achieve a higher gross margin for this year as opposed to running our communities at a faster pace to preserve delivery volumes.

As a result, we're now expecting a gross margin of approximately 18% for this year at the high end of our previous guidance range. Our results this quarter clearly illustrate the strength of our returns focused growth plan, and our balanced approach to effectively deploying our substantial cash flow.

During the quarter, we reinvested $600 million in land acquisition and development, driving our owned and controlled lot count to 53,400, a sequential increase of more than 3,800 lots, further supporting our future community count growth.

We also repaid $300 million of debt at its maturity and still ended the quarter with a very healthy third quarter cash balance of over $350 million in addition to our undrawn revolver. Growing our active inventory, while reducing our debt balance and interest incurred is a powerful combination that is already generating gross margin improvement.

With the progress that we've made in generating cash, we are well-positioned to strategically expand our business.

In the third quarter, we acquired the assets of Landon Homes in Jacksonville, Florida including approximately 2,100 lots that we now own or control across 17 communities, eight of which are open today and nine communities which will open over the next 18 to 21 months.

We are currently the fourth largest builder in this market based on deliveries, and our position will be enhanced in 2019 and beyond with this acquisition.

Our local team is moving quickly having completed the rebranding KB Home and the introduction of our product in all but one active community that we acquired, which is a higher ASP move-up community. We also expanded into Seattle, a market that we have been evaluating for several years.

Seattle has similar dynamics to the Bay area and Denver, two markets that we know well. And we hired an experienced division president who's a Washington native with local market expertise and a strong network of relationships.

This enabled us to move quickly on acquiring land having already completed one acquisition with first deliveries planned for 2019, and a second scheduled to close in a couple of weeks.

Our market approach in Seattle is to offer affordable product in the high $300,000 to $400,000 price range targeting first time and first move up buyers in keeping with our core business strategy and our personalized approach to homebuilding.

While it will take some time for us to reach meaningful scale in Seattle, we are excited about this opportunity to augment our West Region. We remain on track with the community count trajectory that we shared with you last quarter. The third quarter marked a turning point where our ending community count increased sequentially.

We estimate that we will be increase in our community openings this year between 15% and 20% year-over-year, and ending 2018 with a higher community count. As we look to 2019, we are again planning a significant year-over-year increase in openings and expect sequential growth and community count each quarter.

We also expect that the makeup of our portfolio will reflect a greater percentage of core communities as we continue to rotate into higher margin higher return communities. Moving on to the regional updates. In the West Coast, demand remained healthy during the quarter.

And we experienced the slight increase in our community absorption rate to 4.6 net orders per month surpassing our company-wide average.

As we share with you on earnings call in June, the mix shift in net orders that we experienced in the second quarter of this year carried over into the third quarter as we continued to sell through many communities with ASPs in the range of $1.3 million to $1.8 million.

This higher price band represent about 7% of the region's net orders in the third quarter of 2017 as compared to 2% of our net orders this year, as we replace these communities with other communities offering more affordable product.

The combined effect of having fewer active communities given the region's community count transition, and selling out of many of our highest ASP communities negatively impacted our net order comparisons in the third quarter of 2018. As a result, the West Coast experienced a 22% decline in net order value on a 15% decline in net orders.

Our ending community count in the West Coast was up sequentially in the third quarter, and with a year-over-year increase in the number of planned openings in the fourth quarter, we continue to expect our 2018 ending community count in California to be up roughly 15% as we resume growth of this business.

We like our sub market and product positioning across the region. And we are solidly positioned for quarterly sequential community count growth throughout 2010. Demand in our Southwest region also remained healthy with an absorption rate that was firmly above the company-wide average.

The Las Vegas market in particular exhibited very strong demand and continued to lead the company in community absorption rate.

Overall, the region's net order comparison was impacted by a declining community count year-over-year, and with most of this year's third quarter openings occurring near the end of the quarter, we have not yet captured their full benefit. As a result, the Southwest experienced a 1% decrease in net order value and an 8% decline in net orders.

In the central region, our largest region in terms of units, net order value increased 9% and a 15% increase in net orders.

While some of the favorable comparison of the prior year quarter reflected the impact from Hurricane Harvey which hit the Houston area at the end of the third quarter of last year, we also once again saw a particular strength in our San Antonio division.

Wrapping up the regional updates, net order value increased 46% in the Southeast region on a 3.5% increase in net orders with every division producing a positive net order comparison. We have seen a continuing trend of net order growth throughout the past year in the southeast, and we are pleased with the momentum we are building.

