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' 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 investors.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 would 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 the 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 continued 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 11.8% for the second quarter. The final pillar of our operational focus is our landline strategies. We are home builders first and foremost, which means we view land as a 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 just-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 going to 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 26.7% and SG&A was 14.4% 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 organizational structure, our reported net income reflects an effective tax rate of 4.4% on the face of our income statement. This income tax expense is primarily attributable to the income related to the 17.3% 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 subchapter C corporation. We believe adjusted net income is a useful metric 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 lots, 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 3.5 to 5.5 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 1.1%, and our net debt to net book capitalization was negative 4.1%. We had approximately $220 million available on our unsecured credit facility and are well positioned to execute on our growth 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 $340,000 and $345,000, with gross margin in the range of 26 to 26.5%. For the full year 2024, we are projecting total home closings between 2,650 and 2,800 homes and 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 14.25% for the full year, which includes approximately 420 basis points for internal and external sales commissions. We believe the primary risk 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 then the number 1 on your telephone keypad. Our first question comes from the line of Michael Rehaut with JP Morgan. Your line is open.

Hi. Thank you for taking my question. This is Andrew Ozzie. I'm 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. You know somewhere in the 70 probably 76 to 7980 range so we'd expect it to to grow a little bit I mean it's there's some communities that are coming offline. Just you know from exceeding sales and then we're hoping to again bring some of our communities. You know online you know on time or a little bit faster, you know we are experiencing, as I mentioned some. Ross Meentemeyer- 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 you know, maybe on the next quarter we'll we'll give some updates on communities, as well as. Ross Meentemeyer- kind of sales and closings for next year.

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

And your next question comes from the line of Raffaele Jodraus 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 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, right? 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 you know really a shout out to that team i mean they've they've been you know phenomenal i think maybe we've lost one person you know in the last year so we we just hit our one year anniversary but um extremely extremely uh great team and uh it's it's been a great acquisition for us and and i think they're going to exceed um you know the closings that we had projected for them for this year and and then just in terms of margins um as good as we could have expected as well. They're hitting the 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, because we were going to try and push a little more volume than they had done in the past. And we thought that was going to 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, you know, sales and demand was great. But I also think, you know, again, they followed a little bit of the typical seasonal pattern, you know, in the second quarter. But yeah, it's going well.

That's really helpful. And then you raised the low end of the gross margin outlook. Can you talk about what's driving that increase? And what are you assuming for stick and brick costs 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. You know, our land cost is really what's driving, you know, year over year land costs is what's driving the margin erosion, right? I think our land costs, maybe it's at 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. I mean, 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%. Through the first half of the year, I think we're what 26 and a half percent through the first six months and with backlog at 26. Yeah, I think you know that 26 to 26.75 is a pretty 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 know, you've been giving a range, you know, 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 26 and a half percent for 3Q. 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, you know, whether it's mixed or otherwise, what's going to deliver in 3Q versus that backlog margin?

Yeah, it's more mixed related. I think you've got, you know, just the way it's trending, I think you're 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 scheduled to close this year, And that assumes that, you know, nothing falls out, right, from a cancellation standpoint. I mean, we feel pretty good about getting to that 2650. You know, we're getting to a point in the year where, you know, maybe we've got another month or so of where we can sell and close in the year. And, you know, we kind of, we just need to see how the margin trends, you know, continue. You know, we've got some specs in the ground that also can close this year and, You know, part of that's just, you know, how much discounting are we going to have to do maybe to move some of those specs. So that's why, you know, that's the reason for the range. You know, even though we're at, you know, 26 and a half for the year and backlog's at 26, I think there's some mix in there. And then, you know, it just depends on, you know, 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 want to make sure I'm clear. I think, Greg, you talked about current trends below typical seasonality. Then, Russ, when you added your comments, you talked more specifically about April, May, and June. So, I wanted to clarify, you know, Greg, when you're talking about current trends, is that, you know, what you've seen in July and August to date that you've referenced still being below typical seasonality?

that's correct yeah we we're back closer to seasonality but we we try so our leading indicators is their traffic and our lead generation and it's it's slightly below where we would expect uh typical seasonality and that is current july and august numbers okay appreciate that thank you both yep thanks bye

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

Thanks, guys. I wanted to do a quick follow-up on Devon Street here. Just maybe talk through where cycle times today sit in Houston relative to your current core operations, and then maybe kind of help us bridge sort of the path to getting to something more consistent with your core business.

Thanks. Yeah. 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 harder 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. probably over the next couple of weeks, we'll be able to benchmark all the cycle times there. 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 day cycle time.

