Smith Douglas Homes Corp. Class A

Thank you for standing by. My name is Kayla and I will be your conference operator today. At this time, I would like to welcome everyone to the Smith Douglas Holmes Second Quarter of 2024 earnings call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you'd like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you'd like to withdraw your question, again, press star and one. I would now like to turn the call over to Joe Thomas, Senior Vice President of Accounting and Finance. You may begin.

Good morning and welcome to Smith Douglas's earnings conference call. We issued a press release this morning outlining our results for the second quarter of 2024, which we will discuss on today's call and to be found on our website at .smithdouglas.com or by selecting the investor relations link at the bottom of our homepage. Please note this call will be simultaneously webcast on the investor relations section of our website. Before this call begins, I'd like to remind everyone that certain statements made on this call, which are not historical facts, including statements concerning future financial and operating goals and performance are forward-looking statements. Actual results could differ materially from such statements due to known and unknown risks, uncertainties and other important factors as detailed in the company's SEC filings. Except as required by law, the company undertakes no duty to update these forward-looking statements. Additionally, reconciliations of non-GAAP financial measures discussed on this call to the most comparable GAAP measures can be found in our press release located on our website and our SEC filings. Hosting the call this morning are Greg Bennett, the company's CEO and Vice Chairman, and Russ Devendorf, our Executive Vice President and CFO. I'd now like to turn the call over to Greg.

Thanks, Joe, and welcome to the team. As we announced last month, Joe is our new Senior Vice President of Accounting and Finance, taken over from Eddie Clyde, who has transitioned to a role of Division President for the company's newly established Central Georgia Division. Joe comes to us from Bank of America, where he provided investment banking services to a number of clients and played a key role in our initial public offering earlier this year. We're thrilled to have Joe as part of the team and expect great things from Eddie in his new operational role. Turning to our second quarter results, Smith Douglas reported pre-tax income of $25.9 million, which translates to $0.40 for diluted share for the quarter. We closed 653 homes during the quarter, which was above our stated guidance and represents a 17% increase over second quarter of 2023 and generated $220.9 million in home closing revenue. Home closing gross margin also came in above guidance at 26.7%, that's a combination of solid demand, stable pricing, and cost containment resulting in better margin performance than we had forecasted. Net new home orders for the quarter came in at 715, representing a 17% year over year increase. We continue to experience a favorable operating environment in our markets highlighted by low level of existing home inventory, healthy job growth, and stable in-migration. Demand trends were fairly consistent across our divisions thanks to our new home offerings, which we believe hit the sweet spot of our market in terms of price, customization, and value. It's no secret there's a real need for quality, affordable housing in this country, and we pride ourselves on being a leader and provide solutions to meet these needs. Another aspect of our business we take great pride in and have spoken about previously is our operational efficiency. Home building is a very competitive industry and success often comes down to how well you execute. From the very beginning, we instill a culture of discipline and accountability at Smith Douglas. We constantly look for ways to improve our operations. From the way we underwrite land deals to the way we procure labor and materials to how we build and sell homes, we feel this is one of our main differentiators and is demonstrated by our cycle time remaining in line with our expectations at approximately 60 days outside of our Houston division, which we continue to successfully integrate into the Smith Douglas operating model and it fully migrated on our IT system. We also feel this efficient cycle time has helped reduce our cancellation rate, which was .8% for the second quarter. The final pillar of our operational focus is our land light strategy. We are home builders first and foremost, which means we view land as the necessary component of our business rather than something for speculative investing. We also know land and land development is one of the most costly and unpredictable aspects of this business. As a result, we have made it a priority to eliminate as much of the land risk from our operations as possible by tying up land with option agreements and seeking to take ownership of lots on as close to a -in-time basis as possible. At the end of the second quarter, 96% of our unstarted controlled lots were controlled via option agreement. While this land acquisition strategy can result in higher lot cost in an upwardly trending market, we feel it serves as an insurance policy against potential downturns. It also allows us to deploy our capital more efficiently and generate better returns. Overall, we feel good about the current state of our operations. We believe we have the right strategy in place in the right markets to allow us to grow our home building operations beyond what they are today. The macro environment remains positive, and there continues to be a real desire for home ownership in this country. Our balance sheet is in great shape, and we have a solid momentum as we head into the second half of the year. As a result, we believe we are well positioned to achieve our goals for this year and beyond. With that, I'd like to turn the call over to Russ who will provide more detail on our performance this quarter and give an update on our outlook for the year.