The region's results also this quarter included 78 net orders from the land and homes communities in Jacksonville. Before I wrap up, I'd like to spend a few minutes on two announcements we made during the third quarter. First, our brand repositioning.

We launched a new logo and built on relationships tagline which speaks to our connection with home buyers in our built-to-order process and our commitment to customer satisfaction. This logo and tagline were developed based on extensive customer feedback as to what the KB Home brand represents to them.

While the values underling our brand remain the same, we ++have modernized its look and feel to further strengthen our engagement with customers in a way that emphasizes their choice and personalization in the homes they purchase. Our new branding is warmer and more contemporary, which can also be leveraged on social media.

The second announcement is our partnership with Google. The first for Google in homebuilding. Our new KB Home Smart System utilizes Google Assistant to integrate compatible devices and features, enabling a higher degree of functionality and automation of smartphone features and elevating the performance of homes in a personalized way.

We were excited to launch the program two weeks ago at our Stapleton Starlight community in Denver where it was well received by attendees who toured the home.

The Smart System will initially be offered as standard in select communities in Denver, Las Vegas, Jacksonville and Orange County with additional components available as options in our Studios. Over time, we expect to roll the system out to all of our markets.

We are excited about this partnership with Google and look forward to updating you on its progress over time. Our goal is to establish a leadership position in Smart Home Technology just as we have in sustainability and healthier homes.

In closing, we are pleased with our continuing trend of positive performance in the third quarter with nearly 60% growth in our pretax income in the first nine months of 2018, and a solid outlook for the fourth quarter, we expect a meaningful improvement in our book value by the end of this year.

We are poised to finish 2018 with growth in revenues and a significantly higher year-over-year operating margin fueled primarily by the expansion of our gross margin, a key goal for us.

As we look ahead to 2019, the combination of community count growth beginning in the fourth quarter of this year, a substantial increase in communities slated to open in 2019, and maintaining our solid absorption pace gives us confidence in achieving our targets next year. With that, I'll now turn the call over to Jeff for the financial review.

Jeff?.

Thank you, Jeff, and good afternoon, everyone. We are very pleased with our solid third quarter results, which were primarily driven by our continued operational execution on a returns focus growth plan in customer centric business model.

I will now highlight some of the significant improvements we produced in the third quarter, provide details on our outlook for the fourth quarter, and discuss our 2019 community count and housing revenue expectations.

In the third quarter, housing revenues grew 7% from a year ago to over $1.2 billion, reflecting an 8% increase in the number of homes we delivered, and a slight decline in our overall average selling price.

Three of our four homebuilding regions reported housing revenue increases ranging from 12% in the central region to 48% in the southwest region more than offsetting a 6% or $36 million decline in the West Coast region.

The decrease in the West Coast revenues for the quarter was due to the impact of lower year-over-year community count during the first nine months of 2018, partially offset by year-over-year increase is an absorption pace. We are expecting favorable community count trends in the future for our West Coast region, as well as for the total company.

And I will provide more detail relating to these expectations in a few minutes. We believe our current $2 billion backlog values supports projected fourth-quarter housing revenues of approximately $1.39 billion to $1.45 billion.

And as Jeff mentioned earlier, we currently expect full year housing revenues of approximately $4.6 billion, which is at the low end of our previous guidance range. In the third quarter, all of our homebuilding regions posted increases in average selling price ranging from 2% in the West Coast region to 7% in the Central Region.

Nonetheless, our overall average selling price of homes delivered decrease 1% year-over-year to approximately $408,000 due to a geographic mix shift of deliveries with a lower proportion of deliveries coming from our West Coast region, which reported an average selling price of $693,000 for the current quarter.

For the 2018 fourth quarter, we are projecting an overall average selling price in a range of $400,000 to $405,000. Homebuilding operating income increased 38% from the year earlier quarter to $105.6 million.

Our third quarter homebuilding operating income margin increased 190 basis points on a year-over-year, mainly driven by continued measurable improvement in our housing gross profit margin.

For the fourth quarter 2018, we expect our homebuilding operating income margin excluding the impact of any inventory related charges will be in the range of 9.3% to 9.7%.

For the full year, we expect the same metric to be approximately 8.2% which is at the high end of our previous guidance and within our 2019 target range of 8% to 9% under our returns focus growth plan, a full year ahead of our original expectation.

