Q1 2024 Smith Douglas Homes Corp Earnings Call

Participants

Eddy Kleid; Vice President, Finance; Smith Douglas Homes Corp

Gregory Bennett; President, Chief Executive Officer, Vice Chairman of the Board; Smith Douglas Homes Corp

Russell Devendorf; Chief Financial Officer, Executive Vice President; Smith Douglas Homes Corp

Sam Reid; Analyst; Wells Fargo

Chris Kalata; Analyst; RBC Capital Markets

Rafe Jadrosich; Analyst; Bank of America

Alex Barron; Analyst; Housing Research Center, LLC

Jay McCanless; Analyst; Wedbush

Presentation

Operator

Good day, everyone. My name is Ellie, and I will be your conference operator for today. At this time, I would like to welcome everyone to the Smith Douglas Homes first-quarter 2024 earnings call and webcast conference. (Operator Instructions)
I'd now like to hand over the call to Eddy Kleid. Eddy, you may now begin your conference.

Eddy Kleid

Good morning, and welcome to Smith Douglas' earnings conference call. We issued a press release this morning outlining the results from the first quarter of 2024, which we will discuss on today's call and can 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 the 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 Eppendorf, our Executive Vice President and CFO.
I'd now like to turn the call over to Greg.

Gregory Bennett

Good morning, and thank you for joining us, as we go over our results for the first quarter of 2024, and provide an update on our operations.
Smith Douglas Homes has generated pre-tax income of $21.4 million in the first quarter, and a $0.33 per diluted share. Home sales revenue came in at $189 million on a 13% increase in deliveries, and new orders totaled 765 on a sales pace of 3.6 homes per community per month, while our cancellation rate remained low at 10.6%.
Our closings and order results came in over the high end of our prior guidance, as our teams did an excellent job selling and closing homes, during the quarter. We continue to see favorable homebuilding conditions in our markets, and thanks to low levels of existing supply, and positive demand drivers including healthy job creation, in-migration, and new household formation.
The lock-in effect from higher mortgage rates, continues to keep existing homeowners in place, which has pushed a greater percentage of the buyers into the new home market. We believe this dynamic will be in place for some time, creating a real opportunity for homebuilders to take market share. Our focus remains on the more affordable segments of the market, which is reflected in our average sales price of $334,000 for the quarter.
We believe it is the most supply-constrained segment of the market, and most attractive from a buyer demographic standpoint. We cater our home offerings to entry-level buyers, and empty-nesters who are looking for customizable homes at an affordable price. This strategy has not only resulted in strong volume growth for our company over the years, but also healthy profitability, as evidenced by our homebuilding gross margin of 26.1% for the quarter.
We continue to employ a land lot strategy, with 95% of our lots controlled via option agreement at the end of first quarter. Through our strong relationship with land bankers, land sellers, and developers, we strive to acquire lots on a just-in-time basis. This allows us to turn our inventory more quickly, and focus on what we do best, which is build and sell homes.
It also allows us to use our capital more efficiently, and mitigate some of the risks associated with land development. Our build times in the quarter were in line with expectations at approximately 60 days. Through our SMART Builder ERP system and our team construction process, we strive to set standards of excellence for homebuilding efficiency.
This is a standard that our leadership team has refined over several decades in the business, and one that requires the coordination of a number of people both inside and outside the organization. We consistently look for ways to reduce costs and number of days it takes to build a home and believe our efficient approach to homebuilding, is a key differentiator for our company.
The net result of our affordable product focus, our land lot strategy, and our proprietary building process, is a return on equity profile that ranks at the high end of public builder peer group. We believe our approach to homebuilding can be replicated in a number of markets, throughout the Southeast and have begun to expand our footprint this quarter, by contracting for lots in Central Georgia, in Houston County, which includes Perry and Warner Robins, and in Chattanooga, Tennessee and surrounding submarkets.
We plan to initially leverage our expansive Atlanta division operations, as we build out our teams in these markets until we eventually drive enough scale to create separate divisions. As we've discussed in the past, our plan is to expand our geographic footprint both organically and through strategic M&A if the opportunity presents itself. Our integration of Devon Street Homes in Houston is progressing.
As the team has embraced the Smith Douglas way of doing business, and we couldn't be more pleased with how it has been going. Overall, we feel good about the current state of our operations. And we saw solid and improving sales and traffic trends throughout the first quarter. Thus far, order trends have remained good through April and May, although slightly below the absorption pace we saw in March.
That said, while buyers appear to have adjusted to the idea of rates, will likely be higher for longer, and our ability to offer financing incentives, has been a key factor to addressing affordability concerns. We remain cautiously optimistic about the strength of the housing market, and the general economic conditions for the balance of the year.
With that, I'd like to turn the call over to Russell, who will provide some additional color on our results this quarter and update our outlook.

