Good afternoon. My name is Devon, and I will be your conference operator today. I would like to welcome everyone to KB Home 2019 Third Quarter Earnings Conference Call. [Operator Instructions] Today's conference call is being recorded and it will be available for replay at the Company's website kbhome.com through October 25.
Now, I'd 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 2019.
With me are Jeff Mezger, Chairman, President and Chief Executive Officer; Jeff Kaminski, Executive Vice President and Chief Financial 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 to Jeff Mezger..
Thank you, Jill, and good afternoon to everyone. We are pleased with our results for the third quarter, which reflect the underlying strength of our business, and consistent execution of our Returns-Focused Growth Plan.
Our performance this quarter is important not only for how we are positioned to close our fiscal 2019, but also in the foundation it provides for continued success into 2020 which we believe is shaping up to be quite solid.
As we approach the three-year mark of our plan with meaningful results generated during this period, our focus remains the same, to profitably grow our business through consistent implementation of our core business strategy, while strengthening our balance sheet by driving greater productivity and efficiency of our assets.
As a result of our solid execution on this plan, we expect to increase our diluted earnings per share in 2019 by the more than 150% relative to 2016. Our higher profitability contributes to significantly improved returns with our return on equity expected to accelerate from 6.3% in 2016 to over 12% in 2019.
Over the past year, our business has generated significant operating cash flow including the incremental cash for monetizing our deferred tax asset, which has enabled us to grow our inventory by $230 million while reducing our debt by over $200 million. These accomplishments contributed two important outcomes.
First, in addition to our planned double-digit growth in community count this year, we are positioned for additional expansion of our community count in 2020 with an enhanced portfolio that reflects the continued shift to higher margin core communities. This outcome supports our anticipated revenue and margin growth next year.
Second, we reduced our debt to capital ratio by 550 basis points over the past year. We essentially achieved the high end of our tightened target range at the end of the quarter. And expect this metric to improve further by year-end.
Carrying less debt while building a larger asset base continues to lower our interest incurred per unit which contributed to a higher gross margin in the third quarter. We believe, this will be an ongoing tailwind in both the fourth quarter and in 2020.
Getting into the details of the quarter, we generated total revenues of $1.2 billion and diluted earnings per share of $0.73. We expanded our gross margin excluding inventory related charges to 18.9%.
We anticipate another step-up in the fourth quarter with a gross margin north of 19% supported by the composition of our $2.3 billion backlog at the end of the third quarter. We opened 26 new communities during the quarter, boosting our average community count 18% from a year ago.
Each of our four regions generated an increase in average community count with the West Coast and Southwest leading the way with greater than 30% year-over-year growth. We remain on track for double-digit expansion in our average community count this year, and as I mentioned earlier, we expect to lift our average further in 2020.
Market conditions remain favorable supported by low mortgage interest rates, steady economic growth, high consumer confidence, and positive demographic trends. While demand is healthy, supply continues to be insufficient to meet homebuyers' needs particularly at the affordable price points where we operate, which is a key element of our success.
We remain an industry leader in absorption pace as our monthly net orders in the third quarter advanced to 4.3 per community. The combination of a strong pace and substantially higher community count fueled 24% growth in our net orders.
As with our 2019 second quarter, each of our four regions produced a double-digit net order comparison to the prior year. This was our highest third quarter pace in many years, which is significant considering that we also increased prices in about 90% of our communities.
Net order value grew 25% in the third quarter to $1.3 billion, helping us to drive the 13% expansion of our backlog value to $2.3 billion. In terms of units, our backlog grew to more than 6,200 homes, our highest third quarter backlog in a number of years.
We believe, our core business strategy is a key differentiator driving the strength of our net orders by investing in land positioned in prime growth sub-markets and positioning our product to target the median household income in each sub-market we primarily cater to the first time buyer.
This core competency is reflected in our third quarter deliveries of which 55% were to first time buyers. Over the past year, this buyer segment has purchased homes in nearly 100% of our communities.
Operationally with our build-to-order model, we enhanced the value we deliver to homebuyers by offering a choice of lots and a range of square footages in each of our communities, and the ability to them personalized and upgrade features in our design studios.
While we position our product for the first time buyer, our business model also appeals to move up buyers and empty nesters, who can make a different set of choices in the same community. As a result, we see a variety of buyers within each of our communities. And therefore, we have a clear ability to attract the largest demand segments of the market.
We believe the opportunity to further increase our scale and gain market share will come from continuing to expand our community count while maintaining our high absorption pace.
In addition, we will continue to invest in locations and products targeting the median household income while sustaining our leadership in the first time buyer category and attracting a mix of buyers to our communities.