Thanks, Greg. I'm gonna highlight some of our results for the second quarter and conclude my remarks with our expectations and outlook for the third quarter and full year for 2024. As Greg mentioned, we finished the second quarter with 220.9 million of revenue on 653 closings for an average sales price on closed homes of 338,000. Our gross margin was .7% and SG&A was .4% of revenue, which includes a true up for annual incentive bonuses that accounted for 30 basis points of the total. Pre-tax income was 25.9 million with net income of 24.7 million for the quarter. Given the nature of our upsy organizational structure, our reported net income reflects an effective tax rate of .4% on the face of our income statement. This income tax expense is primarily attributable to the income related to the .3% economic ownership of our public shareholders that is held by Smith Douglas Homes Corp and Smith Douglas Holdings LLC. Our adjusted net income, which is a non-GAAP measure that we believe is useful given our organizational structure is 19.4 million for the quarter and assumes a 25% blended federal and state effective tax rate as if we had 100% public ownership operating as a sub-chapter C corporation. We believe adjusted net income is a useful measure because it allows management and investors to evaluate our operating performance and comparability more effectively to industry peers that may have a more traditional organizational and tax structure. You can find more information about our structure and income taxes in the footnotes of our financial statements. Our net income for the quarter included a one-time charge of 1.2 million related to a purchase accounting adjustment for the true up of the expected earn out payment related to our Devon Street acquisition that will be paid early next year. This expense is included in other expenses on our income statement. We finished the first quarter with over 15,800 total controlled LOPs, an increase of 81% over the second quarter of 2023 and just over 12% from the first quarter of this year. Our corporate investment committee, which meets every week to review and approve new land deals continues to remain busy as we focus on increasing market share and driving scale throughout our existing footprint. We expect our lot supply to stay within a targeted range between three and a half to five and a half years of supply calculated based on our forecasted closings over a rolling 12 month period. We finished the second quarter with 1,173 homes in backlog with an average selling price of 345,000 and an expected gross margin on those homes of approximately 26%. We finished the quarter operating out of 75 active selling communities versus 70 at the end of the first quarter. Looking at our balance sheet, we ended the quarter with approximately 17 million of cash and no borrowings under our 250 million revolving credit facility and 344.6 million of total members and stockholders equity. Our debt to book capitalization was .1% and our net debt to net book capitalization was negative 4.1%. We had approximately 220 million available on our unsecured credit facility and a well-positioned to execute on our gross strategy as Greg previously mentioned. Now I'd like to summarize our outlook for the third quarter and full year for 2024. We anticipate our third quarter home closings to finish between 725 and 775 homes at an average sales price between 340 and 345,000 with gross margin in the range of 26 to 26 and a half percent. For the full year 2024, we are projecting total home closings between 2,650 and 2,800 homes, an increase of 50 closings to the low end of our prior guidance. We expect our average selling price to range between 339,000 to 343,000 and our home closing gross margin to finish between 26% to 26.75%, which is a 25 basis point increase to the low end of our prior guidance. Additionally, we continue to expect our SG&A expense ratio to be in the range of 13.75 and .25% for the full year, which includes approximately 420 basis points for internal and external sales commissions. We believe the primary risks to our projections are around our ability to maintain sales pace and bring our new communities and lots online. As I have mentioned on prior calls, we continue to see some delays with municipalities on permitting and plans. Macroeconomic factors, primarily around jobs, inflation and interest rates could also have unforeseen impacts to our numbers. With that, I'd like to turn the call over to the operator for instructions on Q&A.