Our housing gross profit margin for the third quarter improved 180 basis points on a year-over-year basis to 18%. Excluding inventory related charges of $8.4 million in the current period and $8.1 million in the prior year period, our gross profit margin for the quarter was 18.7% also a year-over-year improvement of 180 basis points.

Reductions in incurred interest from declining debt levels drove a decrease in the amortization of previously capitalized interests that accounted for 40 basis points of the gross profit margin improvement.

Our adjusted housing gross profit margin which excludes inventory related charges, and the amortization of previously capitalized interest was 23.1% for the third quarter, up 140 basis points compared to the same period of 2017.

The year-over-year increase primarily reflected a continuation of the favorable factors realized during the first half of this year.

These factors include margin improvement from community specific action plans, including targeted home selling price increases calibrated with demand and the opening of new higher margin communities, partly offset by increases in land, trade labor and material costs.

Assuming no inventory related charges, we expect our fourth-quarter housing gross profit margin will be in the range of 18.3% to 18.7%.

Using the midpoint of the fourth quarter range and excluding inventory related charges, we expect the full year 2018 gross profit margin at the high end of our prior guidance range of approximately 18%, which would represent a year-over-year improvement of 110 basis points, and the achievement of our 2019 returns focus growth plan goal for this metric a year ahead of schedule.

Our selling, general and administrative expense ratio of 9.4% for the quarter reflects an improvement of 20 basis points from the same period of the prior yearend a new quarter record low. As we continue to focus on containing overhead costs, we are forecasting our fourth-quarter SG&A expense ratio to be in a range of 8.8% to 9.2%.

Assuming the midpoint for the fourth quarter, our 2018 full-year SG&A expense ratio will be approximately 9.8% which is within our prior guidance range. Our effective tax rate for the third quarter of 24% decreased from 37% in the prior year period, primarily due to the favorable impact of the Tax Cuts and Jobs Act.

We still expect our effective tax rate for the fourth quarter of 2018 to be approximately 27%. Overall, we reported third quarter net income of $87.5 million or $0.87 per diluted share, up significantly from the $50.2 million or $0.51 per diluted share reported in the third quarter of 2017. Turning now to community count.

Our third quarter average of 217 was down 7% from 234 in the same quarter of 2017. We ended the quarter with 224 communities, representing a 3% decrease from the year ago quarter.

On a sequential basis, our ending community count increased 7% and marked the beginning of a trend of sequential increases in community count that we expect to see for both the fourth quarter and throughout next year.

On a year-over-year basis, we anticipate our fourth quarter average community count will be about the same as the average of 228 communities in the fourth quarter of 2017. We now expect our community count at the end of 2018 to be up about 4% as compared to year end 2017.

In addition, while our third quarter average community count for our West Coast region was down 16% from the prior year period, we ended the quarter with 55 open selling communities representing a sequential increase of 8%.

We expect another sequentially increase in the fourth quarter and further growth throughout 2019 resulting in notable year-over-year increases in average community count for the region in each quarter of next year.

We invested $601 million in land, land development and fees during the third quarter with 58% of the total representing new land acquisitions. On a year-to-date land related investments of $1.4 billion increased 29% versus the prior year period.

We enter the quarter with over 53,000 lots owned or controlled, our highest quarter and lot count in four years. Our lot count was up 8% sequentially from the second quarter, including the addition of approximately 2,100 lots that we own or control due to the asset purchase from land and homes in the third quarter.

We are excited to put more capital to work in Jacksonville through this asset acquisition that complements our current footprint and customer focus was free of goodwill and debt, and we'll add incremental revenues and earnings to our result beginning in the fourth quarter of 2018.

We remain focused on growing our community count and driving top-line revenue expansion as key components of a core business strategy and returns focus growth plan.

Consistent with our operating model, our investment strategy is focused on acquiring land for new communities that can offer product at price points attainable for the respective sub markets median household income.

We expect our increased level of land investment will drive additional such community openings resulting in 2019 year-over-year growth in average community count in the 10% to 15% range.

Combined with our anticipated yearend backlog, we believe the number and mix of our open selling communities in 2019 will generate full-year housing revenues in a range of $5 billion to $5.3 billion, up 12% over the prior year at the midpoint and achieving our original three-year target for this metric under our returns focus growth plan.

We enter the quarter with total liquidity of $817 million including $354 million of cash and $463 million available under our unsecured revolving credit facility. During the quarter, we retired $300 million of our 7 1/4% senior notes at their maturity using internally generated cash.

In August, Fitch upgraded our credit rating to BB minus equal to the S&P rating which was upgraded in January 2018 marking our fourth rating agency upgrades since April 2017.