We currently have a top five position in about 70% of our served markets and remain committed to advancing our market share recognizing the benefits of local scale.
A good illustration of scale benefit is our ability to reduce our build times even in a tight labor market, and we have done so both sequentially and year-over-year for the last two quarters. Moving on, I will now highlight a couple of our regions beginning with the West Coast.
This region delivered 32% growth in net orders with every division in California producing a positive net order comparison. We continue to rebuild our community count in the West with its average up 34% while essentially maintaining a high-absorption rate of 4.5 net orders per community per month.
While market conditions were generally healthy across California, we generated an outsized order comparison in Northern California, particularly in our Bay Area communities, where net orders and community count more than doubled.
With these results in the region, we expect the Bay Area mix shift to drive a year-over-year step up in both our fourth quarter and 2020 West Coast average selling price. Our Southwest region delivered the highest net order increase of our four regions with a 40% rise in net orders.
Our business in Las Vegas continues to lead the expansion of this region with strong market fundamentals supported by population and job growth.
There are a number of large projects underway in Las Vegas that will fuel job creation for years including the Raiders football stadium and headquarters, a new convention center, and hotel and casino development.
In addition, our product positioning and price point have proven compelling for the growing demand enabling this division to sustain one of the highest community absorption rates in the Company at above six per month.
With the third quarter average base price up $313,000, we are well positioned below the new home median sales price of above $400,000 and at a slight premium to the resale median sales price of roughly $300,000.
Demand in Phoenix is also strong with net order growth exceeding 60% in the third quarter driven by increases in both community count and absorption pace.
The economy in Phoenix is robust, and this market is experiencing significant immigration as a result of more jobs and higher wages together with its lower cost of living relative to other major metro areas.
Similar to Las Vegas, our positioning at affordable price points in Phoenix is helping to fuel demand with the third quarter average base price of $254,000 below both the median new home price of $330,000 and the median resale price of $270,000. Before I wrap up, I'll spend a moment on KBHS, our mortgage banking joint venture with Stearns Lending.
The JV is continuing to elevate its execution providing high levels of customer service to our home buyers and supporting our divisions with greater predictability and deliveries. In the third quarter, the capture rate advanced to 72% of deliveries from 55% in the year ago quarter.
As a result of the capture rate steadily climbing and our expectation for ongoing solid execution, we anticipate healthy year-over-year growth in profits from our JV in both the fourth quarter and next year.
In closing, we are poised for a strong finish to 2019, as we look to produce meaningful year-over-year increases in our key financial metrics including revenues and gross margin in the fourth quarter.
In addition, with our community openings from earlier this year, starting to produce revenue in the fourth quarter, we expect to leverage our SG&A expense which we believe will result in year-over-year growth in our fourth quarter operating margin as well.
Although, we are nearing the three-year mark of our Returns-Focused Growth Plan, the principles of the plan will continue past 2019 with an ongoing focus on profitable growth and driving higher returns.
Looking ahead, with healthy market conditions and our backlog value of $2.3 billion together with community count growth and an industry-leading absorption pace, we are positioned to deliver greater than $5 billion in revenues next year. In addition, we foresee generating higher profitability on this larger revenue base.
We look forward to updating you on our progress as we move ahead. With that, I'll now turn the call over to Jeff for the financial review.
Jeff?.
Thank you, Jeff, and good afternoon, everyone. I will now review highlights of our financial results for the third quarter, provide details on our outlook for the fourth quarter, and discuss our 2020 housing revenue and community count expectations.
We are very pleased with our third quarter performance, particularly the measurable expansion of our gross profit margin, and the solid absorption pace and significant community count growth that produced a 24% year-over-year increase in net orders.
We believe, we are well positioned for a strong fourth quarter and expect to generate meaningful improvements in virtually all of our key financial metrics.
In the third quarter, our housing revenues were $1.15 billion compared to $1.22 billion in the prior year period, reflecting a 7% decrease in our overall average selling price and a slight increase in the number of homes delivered.
The housing revenue decrease was primarily attributable to a decline in our West Coast region average selling price that stemmed from both mix shift toward deliveries in lower price inland markets and the absence of certain communities with relatively high average selling prices that closed out in prior quarters.
We ended the third quarter with over 6,200 homes in backlog, an increase of 14% versus the prior year. Our ending backlog value of $2.3 billion was up 13% as compared to the year earlier level of $2 billion, reflecting increases in each of our four regions ranging from 7% in Central to 20% in the South West.
Based on our robust quarter and backlog value, expected continued strong absorption pace and improved construction cycle time, we currently anticipate fourth quarter housing revenues in a range of $1.56 billion to $1.64 billion, up from $1.34 billion in last year's fourth quarter.