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

Thanks. 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 in full capacity. If we hit a stated slot and we don't have a pre-sale ready, we'll start a home. Our WIP, as a percent of WIP, I think we are at about 3%. of our homes are at drywall that are spec homes. So it's a small sampling. I think 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, we can convert that cell, it still closes on its original schedule time.

yeah the the other thing sam i would add is um and sitting here today i'm just looking at the numbers we've got uh as of this week we had we only had 45 finished specs uh and that was pretty evenly distributed through our through our divisions we we track uh spec count um by community every week we kind of look at that and see what the sales trends are but but to greg's point i mean we're trying to keep the the machine um you know, going and we'll start, you know, adjusting price to meter, you know, pace to get, you know, 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, you know, 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. Um, and in that market and primarily because you're competing with, um, we're competing, I think it's about 70% of our communities are in master plans where you've got four or five other builders. And it's just, it's, 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, you know, as Greg pointed out, I mean, 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 going to 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 a lot 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 Wedbush Securities. Your line is open.

Good morning, everyone. So, Russ, talking about the gross margin, I think you said probably higher in 3Q versus 4Q. 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, it's, 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, you know, timing of what's going to close. And I think that's just a reflection of, you know, where we've just seen, you know, so those closings, the margins that's going to close in the back half of the year, you know, you think that that was sales that was kind of, you know, in the first quarter, in the second quarter. So it's just, I think it's just where we've seen costs, you know, it's just as we move through, communities just in terms of mix it's it's mostly land costs so it's really just kind of you know just more timing of what's what's closing you know if that answers your question it's it's I don't think you can glean anything into you know how that translates into what we think our sales necessarily are going to be or kind of what we think in terms of future discounting that's just more of you know what our backlog is showing for for sales that we've already you know made

So I guess, yeah, that makes sense because I'm assuming that's when mortgage rates were higher, et cetera, and you probably had to do a little more on the buy-down side. I guess, could 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, you know, first quarter. TAB, Mark McIntyre:" You know we're still offering kind of a your choice incentive for our buyers the the the incentive, you know 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. 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 rate down. 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, you know, a lot of folks just feel like, hey, let me take the credit now because ultimately I'm going to refi.

uh you know my mortgage in a couple years if you know because the expectations for rates coming down yeah that's accurate jay good morning uh and uh i would say you know our incentives are you know one and a half two percent range on average currently um and then just the 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, the learnings 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 regrets. doubt or reservations about how well this is going to continue to go at Houston. I think now is evaluating growth within that market and then the 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 of transactions. I think, as we've stated in the past, our greatest opportunity is in our current divisions and expanding as we have with our land across all those markets.

Okay. Great. Thanks, guys. Appreciate it. Thanks, Jay.

And as a reminder, if you would like to ask a question, please press star and the number 1 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. You know, 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, you know, in Houston, I still think it's kind of seasonal trends. So, you know, the first quarter was probably better than we expected, but I think it just kind of season and now you're getting into, you know, second quarter, you kind of hit summer months, you know, school starting to get out. So I don't, I can't sit here and say that it wasn't, you know, 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, you know, just, you know, anything more than just a little bit of a blip or just kind of typical. Again, this was our first year, our first, you know, first half year with Houston ourselves. So, you know, we're still Just kind of, you know, feeling out the market, seeing kind of 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 going to exceed our internal projections.

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, you know, 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? I mean, but we are getting our fair share of deals. As we mentioned during the roadshow, you know, one of our main goals here with raising the capital is to continue to drive scale through the operations, you know, specifically outside of Atlanta. You know, Atlanta, we're top three builder in Atlanta. So, you know, we've been focusing on Really driving scale in other markets, but we're seeing, you know, a lot of great deals in Atlanta. I mean, just across the footprint, as we mentioned on the last call, you know, we we started pushing up into Chattanooga. So we put I think we put another couple of deals under contract in Chattanooga. So we continue to push, push north there. So there's some more opportunity. Um, you know, with the transition, we just, you know, we, we mentioned with, with Eddie, you know, our, our VP of finance that's just transitioned into, uh, a central Georgia, uh, DP role, you know, a newly created division. So we're, we're looking to, you know, further expand our, our footprint out from Atlanta into, you know, more middle Georgia. So, um, you know, these are just, you know, more opportunities that we're, we're seeing. So, yeah, we're, we're being opportunistic, um, 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 got to be at the right price. It's got to 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 use.

Okay. Best of luck. Thank you.

All right. Thanks, y'all.

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.