The implementation of our returns focused growth plan including the execution of our KB 2020 business model has generated substantial cash flow over the past seven quarters, enabling us to significantly reduce outstanding debt levels and fund measurable increases in land investments.

These land acquisitions in turn drove a sequential increase in our third quarter ending community count, and positioned us for continued future growth.

In summary, we delivered strong results in the third quarter with 7% growth in revenues; 190 basis points of improvement in our operating income margin, and an increase of 45% of pretax income on a lower tax rate, all of which contributed to a 74% increase in our net income versus the prior year quarter.

We also expect to generate further improvements in our financial performance in both the fourth quarter and 2019 as we continue executing on our returns focus growth plan.

Finally, we have announced a date for our Annual Investor Conference Call scheduled for November 14th to provide an update on our progress towards achieving our three year returns focus growth plan objectives, and furnish detailed guidance for the 2019 first quarter and full year. We will now take your questions. Devon, please open the lines..

[Operator Instructions] Our first question comes from the line of Alan Ratner with Zelman & Associates. Pleased proceed with your question. .

Hey, guys. Good afternoon. And a really nice quarter. So appreciate all the commentary and guidance. I think that clearly from your actions this quarter you guys are still very optimistic about the cycle as evidenced by the acquisition in Jacksonville and during Seattle. And just generally the big ramp in your land activity.

On the other hand, we're seeing in the stock market there's a lot of trepidation over where we sit in the cycle today. I think some other builders have highlighted more deceleration of late and probably at higher price points than you're operating at.

But I'm wondering if maybe you could just talk a little bit about what you're seeing in the broader market maybe outside of your core price points, and talk about the overall environment for incentives, discounting this time of year, inventories on the ground.

You mentioned Jeff it's obviously very tight but we have seen those numbers creeping higher.

So do you think this is a function of your out performance based on the price point you're operating in the location of your communities? Or do you think the stock market just has it wrong at this point and the market remains on much stronger footing than perhaps investors are given credit for?.

Alan you hit on two key points there in what you just rattled off. One, I do think with how we're positioned, where our prices are at and targeting the medians in the sub markets that we continue to enjoy very healthy demand as I shared our absorption rate for communities actually up.

And we took the time to go into the detail on our community count and what's going on in each region to hopefully communicate that the markets are very healthy right now at the price points that we play at. Like you I have seen all the coverage in the media and in the Investor world on where we're at in the cycle.

And I keep getting back to the current inventory levels which are low. And while the national numbers are four months, many of the markets we are in today, it's still two months, month and a half. And then when you get into the price points we play at it even less. So there's not a lot of inventory out there at the affordable price bands.

And much of the headlines I think are tied to higher price points that are seeing some slowdown.

And we're trying to stay ahead of that at the price points that are slower are well above us today and where we're operating, but if it comes down we have to be prepared for that and it is in part why we're rotating to lower price communities, positioning smaller models in higher price areas even to keep affordable and keep some insulation there.

But we think market conditions are very good and continue to see a great opportunity as we head into 2019..

Thanks for that, that's helpful. And then second, you gave the community count and revenue targets for next year. Just as you sit here today with the communities that are coming online and where you see your portfolio.

Any indication you could give us just directionally on margin at this point? I mean it sounds like you're raising prices still in the majority of your community as your sale pace is very strong.

So I would think just based on that that you have confidence and at least an ability to hold margin at the levels you're achieving today, but is there something else maybe kind of going on behind the scenes from a mixed standpoint that we should be aware of?.

No, not really. Just more continuation of the trends that we've been experiencing for the past couple years. We will still have a bit of a headwind from the reactivated communities. And we'll still be dealing with that next year, but I don't think it will change significantly in one direction to the other.

We are enjoying and we're starting to see it come through the financials the results of the de-levering and lower interest amortization. So that'll be a tailwind for the margins as we go into next year. And we're still seeing a really good experience with the new community opening.

So they continue to be really the main driver of the margin improvement in 2018 and the current year and hopefully that'll continue into next year, but no, there's nothing outside of that..

Our next question comes from the line of Stephen East with Wells Fargo. Please proceed with your question. .

Thank you and congratulations guys, a nice quarter there. So, Jeff, you talked about the demand that you're seeing and we would agree based on what we're seeing out in the field.

As you look at your entry-level trends across the market, are you seeing any markets where you're starting to hit price constraints? Alan talked a lot about --been pretty worked up about it and I think this --the pricing and the affordability issue is really bubbled to the top.