In the third quarter, our overall average selling price of homes delivered decreased 7% year-over-year to approximately $381,000 mainly due to the impact from our West Coast region that I previously mentioned, along with a mix shift in our Central region with a lower proportion of deliveries from our Colorado operations which typically have a relatively higher average selling price.
We believe an expected higher proportion of West Coast region deliveries, driven by our strong third quarter net order performance and the successful expansion of our California community count will result in higher average selling prices in the fourth quarter, both on a year-over-year and sequential basis.
For the 2019 fourth quarter, we are projecting an overall average selling price in a range of $400,000 to $410,000. Homebuilding operating income decreased from the year earlier quarter to $85.5 million or 7.4% of revenues, but improved sequentially from $52.1 million or 5.1% of revenues in the 2019 second quarter.
Excluding inventory related charges of $5.3 million in the third quarter and $8.4 million in the year-earlier quarter, operating income margin was 7.8% compared to 9.3%.
For the fourth quarter, on both a sequential and year-over-year basis, we expect to realize improvement in our homebuilding operating income margin, excluding the impact of any inventory related charges, we believe this metric will be in the range of 9.9% to 10.5% up from 9.7% a year ago.
Our housing gross profit margin for the third quarter was 18.5% compared to 18.0% for the prior year period. Excluding inventory related charges, gross margin for the quarter was 18.9% compared to 18.7% for the 2018 third quarter.
The current year result was favorably impacted by lower amortization of previously capitalized interest as well as the change in the classification of certain model complex costs due to our adoption of the new revenue accounting standard ASC 606.
These favorable impacts were partly offset by pricing pressure we experienced on first quarter orders due to the weaker market conditions at that time.
The effect of certain high ASP and high margin West Coast communities having closed out on previous quarters, and reduced operating leverage due to lower housing revenues and higher fixed community level expenses supporting community count growth.
Assuming no inventory related charges, we expect our fourth quarter housing gross profit margin to increase on a sequential and year-over-year basis to a range of 18.9% to 19.5%.
Our selling, general and administrative expense ratio of 11.1% for the quarter increased from the 2018 third quarter record low ratio of 9.4% mainly as a result of the ASC 606 impact mentioned earlier, reduced operating leverage due to lower housing revenues and increased marketing expenses to support new community openings.
As we continue to prioritize containment of overhead costs, and expect to realize favorable leverage impacts from higher housing revenues in the period, we are forecasting our fourth quarter SG&A expense ratio to be in the range of 8.8% to 9.2%.
Income tax expense for the quarter was $23.8 million representing an effective tax rate of approximately 26% as compared to $27.2 million and approximately 24% for the year-earlier period. We are projecting an effective tax rate for the fourth quarter of approximately 28%.
Turning now to community count, we ended the quarter with 254 open selling communities including 27 communities or 11% that were previously classified as land held for future development. Our third quarter average of 255 was up 18% from 217 in the same quarter of 2018.
On a year-over-year basis, we anticipate our fourth quarter average community count will increase about 10% as compared to the 2018 fourth quarter, resulting in an increase of approximately 12% in our overall average community count for the 2019 full year.
As of the end of the third quarter, our land held for future development was less than 4% of total inventories. With our continued success in monetizing these inactive assets and our investments in new core communities, we have realized an improved mix of our community portfolio with a lower percentage of reactivated communities.
We expect further improvements in our portfolio mix in the future as we believe the number of reactivated communities will continue to decline. We invested $442 million in land, land development and fees during the third quarter with $174 million of the total representing new land acquisitions.
Over the past 12 months, in addition to the capital allocated to pay down debt, and to pay dividends to stockholders, we deployed nearly $1.7 billion into land related investments, and opened 123 new communities.
With respect to next year, we expect the land investments we have made over the past 12 months to drive additional community openings throughout 2020 and produce year-over-year growth in average community count in the mid-single digit range as compared to 2019.
Combined with our strong order pace per community and anticipated year-end backlog, we believe we will generate full year housing revenues in 2020 in the range of $4.9 billion to $5.3 billion.
We ended the third quarter with total liquidity of approximately $611 million including $184 million of cash, and $427 million available under our unsecured revolving credit facility. Over the past 12 months, we have made significant progress in reducing our leverage ratio.
At quarter end, our debt to capital ratio of 45.1% improved by 550 basis points as compared to the third quarter of last year. We still expect to be within our tightened target range of 35% to 45% by year-end. As our credit metrics have continued to steadily improve, we recently received our fourth credit rating upgrade in the past 2.5 years.