At this time, I would like to remind everyone in order to ask a question, press star as in the number one on your telephone keypad. Our first question comes from the line of Michael Rehaut with JP Morgan. Your line is open.

Hi, thanks for taking my questions. This is Andrew Ozzy on for Mike. I was just hoping to maybe get some more granularity and an update on community count growth and how you're thinking about it as we go through the year and maybe any initial thoughts for next year. Thank you.

Hey, Andrew. Yeah, from a community count perspective, and I think we've stated this before, we expect to end somewhere, maybe two or three more communities higher than where we're at at the end of the quarter, somewhere in the 70, probably 76 to 79, 80 range. So we'd expect it to grow a little bit. There's some communities that are coming offline just from exceeding sales. And then we're hoping to again, bring some of our communities online, on time or a little bit faster. We are experiencing, as I mentioned, some flat delays, but so that's where we would expect. And then into next year, we haven't really provided any guidance yet, but maybe on the next quarter, we'll give some updates on communities as well as sales and closings for next year.

Thanks, Ross. And then maybe if we could drill down a little bit on your demand trends over the last few months, any kind of progression you can give us or how the sales case is coming through the door maybe versus your expectations.

Yeah, I'll take that one. And our current trends are probably slightly off from typical seasonality. We're still seeing a lot of demand the last few weeks have been good, although you've got the typical seasons with school starting, we just had a storm move through, a lot of our coastal, I mean, a lot of our coastal Carolina divisions and had some interruptions with those sorts of things. So it's kind of hard to pinpoint some of that, but I think seasonality is maybe just a little soft, but those trends are the same.

Yeah, just to add onto that, as Greg mentioned, we also had, Houston got hit pretty hard with a storm during the quarter, but as you would expect, I mean, you can see absorptions trended down a little bit when you looked at our monthly net sales through the quarter, April and May were actually about flat in terms of their sales. I think we were at 246 and 253 in May, and then June tailed off a bit for the balance. So we, again, that's kind of your typical seasonality, but also I think there was some weather factors in there.

And your next question comes from the line of Rafa Doudraus with Bank of America. Your line is open.

Hi, good morning, it's Ray. Thanks for taking my question. I wanted to ask on just on Devon Street in Houston, can you talk a little bit about what the margins are for that division compared to sort of the legacy business and how you're seeing the progress there in terms of integrating them?

Yeah, so to take the last part of it, integration is going as good as we could have expected, I think as we've mentioned on last quarter, we had continued to kind of migrate systems, getting them into the Smith Douglas way of doing business and that has continued. I think as of today, we are totally 100% migrated onto our system. We've had our team meetings out there. So again, we've continued to, we've turned over the brand, so the brand was turned over pretty early. We are building out some of the legacy homes, floor plans, but we've already started to integrate our models. We're doing more of the Smith Douglas marketing, CRM. So everything's on track and really a shout out to that team. I mean, they've been phenomenal. I think maybe we've lost one person in the last year. So we just hit our one year anniversary, but extremely, extremely great team and it's been a great acquisition for us and I think they're gonna exceed the closings that we had projected for them for this year. And then just in terms of margins, as good as we could have expected as well, they're hitting a mid 20s, 25% gross margin. And I think that's consistent with their legacy business and probably a little bit higher than we would have expected to be honest, I think, cause we were gonna try and push a little more volume than they had done in the past. And we thought that was gonna come a little more at the expense of margin, but yeah, it's been good. The first half of the year, the first quarter was great. Sales and demand was great, but I also think, again, they followed a little bit of the typical seasonal pattern in the second quarter, but yeah, it's going well.

That's really helpful. And then just you raised the low end of the gross margin outlook. Can you talk about like what's driving that increase and what are you assuming for stick and brick cost and land inflation for the second half of the year?