Are you seeing any markets where at the entry level you're hitting that price constraint now you've got to do something different, i.e.

smaller product et cetera?.

We haven't seen it yet, Stephen. We -- few things we track our LTVs, the qualifying ratios of our customers, the down payment the FICO scores that hasn't changed at all.

Our average footage also hasn't changed at all and to me that's another proxy for what's going on with a consumer in that-- it's a consumer pick in that size home not us building a spec and then selling it. So footages are holding, our LTVs are holding. We've been moving to more affordable areas.

So it's the same size home price may go down because we've moved two miles or five miles further from the employment centers. But we're not seeing any indication of our customer today that they're feeling a pinch. I've seen a lot in the media about interest rates going up. And I looked at the 30-year Fannie Mae numbers and it's 4.6%.

It's the same thing as been for four or five months. I'm wondering if the media is banging that drum more because of what could happen in the future versus the reality of today. The rates really haven't moved that much this year..

Okay, all right.

And a follow-on just quickly how long does it take you to reposition your product? Is this like a six-month of then or if you start to see constricts out there how long it does take for you to reposition your product because of community constraints et cetera? And then you all built in off-site home in Vegas, just interested to know how that is fitting into your future? How you all are thinking about off-site manufacturing?.

You just exceeded your two questions but I'll honor it and answer the third too, Steve. I’ll go to that one first, we have done concept. We've done many concept homes over the years.

And the one that we're doing in Vegas in conjunction with a lot of our national suppliers and builder magazine, Hanley Wood, we always come up with new ideas out of these things.

When you get everybody working together on how to create a more advanced home and technology or more advanced in energy efficiencies or healthier, and in this case it'll be all the above.

Great ideas bubble up, you find some that resonate; you find a way to get that component to scale prices come down and over time it becomes a standard feature in the industry. So it's part of the evolution and with that comes the --how do we manufacture our product for less cost. And that's been a challenge for decades.

And so far we haven't been able to crack the code. So we're testing that one as well to see on a modular basis what can we do. And how do we explore, bringing our cost to build or our time to build down through things like that.

As we keep trying these things so far we haven't been able to find one that where the costs are close enough, where it makes financial sense, but we're continuing to push the envelope there.

Specific to retooling product, if it's a city like Phoenix or Texas or Florida, we have product series that range from 1, 200 feet to 3,400 feet that are all the same width and all fit on the lots.

And as we bracket the incomes and the medians will put houses out there that are attainable in the model park; that are attainable to that consumer profile.

And if rates were to go up or affordability goes down or cost-push price up, we can rotate into new models in a matter of a few months because they're all plan approved and you just go get a permit and you build a new model park if you want to reposition the community. And we've done that pretty quickly over time.

It's a little dicier when you get to California where everything is pre plotted and you'll have architectural reviews and the cities and the planning departments get back involved, if you want to change the product there but we've navigated that one as well. So we're very nimble in that regard, it's plug and play for the most part..

Our next question comes from the line of Mike Dahl with RBC Capital Markets. Please proceed with your question..

Hi, thanks for taking my questions. Jeff, I wanted to ask a little about the revenue guide as it relates to next year. And I think the starting point really around the change to this year. I think you mentioned in your opening remarks probably a little too aggressive on the opening schedule, and establishing a target sales pace.

So could you just talk a little about as you're establishing this 2019 guide? What you have layered into the assumptions around those same issues to give yourself a bit of a buffer around that 2019 guides so that you don't encounter or give us confidence that you're not going to encounter some of the similar headwinds?.

Sure, well. As we've been sharing for probably a year now we've been playing catch-up on community count. And there's a pretty quick turnover here where we're opening a lot of communities and closing out of a lot of communities.

And we're working hard to stay ahead and we keep --we picked up our absorption rate this year with intent and that we knew our community count was going down. And we had to build a bridge until the community count would come back.

As we entered the year, we thought the community count would come back in the second quarter then it was a third quarter and now it's settled into the fourth quarter.

But it's now settled and I guess I'd say that we've already taken that bullet in terms of fighting through the delays that we've experienced over the last year and getting communities open.

As we go forward, we're going to be positioned at the end of the year with a community count in a backlog that sets us off on the trajectory that gets you to the range that Jeff shared. So as we sit here today, we don't see any storm clouds that would get in the way of the guidance we just put out there.

It was more the frustration we've lived through over the last three or four months as communities miss a month or miss two months. When you think about it in our built-to-order model, once you open the community then you got to sell the home and then you got to build the home before you can close the home.