In July, Moody's Investor Service upgraded our corporate credit rating to Ba3 from B1. Our capital allocation priorities remain consistent.
We continue to focus on investing in land assets to grow the business and improve returns, deleveraging the balance sheet through retained earnings growth and potential additional debt reduction, and returning capital to stockholders in the form of our quarterly dividend.
Consistent with these priorities, in July, we announced an increase in our quarterly cash dividend and our common stock to $0.09 per share.
In summary, in the third quarter, we measurably increased our community count and improved our already strong average sales pace per community driving a 24% year-over-year increase in net orders, generated year-over-year improvement in our gross margin, and produced a sequential expansion of our operating margin.
We believe that our higher community count, solid quarter-end backlog value, and continued focus on consistent execution of our Returns-Focused Growth Plan, position us to achieve significant growth in housing revenues along with improvement in both our gross profit margin and operating income margin during the fourth quarter, and continuing into 2020.
We will now take your questions. Devon, please open the lines..
[Operator Instructions] Our first question comes from the line of Truman Patterson of Wells Fargo. Proceed with your question..
Good afternoon guys, nice results. First question, I just wanted to get a little bit of an update on the pricing. I believe, you guys said you were able to push pricing in about 90% of your communities.
Clearly strong results, is there any way you could maybe parse out the strength of the price hikes by product segments, entry level move up and possibly the magnitude of some of those price hikes you're seeing?.
Truman, it's a per community stories.
I don't know that we have any of the data that we can share on the magnitude or certainly, the product mix in my prepared comments, I spoke to the fact that we're appealing to the barbells if you will of demand and that we're seeing a lot of empty nesters along with obviously a lot of first-time buyers and then the move up in between.
As we guided, we expect a higher margin in the fourth quarter based on our backlog and add some [indiscernible] to the some of the pricing that we've been able to take, but I can tell you that the markets are pretty good right now, and very rational.
So, we continue to balance price and pace, and we'll take price where we can as long as we're achieving our target absorption in that community..
Jumping to California, really nice order growth even better than what we were expecting. Could you just walk through the various regions inland versus coastal, and possibly consumer price point.
And one other item I'd like to touch on in Northern California, I believe you said communities were up 2 times, so were orders, I guess given that growth, could you maybe talk about your ability to keep the pipeline flowing out into 2020 and where we're not going to see a potential hangover, if you will..
Well the two times on the community count was specific to the Bay Area, Truman as I recall it, in the comments, we said that community count was up 34% in the state.
And it's -- the community count growth is kind of chunky I'll say in the Bay Area, because it's so hard to get things in title and then hard to bring them to market, and then when you finally bring them to market. They do very well.
And part of what we've been bridging through this year was we sold through the existing communities and the new ones took longer to get online and that's all starting to come into place now here in the -- actually started in the second quarter, but even better in the third quarter.
So with that comes a solid backlog position and we're set up heading into 2020. We already control all the lots we need for deliveries in 2020. So we -- our hope is to sustain as we keep going from here. We think, we bridged the gap through the trough that we had to deal with..
Our next question comes from the line of Alan Ratner with Zelman & Associates. Please proceed with your question..
Congrats on another really strong quarter.
I was encouraged to hear you talk about your cycle times continuing to trend lower and just kind of occurred to me as I look at your order numbers and some strength from some of your peers that have announced recently, it kind of feels like maybe some of the order strength in the first half of the year across the industry, not necessarily for you guys, but might have been weighted more towards some standing inventory that was built during the softer demand period last year.
So I'm curious with while it's certainly encouraging to see the cycle times trending lower.
Have you had any conversations or gotten any inkling from your trades that as backlogs are starting to build up across the industry, now that we might start to revisit any of the labor tightness that was obviously a big issue across the industry several years ago, as the cycle was accelerating?.
I do think Alan that comes with a stronger demand. We're predominantly build-to-order 75%, 80% build-to-order. So we have the backlog and we're building that backlog out over the next five months or six months. So in the spring, a lot of our competitors had an inventory overhang, we really didn't have that.
We will monitor our pace and do what we have to -- to keep the pipeline going and we built through that backlog of our sales in Q1 actually delivered out in Q3, and so on, as you go forward.
I do think that the industry has cleaned out a lot of the inventory overhang that we had from last fall and into the first quarter, and it wouldn't surprise me if there is a little more pressure now on labor that starts to tick up, but our offset to that in our strategy is to continue to lever our scale and we've been able to shrink build times in part because we've got bigger businesses evolving that are more attractive to the contractor base, where they like working for us.
So we'll continue to push the scale and hopefully remain a builder of choice for the contractor base..