Russell Devendorf

Thanks, Greg
I'm going to highlight some of our results for the first quarter, and conclude my remarks with our expectations, and outlook for the second quarter and full year of 2024. As Greg mentioned, we finished the quarter with $189 million of revenue on 566 closings, for an average sales price on closed homes of $334,000.
Our gross margin for the quarter was 26.1%, and SG&A was 14.6% of revenue. We finished with $21.4 million of pre-tax income. Given the nature of our Up-C organizational structure, our reported net income is $20.5 million, which reflects an effective tax rate of 4.3% on the face of our financial statements.
It should be noted that this income tax expense, is attributable to Smith Douglas Homes Corp., which controls the 17.3% economic ownership of our public shareholders in Smith Douglas Holdings LLC, and not the non-controlling interest, which is the 82.7% economic ownership controlled by our continuing equity owners, as documented in the footnotes of our financial statements.
Our adjusted net income, which is a non-GAAP measure that we believe is useful given our organizational structure, was $16.1 million 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.
Our cost of sales for the period, includes the amortization of approximately $100,000 of purchase accounting costs, attributable to the acquisition of our Houston operations, Devon Street Homes.
Additionally, SG&A for the period includes a one-time expense of approximately $100,000, related to the write-off of loan costs, attributable to our amended and upsized unsecured credit facility that, we closed concurrent with our IPO, and $900,000 of non-cash stock compensation expense relates to the staking grants we made, to all of our full-time employees at the time of our IPO in January.
We finished the quarter with over 14,000 total controlled lots, an increase of 86% over the first quarter of 2023, and just over 10% from our prior year end. 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.
True to our land-light operating philosophy, only 693 of our controlled lots were owned, unstarted, meaning that 95% of our controlled lots were either work in process, or under option. In a normalized market, we would expect our lot supply to stay within a targeted range, between 3.5 to 5.5 year supply, calculated based on our forecasted closings over a rolling 12-month period.
We finished the first quarter with 1,110 homes in backlog, with an average selling price of $343,000, an expected gross margin on those homes of approximately 26.5%. As we sit here today, we are currently operating out of 71 active selling communities versus 70 at the end of the quarter.
Looking at our balance sheet, we ended the quarter with approximately $33 million of cash and no borrowings under our $250 million revolving credit facility. We finished with $333 million of total members' and stockholders' equity, which includes $116 million of net proceeds from our IPO, after underwriting and professional fees.
Our debt-to-book capitalization was 1.3%, and our net debt-to-book capitalization was negative 9.4%. We had approximately $188 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 second quarter and full year for 2024. We anticipate our second quarter home closings, to finish between 600 and 625 homes and an average sales price between $335,000 and $340,000, with gross margin in the range of 25.5% to 26.5%.
For the full year 2024, we reiterate our prior guidance of projected total home closings between 2,600 and 2,800 homes, and now expect our average selling price to range between $338,000 to $343,000. We project home closing gross margin to finish, between 25.75% to 26.75%, inclusive of any purchase accounting adjustments from our Devon Street acquisition, which we expect to be less than 25 basis points of revenue, given our final purchase price allocation.
Additionally, we expect our SG&A expense ratio, to be in the range of 13.75% and 14.25% for the full year, which includes approximately 4.2% 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 mentioned on our prior call, we continue to see some delays with municipalities on permitting and flats. 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.

Question and Answer Session

Operator

(Operator Instructions) Sam Reid, Wells Fargo.