Yeah, so we raised it because margins have been coming in better for our sales in second quarter. So it's just really a function of, we've been able to raise prices in excess of cost inflation and that's really more on the direct cost side. Our land cost is really what's driving, year over year land costs is what's driving the margin erosion, right? I think our land costs, maybe it's up about 300 basis points as a percentage revenue versus last year, but that's the big driver. I don't have the percentages in front of me. Maybe we can talk offline, but it's all in the land costs which is driving that margin erosion. But as I mentioned, our margin and backlog is about 26%. So through the first half of the year, I think we were at .5% for the first six months and with backlog at 26, yeah, I think that 26 to 26.75 is a pretty safe range.

Thank you, that's helpful. Sure.

And your next question comes from the line of Mike Dahl with RBC Capital Markets, your line is open.

Hey, thanks for taking my questions. Russ, maybe just to follow up on that comment on backlog margins, I think coming out of the gates, you've been giving a range, plus or minus around where your current backlog margin sits. And if I heard you correctly, if your current backlog margin is at 26, you're guiding 26 to .5% for three Qs. So you're not really necessarily assuming like incremental erosion at the low end, maybe just help us understand kind of how you're thinking through whether it's mixed or otherwise, what's gonna deliver in three Q versus that backlog margin.

Yeah, it's more mixed related. I think you've got, just the way it's trending, I think you've got a little bit higher gross margin probably hitting in Q3 than Q4, if I recall correctly. So I think it's just more of a mix. And we're pretty baked in terms of trying to get to that low end closing number. When you look at our closings plus our backlog schedule to close this year, and that assumes that nothing falls out from a cancellation standpoint. We feel pretty good about getting to that 26.50. We're getting to a point in the year where maybe we've got another month or so of where we can sell and close in the year. And we just need to see how the margin trends continue. We've got some specs in the ground that also can close this year. And part of that's just how much discounting we're gonna have to do maybe to move some of those specs. So that's the reason for the range. Even though we're at 26.50 for the year and backlogs at 26, I think there's some mixing there. And then it just depends on maybe what we can move some of these specs at and what some of the demand trends in the next month will look like and how we can hold margin.

Okay, that's helpful. And then back to the comments that both you and Greg made around the demand trends. I wanna make sure I'm clear. I think Greg, you talked about current trends below typical seasonality. Ben Russ, when you added your comments, you talked more specifically about April, May, and June. So I wanted to clarify, Greg, when you're talking about current trends, is that what you've seen in July and August to date that you've referenced still being below typical seasonality?

That's correct. Yeah, we're back closer to seasonality, but we, so our leading indicators is our traffic and our lead generation. And it's slightly below what we would expect typical seasonality. And that is current July and August numbers.

Okay, appreciate that. Thank you

both. Yep, thanks Mike.

And your next question comes from the line of Sam Reed. Sam Reed with Wells Fargo, your line is open.

Thanks guys. I wanted to do a quick follow up on Devin Street here. Just maybe talk through where cycle times to date that it's used in relative to your current core operation. And then maybe kind of help us bridge sort of the path to getting to something more consistent with your core business.

Thanks. Yeah, so Sam, thanks for the question. We're benchmarking right now all of our trends and our cycle time in Houston. We had some legacy, some of the master plan communities where we had a little part of time changing product over that we've just got plugged up over the last month or so and we've got all of the units now in the system. And probably over the next couple of weeks, we'll be able to benchmark all the cycle times there. They're, you know, if I'm guessing without putting numbers on it, we're probably in the mid high 70s today. We're doing a great job there on cycle time, but we've now got schedules in place on everything and our team's in place. We've launched those meetings. Tom and I have been in person there to their trade meetings. And as Russ said, things are going great with all the transitions. So now it's a matter of being able to set benchmarks moving forward. We would hope by the end of the year to be near our numbers that if we look across all of our footprints today, we're in that high 50s, 58, 59, cycle time.