Second question, just -- thank you for the preliminary color on 2020. Yeah, I think you kind of flagged coming into this year that you were expecting a lot of community growth in California, and obviously that's come to fruition.
As you look at the plans over the next 12 months, can you just give us a little bit of insight into kind of where you're maybe more heavily investing today for growth or are there any markets or price points that you're over weighting your investments in based on kind of the strength to market or what you perceive an opportunity to be?.
Alan, as we talked about before, I mean, we really push growth across the business. I mean the grow targets and the scale targets are relevant for all of our divisions, and we review deals across the business. We owned -- budget certain divisions at lower dollar investment numbers than others, and just judge every deal on its own as we move forward.
I think, though the most significant factor relating to our community count next year would just be the shift between our core communities and our reactivated communities. We've been seeing, the percentage of our reactivated communities coming down fairly steadily, this past quarter is down to 11%.
We believe for all of next year, we'll be in the single digits and we'll be trending probably close to that 5% level by the end of next year. And it's just going to strengthen our portfolio, our community portfolio tremendously to see that shift happening and to see some of the new investments we're making coming to market.
So, that's probably one of the most important things. I mean, when you look at our community count, you split it on that basis.
Our core communities will be up fairly strongly in the double digits and the reactivated communities will be down in the double-digits and because of the size of the weighting of each it will -- it will arrive at about a mid-single digit increase for the year, with much better book of business as we come out of 2020..
Our next question comes from the line of Mike Dahl with RBC Capital Markets. Proceed with your question..
Sticking with the 2020 commentary and, yes, thank you for the preliminary guide. I just wanted to talk about margins, I think you mentioned margin growth in '20.
It seems like at that revenue growth, certainly should be some SG&A leverage, but you've also got the tailwinds from the gross margin side from the reactivated community rolling off and also the lower interest expense.
Is there any color you can give on just, a, do you expect both gross margins up and SG&A down, and any order of magnitude that you are willing to talk about at this point?.
Right. As we went through preparing for the call. I mean, we're basically elected, we normally don't provide a lot of detailed guidance on the third quarter call, but I could give you a little bit directionally of where we think things are heading. And I think your assessment is correct.
We do expect to see incremental improvement in our -- in both gross margin and SG&A for next year, and certainly a stronger operating margin. We'll gain leverage on fixed costs contained in both the gross margin as well as in our SG&A next year with the higher revenues as we guided.
As you pointed out, we will have continued tailwinds from both lower interest, amortization and from a lower percentage or lower mix of reactivated communities coming into it. And what we're seeing right now is fairly strong performance from our recent community openings, as well as from the communities that have been open throughout the year.
And we're seeing strength in our backlog gross margins. So we're fairly confident at this point, assuming stable market conditions that we should see further gross margin gains out into 2020.
At this point, it's a little early for us to put an exact range on it or to exactly quantify it for everyone, but directionally, things are improving on both fronts, both gross margin and SG&A and obviously resulting in stronger operating margin for next year..
The second question, you guys talked about the strength in KBHS which I think is interesting, just given some of the noise around the parent company bankruptcy proceedings.
It seems like -- like you've got, cancellation rates are down across your business, mortgage capture rates up not apparent that there has been an -- any impact at all on that joint venture. But can you give us a little more detail on what you're seeing, if you're hearing anything from the field.
And if you're having to evaluate any other changes to that structure or partnership, just given the parent company proceedings..
Mike, it has been an interesting chain of events with timing in that -- the parent company firms did announce a bankruptcy action after our last earnings call, and the owners and the creditors have already concluded a resolution coming into this call and on our JV, it's wholly owned between us and the employees or -- employees of the JV, it was really a non-event in the operation.
If you look at our deliveries in the quarter, I think part of the upside in units was because of the performance of the mortgage company. And they're just now hitting their stride. That's why in my prepared comments I called it out.
Well the capture rate is 72 in the third quarter, we think it's still going to go up here in the fourth quarter and then in 2020. So they are very solid business partner for us, and managing our backlog and we see a bigger income stream coming out of it..
Our next question comes from the line of Matthew Bouley with Barclays. Proceed with your question..
I wanted to ask a couple of questions about sales pace. Just given the strength we saw in the quarter. Obviously, last year, it was a tougher market, you guys saw pace kind of below three per month, but the prior two years that number was up over three.
So just based on the communities, you've got operating right now and what we're seeing in this market here. Just how do you think about what a normal seasonal pace should look like in the fourth quarter? Thank you..
Matthew, if you just look historically for us over the years, there is typically an 8% to 10% fall-off in pace in Q4. As -- if you look at our comps and there was a reason we faked the way we did in our comments.