Sam Reid

Awesome. Thanks so much, guys. I wanted to unpack the order trends you highlighted, on April and May in a bit more detail. I think you mentioned the absorption rate might have been a bit below, what you saw in March. So can you just give us a sense, as to how this compares to what you've seen in a typical April-May period? And then along those lines, kind of any sense as to what foot traffic might be looking like in your model homes relative to expectations?

Russell Devendorf

Yes. I'll give you some of the specific numbers through the quarter and what we're seeing. And then maybe Greg can give you some color, just on how this plays into typical seasonality. So through the first quarter, we saw sales and traffic trends continue to improve throughout the quarter. And again, part of that I believe is seasonal, as we got deeper into the selling season.
So March was the strongest quarter - strongest month. It was about a four-time. I think we had four sales per month. February was about 3.6, and then January was just slightly lower. And so, then moving into April, we were back down to a 3.6 sales per community. And May, is trending very consistent with what we saw in April. So it's still good, right? The traffic's still good, but March - did pop a bit.
But again, it's hard to say, at least from my perspective, if that's just kind of a little more seasonality, where maybe we kind of peaked in March and as we get through selling season, it's coming back a bit. But we had some rates were a little bumpy, but traffic trends have been good throughout the quarter, and they continue to - foot traffic is real good. So Greg, if you've got --

Gregory Bennett

Yes Russell, I can't add much to that. We've seen really strong traffic across all of our divisions. And I think sometimes it's hard with a little pinned up demand with communities opening, and getting flats and releasing a bulk of sales. And we sure had good activity in March, but I don't think there was any real anomalies out there with sales activity for our spring.

Sam Reid

No that helps, guys. And then, wanted to touch quickly on gross margin here. I think you tweaked guidance just a little bit, and it sounds like Devon Street, at least that purchasing accounting dynamic, is going to be less of a headwind. But any other things we should be mindful of as we think about the margin guidance? I just want to make sure I fully understand that? Thanks a ton.

Russell Devendorf

Yes, thanks, Sam. The margin - really, we finished our purchase accounting, so when we had our call, we were about a week from finalizing our 10-K, and so, we did finalize some purchase accounting. We had some changes to our goodwill number on Devon Street in that last week, subsequent to our call. And so, we now think, based on the final purchase price allocation that, that impacted those headwinds from purchase accounting are going to be less than, what we had originally guided to.
So, I think we had said something about 50 basis points. Now I think it's going to be 25 basis points, or less. We did book a little more goodwill, which reduces the allocation to the real estate inventory. So yes, I think the margin, when you roll all that together, our gross margin guidance really hasn't changed from last period, our guidance last time. So we do think kind of, like we said, 25.75% to 26.75%. I think somewhere in there, 26% range would - as we sit here today, I think that's kind of - if you tick the midpoint.
I think that's a fair estimate. But we'll see. We still have some sales and closings that we've got to continue to fill with backlog, to get to our numbers. But where we sit today, and as we mentioned, or as I mentioned on the call, our backlog0 margin is 26.5% right now. So we feel good about it. Anything can happen with the additional sales, and that we need to get to fill out the year. But hopefully that answers your question.

Sam Reid

No, that certainly helps. Thanks, guys. I'll pass it on.

Russell Devendorf

Thanks, Sam.

Operator

Mike Dahl, RBC.

Chris Kalata

Hi. This is actually Chris on for Mike. Just a follow-up on the gross margin comments. I think I said it seems like outside of Devon Street, not much change. How are you guys thinking about pricing and incentives into the rest of this year? What's being baked in in terms of your guide last quarter, this quarter? Has there been any changes there? Just talk a little bit on that. That'd be helpful?

Gregory Bennett

Yes. I don't see, Mike, a lot of changes to incentives. We've held prices. We've actually increased some prices with demand in a couple areas. We are still offering incentives. But I think it's trending with what we've been seeing in the past several months.

Chris Kalata

Got it. Okay. So no change in the back half. And it sounds like so far this quarter, your quarter to-date, it's been stable?

Russell Devendorf

Yes. It's been consistent. What we saw in the first quarter has trended through this part of the second quarter. And again, as we sit here today, don't expect much change in that. But I think a lot's going to be dependent on rates and what happens. I mean, it's also an election year. So, we'll see. But like we mentioned, 26.5% is what we're sitting with our backlog, which takes up a good portion of what we'll close for.
If not all of that, through the balance of the year. So we've already got a good portion of that baked. But yes, I think current sales trends are pretty consistent with what we've been seeing. I don't expect much change in discounting.