No, thanks Greg, that's helpful. And then one question I had just on mix here, I mean, I know you guys predominantly built the order, but you know, there is some spec in your business, you know, just kind of curious, you know, kind of how that spec mix looks into the second half of the year, just mindful of, you know, potential incentives on those specs. So curious what the mix looks like. Thanks.

The, you know, our spec, so we've always had some spec and I don't know that it's that much different than typical. So, you know, we operate and focus as a manufacturing business. We make more, we lose less than full capacity. If we get a stated slot and we don't have a pretail ready, we'll start a home. Our whip, as a percent of whip, I think we are at about 3% of our homes are at drywall that are spec homes. So it's a small, small sampling. I think the most of those we are able to get moved and sold prior to, and we call it a line in the sand. When we look at it around drywall, that's still, we can convert that sale. It still closes on its original schedule time.

Yeah, the other thing, Sam, I would add is, and sitting here today, I'm just looking at the numbers. We've got, as of this week, we only had 45 finished specs and that was pretty evenly distributed through our divisions. We track spec count by community. Every week we kind of look at that and see what the sales trends are, but to Greg's point, we're trying to keep the machine going and we'll start adjusting price to meter pace to get for our teams kind of that one a day. And then when you look at specs, so the one thing to keep in mind, so specs are up year over year, probably just maybe about, it's about 200 versus last year. Now, half of that, over half of that comes from Houston. So you got to remember Houston's probably more of a spec market and in that market, and primarily because you're competing with, we're competing, I think about 70% of our communities are in master plans where you've got four or five other builders, and it's just kind of the way you've got to compete there. So we've got a little more spec in Houston. We are, as Greg pointed out, we're getting them integrated, the Smith Douglas way of doing things. We are focused more on trying to get them a little more pre-sale, but I think specs in Houston are always gonna be kind of part of that business when you compare it to our other markets.

And for us, one note to add there too, a spec home for us becomes a spec the day we identify the need to go into permitting. So we identify within our system very early if it's got to be a spec because of the law of elongated permitting cycles. That's right.

No, guys, that's very helpful. Thanks so much. Sure, thanks,

Sam. And your next question comes from the line of Jay McCandless with Web Bush Securities. Your line is open.

Good morning, everyone. So Russ, talking about the gross margin, I think you said probably higher in three Q versus four Q. I guess, is that all land costs or are you all expecting maybe a little more competitive pressure from some of the larger builders going into year end?

Yeah, I mean, that's the gross margin on our closings, right? So a lot of that's just baked. So it's just kind of mix and just timing of what's gonna close. And I think that's just a reflection of where we've just seen. So those closings, the margins that's gonna close in the back half of the year, you think that that was sales that was kind of end of first quarter and the second quarter. So it's just, I think it's just where we've seen costs. It's just as we move through communities, just in terms of mix, it's mostly land costs. So it's really just kind of just more timing of what's closing. If that answers your question, I don't think you can glean anything into how that translates into what we think our sales necessarily are gonna be or kind of what we think in terms of future discounting. That's just more of what our backlog is showing for sales that we've already made.

So I guess, yeah, that makes sense because I'm assuming that's when mortgage rates were higher, et cetera, you probably had to do a little more on the buy down side. I guess, as you talk about what you're having to do for incentives now and what are you seeing from some of the larger builders?

Yeah, I would say, and Greg can jump in too, but it's pretty consistent with what we've seen in the first half of the year or first quarter. We're still offering kind of a your choice incentive for our buyers, the incentive percentage hasn't changed too much. And it's, I'd say most are still, have still been taking a credit towards closing costs versus actual buy downs. We did a forward in one of our markets where, we just did a small, maybe a couple million dollar forward contract in buying a breakdown. And it took us, I think a couple months to actually fill it because our buyers were, like I said, taking more of that closing cost incentive. And I believe it's, a lot of folks just feel like, hey, let me take the credit now because ultimately I'm gonna refi my mortgage in a couple of years, because the expectation is for rates coming down.