Last year, our third quarter was very good, we were at four a month last year, and then we saw the slowdown right after our earnings call, last year, where it tapered off and it was a combination of the market getting a little tougher and we had a transition in community count that really hit our pace last year in the fourth quarter.
So we're set up to have a very good order comp this quarter, in part because of the community performance and in part because it was sought last year, but we expect that our Q4 pace will go down from Q3. If they were to hold at the Q3 levels, we'd be pushing price more..
Yes, understood. Perfect. And then just thinking beyond the fourth quarter, we kind of get past the -- these easier comps. I think, you made the comment Jeff that you kind of expect to maintain pace while increasing community count to boost your market share. The community count that you guided to mid-single digit growth.
So is that a good way to think about modeling 2020 at this point that we kind of get past these easy comps, but you're effectively planning to manage sales pace at a relatively normal seasonal rate going forward and that most of the order growth would therefore come from community growth, is that how we should be thinking about 2020?.
That's absolutely correct, Matthew.
On a normal comparable, if we had a tougher patch last year, we'll have a stronger comp, but we're going to manage the pace we targeted on an annualized basis about four, a little lower in Q4, a little lower in Q1, little higher in two and three, but on average, it will be four, and if we're running stronger then we will get price..
Our next question comes from the line of Stephen Kim with Evercore ISI. Proceed with your question..
Good quarter. What's not to like really. I did want to dig a little bit more into the SG&A.
Specifically, I know that you guys have been seeing a little bit of burden although you'd performed well in that metric, but you have been burdened by your aggressive community count ramp and I was curious if you could quantify, what you think that headwind was in the quarter on your SG&A rate from just having an unusually large number of newer communities?.
Yeah, it's maybe a little bit difficult to quantify in basis points or whatever. I think probably the best way of looking at it is just looking at where it's going to turn and how it's going to turn in the fourth quarter. So we're finally going to see some revenue coming in from the community count build in the fourth quarter.
We will have a higher -- we're forecasting a higher revenue -- housing revenues in Q4 '19 relative to the prior year. And as a result, we believe our SG&A percentage in our ratio will come in nicely at the midpoint, rather on that 9% range. Which is some pretty nice improvement compared to where we’ve been.
And so that puts us back on, again at the midpoint, about even footing with last year after overcoming about 70 -- or yeah, about 70 basis points. So it's got 50 basis points to 70 basis points in the fourth quarter of ASC 606 impact.
So it's starting to come around, and I think, the investment we made throughout 2019, the early part of 2019 is starting to pay back in the fourth and we will see it more strongly as we get into next year, because you're right, there was a lot of expense that went into building that community count, the way we did this year and we'll start to reap rewards starting right now in the fourth quarter..
Yes. No. That's really encouraging. My second question --- for my second question, I wanted to follow up on your comment about reducing cycle times, even in a tight labor market. I wanted to take it in a slightly different direction then, Alan's question.
I know, you've been one of the industry leaders in homebuilding technologies and that you've been actively studying what I call e-builder initiatives like panelization and ready frame and things like that.
Can you talk about what you think the opportunity is in the next couple of years from utilizing offsite manufacturing to a greater degree, maybe not a whole board -- whole hog or anything like that, but just utilizing that more than you do, now.
What are the most promising areas, what's probably just hype?.
Stephen, we've been a big user of wall panels for 25 years now, and continue to do so, and that is a way to pick up several days in your framing part of the cycle, and you're right, we are always pushing the envelope and trying to find new ways to do things better and faster and hopefully less expensive.
And a lot of what you're seeing with the pre-built and the modular and those things, it's not that it's hype, but it's -- because it's real. But it's not -- it hasn't crossed over where it makes financial sense, yet, Stephen. The cost far outweighs the time savings and we're trying to figure all this out.
We -- as you know, we did the project home in Las Vegas early this year, where we shipped in cubicles of pre-built sections of a home and then put it together on site and the whole thing came together in a couple of days, the structure. But it was not nowhere near as affordable as building it on site. It's really challenge for the industry.
We can't count on being able to raise price and land isn't getting any cheaper. So we have to find other ways to manufacture home to keep expanding margins for all the companies in the space. So far it has been difficult to really advance that area..
Our next question comes from the line of Megan McGrath with Buckingham Research Group. Proceed with your question..
Just wanted to clarify a little bit on California, given your commentary around the impact it's expected to have on fourth quarter ASPs and margin, is there an incremental sort of boost that you're getting in the short term from those California communities that we shouldn't expect as we make our way through, let's say the next three quarters or four quarters or given the pace of community openings there, is that something that we should kind of expect to continue at least for the next maybe through 2020?.