Chris Kalata

Okay. Appreciate that. And just as a follow-up, I was hoping you guys could touch on your community count growth outlook. Has there been any changes there? I know you guys announced a new entrance to new markets. So just relative to your expectation, has there been any changes in community count ramp, whether that be delays or kind of new openings?

Russell Devendorf

Yes. As we sit here today, no changes from what we discussed on the roadshow. I can't remember, I think we expect to end somewhere in the 70s, mid to high 70s. Maybe we'll get to 80. But we had expected community count, to peak a bit and then maybe pull back through the fourth quarter. But like I said, our expectations are consistent with what we thought coming into the beginning of the year.

Operator

Rafe Jadrosich, Bank of America.

Rafe Jadrosich

Russell, I just wanted to clarify. I think you said the gross margin in your backlog was 26.5%. Did I get that right?

Russell Devendorf

Yes. 26.5%.

Rafe Jadrosich

Got it. So the - just for the gross - and how long will that take you? Is that - basically, is your backlog probably one or two quarters out? Just how much of that is - like how long will that backlog carry you this year?

Russell Devendorf

Yes. So if you do the math, so we closed 566. You've got - there's 1,100 in backlog. So yeah, the next couple quarters. That'll go through if not. And stuff we're selling today, what we've continued to sell in the second quarter, is stuff that will close - that we sold earlier would close kind of end of quarter, and into next quarter. So yes, most of that should be through third quarter.

Rafe Jadrosich

And then the homes that you're selling today, it sounds like you're seeing similar margins as to what's in the backlog?

Russell Devendorf

Yes. It's been pretty consistent. Yes.

Rafe Jadrosich

Got it. Okay. Very helpful. And then I guess what are you seeing in terms of lot costs right now? I think we've heard from some other builders that particularly on finished lots, there's been sort of a little bit of a step up in inflation. What are you seeing in terms of land and lot prices? Has there been any change there? And then, just what level of inflation are you assuming in your guidance?

Gregory Bennett

Yes. So we are seeing increases in lots, new contracts, new deals that we're doing are definitely contracting at higher rates. Those are - with entitlement timeframes and development timeframes, those are deals that'll be into the back half of next year. So it's really not anything, we're guided for yet. But yes, sure. There's some material increases we're seeing out in lots. And there's a little - the entitlement processes out there have caused a little bit of a scarcity. So there is a great deal of pressure on those.

Rafe Jadrosich

Got it. But not something that flows through P&L until '25, or something like second half of 25?

Gregory Bennett

Yes, it would be back half of '25.

Rafe Jadrosich

Okay. And then the last question is just on Devon Street. Now that you've had it for another quarter here, can you talk about how the margins are coming in relative, to your expectations and relative to other new markets that you've opened? Where are margins there, relative to kind of your core business? And how do you think about the progression there? Thank you.

Russell Devendorf

Yes, sure. Margins are coming in better than we probably anticipated. Part of that is due to the purchase accounting. So, we did not allocate as much to inventory, which would have been a drag on some of the margins that, we'd see over the - really the first 12 months as we worked through their working process, and some of the lots that they had on the books.
But it's coming around - it's in the mid-20s, 24%, 25% range in Houston. And that's with us pushing more volume. Prior to us acquiring Devon Street, they were probably a little more focused on margin. But I tell you, we've implemented some of our sales tools. We're pushing down our ERP, our CRM tool. We're really pushing leads and doing more marketing in Houston.
And so, we couldn't be more, happy with how that's progressed from both the sales side and the strength of sales. And I think Houston just in general, has been good through this selling season. But we've been really pleased with how well, in addition to pushing volume, that we've been able to hold some pretty good margins.
So it's really a credit to that team. And again, as Greg said, they've really embraced the Smith Douglas way of doing business. And so, we couldn't go as - probably couldn't have gone any better. So real happy with it.

Operator

Alex Barron, Housing Research Center.