Every month you miss in the opening, you're not building houses out there because your wait until you get your models done. And then you let the buyer pick their home and they build it. So when we lose a month or two it can push deliveries out of a full quarter. And it's been painful but we think we're over that bump now..

Okay, thank you. And the second question and you provided a lot of helpful color and just breaking down some of the regional trends and some of the mix impact going on. I'm curious to dig into California specifically just with some mix in product and potentially sub markets.

It sounds like that band of very high priced homes is now kind of at a potentially more normalized level. And so I'm wondering if we look at the order average selling price of, call it, $580 and it goes $587 this quarter.

So $580 to $590, it is that now a band that we should be thinking about like you look at your community mix going forward into 2019 and that's a reasonable price range or how should we think about kind of directionally where they are you --.

Are you referring Mike to California or the whole company?.

California, West Coast specifically just how to think about kind of where you're positioned for? And also with respect to the expectations 2019 how to think about?.

Yes. And there's a few --we hate to use this, but we'll do it, there's two different mix dynamics that are influenced in our California ASP. One is in our coastal areas strategically we're moving to lower price points where we can. We've enjoyed great success up at a $1.5 million, $1.8 million, $2 million. And those communities of all sold through now.

We're reloading with more town homes, duplexes, more density but not into the condos necessarily, but more density and lower price points. So the coastal areas that may have been up in the low millions or probably in the seven or eight. And that's where I would think of the coast.

And then we also have a geographic mix shift in that the inland areas are now performing very well. And a larger percentage of our business is coming from the inland area as opposed to the coastal zone, which was predominant five years ago even where a lot of our mix was just along the coast.

So if it wouldn't surprise me if between the two next years, our ASP and California is down versus this year. But it'll be a better business, our profitability will be better and I think it's a better position if we were to get some kind of a slowdown; you're insulated a little better.

So we like that move and I think you'll see our ASP take down some. That would be included in the assumptions Jeff gave you on the guidance..

Our next question comes from the line of John Lovallo with Bank of America. Please proceed with your question..

Hey, guys. Thank you for taking my questions. First one is I'm just looking at the tape right here and the headlines are reading that KB Home sees a housing slowdown at higher price points.

I don't think that's what you said but Jeff that might --can you maybe talk about if there is any moderation at higher price points? Where you're seeing it? Maybe can you help us what are the price points that could be happening?.

I'll give you an example in many of the Texas cities sales are a little slower when you get above $400,000, $400,000 to $500,000. And it's not a price point that that we play at. I think if you get within those states or that state in this example that the sales are still okay. They're just not as strong as they were.

But that's not a price point we play in so..

Got you. So it is kind of more of a moderation you would say..

Yes. That price points well above the medians in the market..

Got you. And then one of the things that we've heard and I just wanted to see if there's --if you guys would agree or not, but given some of the labor shortages in the markets, we've heard that some builders have been kind of toggling between starts and kind of completions. And that's why we've seen some variations in those numbers.

I mean is there any truth to that or you guys seeing that in the market?.

That's the first I've heard of that. In our case, we pace our starts to our sales and we work with our contractors to have adequate labor based on our sales rate in that community. And if we're selling five a month, we're starting five a month and they manage to that. So I've not heard of people that are trying to meter our deliveries tie to start..

Our next question comes to the line Jack Micenko with SIG. Please proceed with your question..

Hey, good afternoon, guys. This is actually Sam on for Jack this afternoon. Jeff, I guess I just want to start with you and get your thoughts on maybe reconciling the trends we're seeing in the existing market versus a new home market today because it really appears to be a tale of two worlds, and a cause for confusion I think for investors.

So what do you guys think is driving the differential I guess between your results especially in California and what maybe we're seeing on the existing side with price cuts in higher inventory levels?.

Again I think if you get into a specific city and look at where the price cuts are occurring; it's at the higher price resells as well. The more affordable product there isn't any inventory out there. So I don't think if you look in a city however is defined as affordable I don't think you'll see a lot of inventory.

But a lot of the coverage on the retail side is supply constraint at the affordable levels which is perfect for us..

Right, okay. And then I guess second question was on the gross margins in the new communities. I think last quarter you said these communities were coming on at roughly 18.5%.

So could you maybe give us an updated figure for this quarter and talk specifically to some of the operational things you're doing at these newer communities to drive the gross margin higher into next year?.