Right. I think the story with the community count in California, it did trough in 2018, and we've been rebuilding it really since mid-2018 and we've seen nice improvements, nice increases actually in community count, pretty much every quarter since that time.
Again, we won't get in a lot of regional detail for next year, but if you think about the number of communities that were opened this year, and most of those have generally, at least a two-year life, you'll see most of the openings continue to perform as part of our base community count in 2020 and I don't think you'll see a big fall off again in community count through the end of next year.
In fact, we hope to build on it a bit more. So, yeah, if you're looking at kind of the ups and downs, we've had in California and everything else and wondering, where that's heading. I think, it will be little more stable and probably a little more on an upward trend, as opposed to what we saw in 2018.
But it's just more or less a continuation of trend, we've been seeing this year..
And then, Jeff, just a quick follow-up on your comments around the reactivated community count percentage going down next year.
Can you remind us what the current margin differential is for those communities?.
Yes the reactivated communities are performing plus or minus 10% pretty consistently on a gross margin basis. So it's a pretty large differential. It's been about a 100 basis point headwind for the consolidated gross margins.
So to the extent we can continue to move that down by selling through the inactive lots and activating them and then selling through them will help overall gross margins.
Again, I would like to reemphasize the point that when we are talking about that and talking about those low margins, about the tremendous returns we're seeing on those communities and the amount of cash it's generating for the business.
It's been one of the various components of the Returns-Focused Growth strategy that we've put in place and it's been an important piece of it, but we're getting closer and closer to the end of the road on this.
We finished the quarter about $150 million left in inactive status as far as land held for future development and we'll keep moving through it, that's been good for the business and continue to be. And it will be a tailwind, I think a little bit to margins next year whereas that percentage comes down..
Our next question comes from the line of Buck Horne with Raymond James. Proceed with your question..
I wonder if you could just talk about potential land optioning strategies and how you think about the availability of land options in today's market and the -- versus the cost and other aspects of what you can do with potential partnerships.
And just, what's your current mix of optioning, and what do you think your target mix would be for the next year or so?.
Buck, we haven't really set a target where we're going to achieve X owned and X option and at a high level, we would love to option every lot but it's difficult to do in the more land constrained desirable sub-markets.
If you look at our mix today, we're about 70, 30 owned versus option and that the option component of that is up from a couple of years ago, we are probably 80, 20 in the mix.
So our options are lift and up a little bit, but it's primarily in states or sub-markets, where they're more option friendly as opposed to places like California or Las Vegas today, it's very difficult to acquire lots on an option.
So what -- but we stay focused on our strategy, getting to good sub-markets and we know that we can achieve returns whether we pay cash and develop or whether we option, it's more about getting the community open in a preferred sub-market at a price point that's aligned with our strategy and the more we can option the better..
And I'm wondering if your thoughts have evolved at all on building for rent or the strategies around that. I know a lot of other builders are contemplating it or exploring options around it.
Have you guys explored it or thinking about growing the concept or what's your general thoughts on the build for rent platforms?.
What we think, to put it, Buck, and our view right now is, let's focus on what we know and do well and put our efforts to grow our market share in the markets that we're in. There is a lot of upside in for sale. So that's where we're going to spend our priorities right now..
Our next question comes from the line of John Lovallo with Bank of America Merrill Lynch. Proceed with your question..
This is actually Spencer Kaufman on for John. Congrats on the quarter and thanks for the question. I wanted to start with orders for your third quarter of 24%, that was obviously pretty strong and better than what we were looking for.
Can you walk us through the monthly cadence of that throughout the quarter, as well as any commentary you have thus far for September order growth. Thanks..
John, I would say that the market conditions and demand were strong throughout the quarter. So I don't know that any one quarter was or any one month in the quarter was drawing -- yeah it is pretty good, all the way through three weeks in the September.
So we don't want to really give too much color on that either, but you can tell from the contrary, out there market conditions are holding pretty well right now..
And then I guess, I'm not sure if I missed this or not, but do you guys mentioned anything about incentive levels in the quarter. I think you mentioned last quarter it was up roughly 30 basis points sequentially. I was just curious if you had an update for this quarter. Thanks..
Yes, I mean, we look at number one, we're not an incentive heavy company, as you guys know, I mean, our business model is basic pricing and everyday whole pricing, so to speak, without a lot of discounting. So it's not a big factor for us. And you need to consider, was that or the base prices as well as incentives.
And if you just purely look at the incentives, I think we were up again about another 20 basis points or 30 basis points, but that was more budgets offsetting part of the price increases that we put in place. So on a net-net basis, we've definitely improved our pricing position and overall average for the Company.