Yeah, that's accurate, Jay, good morning. And I would say, our incentives are one and a half, 2% range on average currently.

Gotcha. And then just the last question I had, thinking about Devon Street in Houston, I guess how, given that you've passed the one year mark there, I guess how comfortable are you with potentially looking at other expansions and do you feel like with our team blurrings you've had so far that you could implement this into another existing organization or do you feel like you need some more time to evaluate?

I think the implementation has gone great and I don't have any doubt or reservations about how well this is gonna continue to go at Houston. I think, now is evaluating growth within that market and then a timing for when we may step out and expand beyond Houston there, but there's no immediate need to look at any of those type of transactions. I think, as we've stated in the past, our greatest opportunities in our current divisions and expanding as we have with our land across

the state across all those markets. Okay, great, thanks guys, appreciate it. Thank you,

Shay. And as a reminder, if you'd like to ask a question, please press star and the number one on your telephone keypad. Your next question comes from the line of Alex Barron with Housing Research Center, your line is open.

Yes, good morning, thank you gentlemen. I wanted to ask about the Houston division, orders were 149 in the first quarter, 98 in the second quarter. Can you talk a little bit about which of those two is more likely to be a run rate right now and what I guess what happened from one quarter to the next?

Yeah, look, I think it's, in Houston, I still think it's kind of seasonal trends. So, the first quarter was probably better than we expected, but I think it just kind of season and now you're getting into second quarter, you kind of hit summer months, school's starting to get out. So, I can't sit here and say that it wasn't just following a normal trend. So, we did see a little bit of an uptick in cancellations in Houston in second quarter, but I can't say if that's just anything more than just a little bit of a blip or just kind of typical. Again, this was our first year, our first half year with Houston ourselves, so we're still just kind of feeling out the market, seeing how we fit there. But no, I think everything like we said is going real well, better than we had anticipated and I think just from our internal projections, as we look for the full year in Houston, I think they're gonna exceed our internal projections,

so. Okay, great. And as far as your land position, I mean, it's been going up pretty aggressively. Do you feel like you're just seeing opportunities right now or you're just trying to get ahead of

expected growth?

Yeah, we're seeing, as I mentioned, our corporate investment committee is very busy. We're seeing anywhere from one to four or five deals a week that the divisions are presenting to us. So, we're very active. I mean, the market is still very competitive, right? But we are getting our fair share of deals. As we mentioned during the road show, one of our main goals here with raising the capital is to continue to drive scale through the operations, specifically outside of Atlanta. Atlanta, we're a top three builder in Atlanta, so we've been focusing on really driving scale in other markets, but we're seeing a lot of great deals in Atlanta. I mean, just across the footprint, as we mentioned on the last call, we started pushing up into Chattanooga. So, I think we put another couple of deals under contract in Chattanooga, so we continue to push north there so there's some more opportunity. With the transition, we mentioned with Eddie, our VP of Finance that just transitioned into a central Georgia DP role, a newly created division. So, we're looking to further expand our footprint out from Atlanta into more middle Georgia. So, these are just more opportunities that we're seeing. So, yeah, we're being opportunistic. We've seen, and just the last thing I will say is, we continue to see M&A opportunities come across our desk, but honestly, I think we're just taking a wait and see approach there. It's gotta be at the right price. It's gotta be at the right fit. I think things aren't cheap. Again, I think both on the land side and the M&A side, I think things are expensive, but yeah, look, we're still getting our fair share of land deals.

Okay, best of luck, thank you.

All right, thanks, Alex.

And there are no further questions at this time. I will now turn the call back over to Greg Bennett.

Thank you. Thanks, everyone, for joining on our quarterly call. Hope everyone has a great day, great week.

And this concludes today's conference call. You may now disconnect.