All right. I'm not sure we actually came out and said 18.5% last quarter for new communities, but certainly it is lifting the margins and we've seen that for the first three quarters of this year is that the new community's coming on has provided a bit of the margin lift that we're seeing in our overall results.

What we're doing I think is we're basically just blocking and tackling. I mean we're -- the underwriting has been very good to do land acquisitions and as communities are coming out and open we're at or above underwriting guidelines and in many cases in most cases which is obviously adding incrementally to be to the business.

I think we've tightened up on just basic things like what it costs to develop land and having a really good fix on our cost to build and pricing in the various sub markets where we're opening.

The product positioning I think has been strong from the point of view of going after predominantly first-time buyers in some cases first move up buyers, but hitting those median income points in the market in the various sub markets is helping a lot.

So just seeing a lot of success and what the -- how did divisions have been operating on new community openings and it gives us really a lot of confidence both in our future land investments, our land investments today for future community openings as well as into next year. And our plan to continue improvements in the business..

Our next question comes to the line of Matt Bully with Barclays. Pleased proceed with your question. .

Good afternoon. This is actually Marshall Metz on for Matt. Thanks for taking the questions and congrats on the quarter. Just a follow-up on gross margin just looking at where you've got it for the fourth quarter and recognizing you had a pretty strong result last year. I think you're looking for something in the range of flat year-over-year.

So we move forward what -- could you maybe speak to some of the moving pieces in there? Just given that some of the capitalized interest is rolling off and maybe would have expected that to be a little bit higher than expectation for the fourth quarter..

Yes. I mean there's a lot of moving pieces as you mentioned. The mix of reactivating communities versus core communities is one. The actual communities that we are operating this year versus last year.

We had a very strong as you pointed out fourth quarter with the quite a number of positive moves in the fourth quarter on the margin side, and very few negative impacts that you normally see. So we think it's a good result. We think the guidance for the fourth quarter would obviously provide us a very nice year-over-year impact.

I think it totals 110 basis points of improvement for the full year, which we are quite happy with. Outside of that I mean it's hard to get into any much more detail without really dissecting in the community level, but the community makes it significantly different. It's probably 40% new communities that will be delivering out of versus last year.

And that's what we're seeing based on today's backlog levels and some of the mix shift away from California. As we talked about a few times during the call, as a community count in California came down this year, we're seeing a little bit lower mix out of the West Coast business.

The best news coming out of that is that we hit the inflection point in a third quarter and expect to see that continue to build as we get into next year. But it will take it a while for those communities come online and for these deliveries to come out of it.

So that's probably the single largest difference between this year and last year's, just a mix on the West Coast, but overall I think a pretty solid result for the fourth quarter and enabled us to lift our guidance for the full year between the third quarter performance and our fourth quarter expectations..

Definitely so and thanks for the clarity on that.

And then maybe moving to next year and your guide for increasing community count 10%, obviously Jacksonville and Seattle are going to factor into that, but you maybe touch on some other sub markets that we should expect additional communities where you're investing and maybe just kind of spell out a little more about the pipeline for next year?.

Sure. Yes, we are getting a little bit more detail. I mean we have their call coming up in November where we're getting a lot more detail on guidance both for the first quarter as well as for the full year in 2019. And not just more detail on the community count but kind of in response to a question from earlier as well on gross margin.

We'll get into some of that as well. So, first of all, just to clarify, and account for next year we're expecting the average count to be up between 10% and 15%. So 10% is kind of the bottom end of the range.

We talked pretty extensively about the California count being up similar --in a similar fashion for next year, and having quarter-over-quarter improvement. We do see improvement throughout the business. Seattle will probably be --to be honest a fairly small piece of it. I mean it's a start-up operation. And we're building community count.

We're building a team there. We're-- we have a land pipeline going right now, but we don't expect that to be significant on the company as a whole, but we are looking to push community count in all the regions across the business next year..

Our next question comes from the line of Nishu Sood with Deutsche Bank. Please proceed with your question. .

Hi, there.

I may have missed it but did you update the guidance for ROE and also any sense of the scope for improvement, continued improvement in 2019?.

Right. We didn't have it in the scripted remarks but I could say I think we said last quarter14%. We're probably that same range 14% to 15% for the full year. And that's obviously backing out the first quarter tax charge that we took due to the tax law change.

So still it's pretty strong and still actually towards the top end of the range that we had set for ourselves for 2019. And I think I'll save any other comments on 2019 until the November call..