You can see in our guide for gross margins, if you kind of calibrated everything. Last quarter, you could come back with an implied fourth quarter margin guide and we're actually guiding up from that level and also have further improvement expectations ahead of us.
So things are going well on that side and we're seeing margins progressed as a result, and have some of the price actions and some of the new communities that we're opening and I think, it will spell good things for the fourth quarter..
Well I though, John, it was still less than 1%. It's still a total de minimis number, right..
Our next question comes from the line of Jack Micenko with SIG. Proceed with your question..
Wanted to - appreciating that you're not really incentive driven business model given the build to order. I'm curious what's your observations were in the quarter on the industry, you know, there's been a lot of incentives earlier in the year.
I think earlier in the call, Jeff, you said, some of that excess standing inventory kind of got absorbed but curious if there's any notable direction in competitor activity on incentives and through the summer?.
Our impression, as the summer evolve that incentives were lessening, some builders were taken price, others were reduced incentives and are having diversified. I think as the inventory cleared, it's a typical cycle, where there's not a lot of inventory pressures, so there's not a lot of incentive pressure either.
But I think, it was pretty rational as the years unfolded..
And then on the mortgage business, I think you get your captures with 72%, which is a big increase.
Where does that go? Where do you think or do you have any internal goals as to where you think you can move the capture rate up to over time?.
We think, it can get higher to 72%. We haven't put a stake in the ground that it will be this and that our customer has options, either to go with our joint venture to go use their own lender and hopefully, our service levels, win at the end of the day, but it wouldn't surprise me if we get it up to 80%. I think, that's realistic.
A little higher in the more FHA, VA markets, it's a little tougher in the heavily conventional market or in the jumbo markets..
Our next question comes from the line of Jay McCanless with Wedbush. Proceed with your question..
The first one I had when I look at the '20 revenue guidance at the midpoint of that versus, where you should come in for the midpoints of '19.
It looks like about 11.5% growth and I was just wondering, if you could talk about how much of that is going to come from volume versus price increases?.
Yes, I -- when you look at the ASP, I mean the ASP for next year, well I don't want to get into single point guidance on any of those comments. So let me back up from that. It will come, obviously from a combination.
But when you look at where our community counts going and where it's been, you look at our year-end backlog number and an assumption that we have stable market conditions throughout next year. I think, the revenue guide is a pretty reasonable number and I think, it's pretty much in a point of where we'd expect to get to.
It's nice to get back over that $5 billion mark. We're looking forward to the leverage benefits that will bring us on both the fixed cost side contained within gross margins as well as the fixed cost contained within SG&A, and that's our target, and that's what we see right now at this point. So I don't really want to get any more granular --.
But Jay, I can share, we have ground-up business plans, where we have a range of units by division in every city and their revenue forecast is high current pricing. We take the position that if prices go up, it covers costs. So your current revenue and margin are based on the reality of today..
That's good point..
And then I know, someone asked about move up earlier. But in our field checks, we've seen move up demand and move up pace in certain cities starting to improve.
I was wondering, if you guys can talk about what you're seeing, and is there a better ability now to push a little more price for the 45% of your sales that aren't to first-time buyers?.
We don't look at it that way, Jay. So it's a hard question to answer. We react based on our sales pace and what price and margin we have and how do we optimize that asset, and we have communities that you and I could stand in front of the sales office and say, this is the first time buyer community, and it will be 70% empty nester.
But it doesn't matter, we're attracting to the median incomes and position our product that way. So we don't look at a buyer segment given you the ability to push prices -- how strong is demand in that location. And how do you run rates and how do you optimize your returns..
Our final question comes from the line of Jade Rahmani with KBW. Proceed with your question..
Can you comment on the M&A environment, and if you're seeing any opportunities you might be interested in looking to execute on.
Is M&A a priority for you guys?.
So Jade, our top priority is growing our business organically and you either do that through buying lots or buying land and developing lots. Or we're always looking at a builder in a city that may want to sell their portfolio. Just like we did this time, last year, in Jacksonville, with the Landon purchase.
But M&A is really not a tough priority for us. It's more, how can we grow organically a need to the city front..
And regarding the 2020 revenue plan, can you just talk about how much land spend is required to execute that maybe a range or anticipated land spend?.
Well to be honest, at this point in time, very little since most of the communities are already been purchased and many of them are under development.
So there'll be a little bit more development dollars to get communities up and running, but most of the deliveries that we'll achieve next year will come from communities that are already open on the ground and already invested in. So we don't see really much of any incremental spend for our communities next year..
Ladies and gentlemen, this concludes today’s question-and-answer session, as well today's call. You may now disconnect your lines at this time. Thank you for your participation and have a wonderful day..