Alex Barron

Yes, thank you. Just wanted to make sure I'm understanding the mechanics of the economics. As far as tax rate, the tax rate for GAAP purposes is different than for calculating the EPS, correct?

Russell Devendorf

Yes. So on a basic, and I won't get -- and we can take it offline, but I'll give you a high level. On a basic EPS calculation, you're taking the public shares against just the income allocated to Smith Douglas Homes Corp. so on the face of the financials. So that calculation is based on that. And then, when you look at the dilution, the diluted EPS actually takes into account if the B shares converted to A shares.
And so, there's a calculation that actually takes a different estimate. So it's a little complicated on the face of the financials, but Alex, we can walk you through the details offline.

Alex Barron

Okay. I'll call you guys afterwards to go through that. And in terms of incentives right now, what have you guys seen after the end of the quarter? Have you guys maintained the incentives roughly the same, or been able to decrease or had to increase, given that they kind of went up a little bit in April?

Gregory Bennett

Incentives have remained on par with Q1. We're obviously - rates, we think, are going to be up for longer going to be less pullback from the Fed on rates. So, we're continuing to forecast things to be the same, and they've been the same over the past quarter.

Operator

Jay McCanless, Wedbush.

Gregory Bennett

Hi, Jay, you there?

Jay McCanless

Yes, it helps -- I hit the unmute button, doesn't it? Thank you for letting me on. A couple of questions. The first one, if you look at the legacy Smith Douglas markets, it looks like closings were down versus last year. Could you maybe talk through that community timing, or just the impact of higher rates? What was going on with some of the older legacy Smith-Douglas markets?

Russell Devendorf

Yes, we were about flat, a few closings down when you exclude Houston. But I think it's a couple of things. Atlanta last year came in with a really strong quarter. And then, we gapped out in some communities, specifically in Nashville. So it's not - a demand thing, I would say. Yes, it's flat gaps, gaps in getting kind of our flats and timing of communities coming online.
So that's what's going on there. Like we said, we reiterated the 2,600 to 2,800, so we're hoping that we're getting community count back up. As I mentioned, we're still seeing, and as Greg mentioned, we're still seeing that has always been outside of market risk. Just timing of developments has been the other risk that we've been most concerned with.

Jay McCanless

Got it. Okay. And then the backlog gross margin, 26.5%, sounds pretty good. I guess what is it, maybe some specs you're having to resell, or some other incentives? I guess what's the delta that's between the 25.5% to 26.5% guide for 2Q, versus what's sitting in backlog right now?

Russell Devendorf

Part of it's just trying to be a little conservative. We don't want to disappoint you guys. But yes, look, I think it's mostly that. And then as we talked about, just filling out the rest of the year in terms of the sales, and what we still need to sell and close, we feel pretty good. Like we said, incentives, we're staying pretty consistent. But we do want to - and we're pleasantly surprised with Houston.
But I do feel like in order to continue to drive scale, to drive some volume as we look into the back half of the year and into next year. In addition to the land and lot costs that we're seeing, I think maybe there's a little margin compression there as we try and drive a little more volume, right and keep our cycle times moving, and our teams full. So that's just generally, where I see some margin compression. But, yeah, for second quarter, we should - I'd be surprised if we're not at 26% or better.

Jay McCanless

Okay. And then - that was going to be my next question, is Houston, and maybe just talk about how the our team implementation is going there, and how you feel like that's going to go for the rest of the year?

Gregory Bennett

Yes. Good morning, Jay. It's going really well. We've - Tom and I were able to travel to Houston a few weeks ago, and we launched with a complete trade force there in Houston, and kind of had a standing room only group there, to roll out to with our trades. And it's been really welcomed.
We did a lot of Q&A there, and it seems to be well embraced. We've had our sales processes converted over here in the past couple of months, and I would say things are going better than, we could have anticipated. And we're optimistic that will be very strong by the end of the year.

Operator

Right now we don't have any pending questions. I'd now like to hand back the call over to Gregory Bennett for closing remarks.

Gregory Bennett

Yes, thank you. So that will conclude our call today. We want to thank you for joining us. Hope everyone has a great day. And if you need us, we ask that you reach out through our Investor Relations. Thank you.

Operator

Thank you for attending today's call. You may now disconnect. Have a wonderful day.