Got it, okay. And in the opening a commentary, Jeff, you mentioned a lot of mix issues for gross margins you specifically called out regional mix benefiting margins this quarter.

Now I just wanted to clarify were you trying to draw out a trend which has been ongoing and therefore we should expect to continue or did you highlight that as something that was particularly this quarter that might reverse in the next quarter or two?.

Particular to this quarter, Nishu. We had the perfect storm where all the high margin deliveries hit and some of the lesser margins didn't, but then they'll hit in the fourth quarter and could tweak us down the couple of cents that Jeff had guide. .

Which is another factor in a question from earlier when we were talking about fourth quarter versus third quarter. That's part of it as well. So we shift a little bit..

But for the year it holds per month -- it seems to be higher..

At the high end of the range..

Our next question comes from line of Stephen Kim with Evercore ISI. Please proceed with your question. .

Hey, guys. This is actually Trey on for Steve. Yes, great quarter by you guys. I want to ask about the fourth-quarter SG&A guide. It is just that you be higher in terms of SG&A as a percent of revenues relative to last year. I'm wondering why are you expecting it to be higher given that most of this year has trended down year-over-year..

Right. I think for the full year this year will be actually fairly close to last year's full-year number. We are back in growth mode for the business and we've seen declining community count now for actually a couple years.

So we're very pleased with the reversal of that trend and coming with that we are adding in and have added in a bit of incremental expense to support the new openings, and support a higher level of business as we move forward. So it's really as simple as that. I mean we had a full year quarter in the fourth quarter last year.

I think it was a company record fourth quarter low for SG&A while we like to set every quarter a company low SG&A record, it's tough to guide to that. And particularly knowing what we have ahead of us in growth of the business. So it's really as simple as that. I think the operating margin improvement speaks for itself.

And that's what will continue to drive and we'll try to get a piece of it out of both sides of that equation on the gross margin as well as the SG&A side, one can get it but in the fourth quarter we're positioning for next year and for further growth as we get into 2019..

Got it, thanks for that. And then touching on your additional expansion in Jacksonville and your entrance into Seattle.

Could you talk about what drove you to take such notable incremental investments to increase your exposures to those areas?.

Well, the Seattle investments minimal right now. We've closed on one parcel and the Seattle markets pretty fragmented. You're not out there buying two, three hundred lots. They're smaller plays and you do a lot of --the dollars involved aren't that great.

If you look at Jacksonville, it's a great story, in that --they're --their product was aligned with ours. We like our floor plans better but the footages and the price points were similar, and the geographic complement of where they were open versus where we were open was also very good.

So we picked up a lot of communities that are a natural complement to us, and we move very quickly to plug and play in a business where it's our best operating team in Florida, very seasoned, and we have a great business in Jacks. So let's go build a scale and as I shared in the prepared remarks, right now we're fourth in Jacksonville.

We don't want to be fourth. We'd rather be for a second third and this will help us to get there. So it's really a pretty quick hit deal at a very reasonable price..

Our final question comes from the line of Jay McCanless with Wedbush Securities. Please proceed with your question. .

Hey, thanks for fitting me in. First question I had with the Hurricanes back east.

Does your guidance assume some impact from Florence? And, if not, what might we expect?.

Jay, good question, and these natural catastrophes are all always a bad thing. In our case, we are pretty fortunate in that rained in Raleigh and close our communities for a couple days, a little bit of flooding but really not bad all things considered.

There's always an unknown when these things disrupt the region relative to building products, utility companies and what not. And we don't see a significant impact to the company in that our Raleigh business is quite small. In terms of the southeast, it's our smallest business.

It may get disrupted a little bit but not enough to really move the needle on our guidance and where we think we're heading..

Okay, that's good to hear. Thanks for the detail.

Then just the other question I had in terms of, could you maybe talk about with the California Coastal markets where you're going down to the lower price points, is there any kind of maybe a price point where you need to get under with these changes to the sales tax deductions that seems to be more palatable to buyers? Is that kind of the strategy or are you just trying to find, lay in the stencils to get your overall ASP down?.

You just hit on it with your last comment. At these price points, the lack of a write-off, a tax write-off on a real estate tax is a real driver. You have to get back up to higher price points for that to impact their taxes. This is all about getting product as more affordable introduced into the market where the need of the market stands.

We're not afraid to go in open communities at higher price points, but we think today it's a better play right now and we're diligently going for higher density, detached or townhomes or small condos, keep pricing down..

Ladies and gentlemen, this concludes today's teleconference. Thank you for your participation. You may now disconnect your lines..