Smith Douglas Homes Corp. (SDHC) Earnings Call Transcript & Summary

Thank you for standing by. My name is Tina, and I will be your conference operator today. At this time, I would like to welcome everyone to the Smith Douglas Homes First Quarter 2025 Earnings Call and Webcast. [Operator Instructions] I would now like to turn the call over to Joe Thomas, SVP of Accounting and Finance. Please go ahead.

Good morning, and welcome to the Earnings Conference Call for Smith Douglas Homes. We issued a press release this morning outlining our results for the first quarter of 2025, which we will discuss on today's call, and which 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 Devendorf, our Executive Vice President and CFO. I'd now like to turn the call over to Greg.

Thanks, Joe, and good morning to everyone. Smith Douglas Homes posted another quarter of strong profitability to start the year, generating pretax income of $19.6 million or net earnings of $0.30 per share. Home closing revenue was $225 million in the first quarter, representing a 19% increase over the first quarter of 2024. Home closing, gross margin for the quarter came in at 23.8%, which was higher than the guidance range we shared on our last call. We generated 768 net new orders in the first quarter. On a sales pace of 3.1 homes per community per month. Overall, I'm very pleased with our execution to start the year and believe Smith Douglas remains on track to achieve our long-term goals. We experienced normal seasonality during the quarter with the quarter activity improving as we headed into the spring. We had solid traffic throughout the quarter. The sales conversions were negatively impacted by affordability concerns and macro uncertainty. Similar to past quarters, we used financing incentives to overcome these obstacles and solve for monthly payments that would fit our buyers' needs. While there are many factors that affect their business and are out of our control, there are many things we can do to optimize our performance in any demand environment. The first is controlling land through option agreements rather than owning it outright. At the end of the first quarter, less than 5% of our unstarted controlled lots were owned on balance sheet, while the remainder was tied up through option and land banking agreements. This land-light strategy gives us some degree of flexibility with respect to our lot take-down timing just needed and limits our downside risk should market conditions soften. Another factor within our control is how quickly we build our homes. For those of you that followed the Smith Douglas story, you know we're highly focused on improving build times and turning our inventories as fast as possible. Not only does this improve our return on capital, it also limits the possibility of cancellation, thanks to a shorter time frame between sale and close. As of the end of the first quarter, our cycle times averaged 56 days, excluding Houston. We also made further progress during the quarter, getting Houston division and their trade partners on board the R-team platform, and we expect to see build times move closer to the company average over time. A third factor we focus on is Smith Douglas has limited the amount of spec inventory for sale in our communities. We believe our business runs better and more properly when we presell our homes. This gives buyers the ability to make important design decisions for their home and allows us to implement lot premiums and offer higher margin home upgrades at our communities, which we feel reduces our cancellation rate as the buyers become attached to their homes, they have designed. In summary, while there is more uncertainty today around the economy and our industry than in previous quarters, we built Smith Douglas to weather the ups and downs of this business. We remain focused on our long-term goals of growing our market share and achieving better economies of scale, while maintaining a strong balance sheet and focusing on returns. This strategy has worked for our company since its inception, and we believe will continue to do so into the future. With that, I'd like to turn the call over to Russ, who will provide more details on our results this quarter and give an update on our outlook.

Thanks, Greg. I'll now walk through our financial results for the first quarter and then provide an update on our outlook for the second quarter. We closed 671 homes during the first quarter, up 19% from 566 closings in the same quarter last year. Homebuilding revenue was $224.7 million, an increase of nearly 19% over the prior year. Our average sales price was approximately $335,000, which is up slightly year-over-year due to shifts in geographic and product mix. Gross margin came in at 23.8%, which was at the high end of our guidance range and compares to 26.1% in the prior year. On an adjusted basis, excluding a $642,000 impairment charge related to a Houston community we exited during the quarter, our gross margin would have been 24.1%. Our lower year-over-year margin reflects the impact of higher average lot costs, which were 25.5% of revenue in the current quarter versus 23% in the year ago period as well as rising incentives and promotional activity, which totaled 4.7% of revenue this quarter, up slightly from 4.5% a year ago. SG&A was 14.7% of revenue compared to 14.5% last year, driven primarily by increased payroll and performance-based compensation expense. We continue to tightly manage overhead, while supporting our growth. Net income for the quarter was $18.7 million compared to $20.5 million in the prior year, and pretax income was $19.6 million versus $21.4 million. Our numbers for the quarter include a $716,000 charge related to the abandonment of a lot option deal with a developer, which is included in other income and expenses. This is related to the same community where we recorded a $642,000 impairment, I mentioned earlier, which is included in our cost of home closings. Adjusted net income was $14.7 million compared to $16.1 million in the prior year. As a reminder, given the nature of our Up-C organizational structure, our reported net income reflects an effective tax rate of 4.4% this quarter, which is attributable to the approximate 17.5% economic ownership held by public shareholders through Smith Douglas Homes Corp., and Smith Douglas Holdings LLC. Because the majority of our earnings are allocated to our Class B members, which is shown as income attributable to noncontrolling interest on our income statement, we provide adjusted net income, which assumes 100% public ownership and a 24.9% blended federal and state effective tax rate. We believe this measure is helpful in evaluating our results relative to peers with more traditional C-corporation structures. Additional details on our structure and related income tax treatment can be found in the footnotes to our financial statements. Turning to the balance sheet. We ended the quarter with $12.7 million in cash and had $40 million outstanding on our unsecured revolver with $195 million available to draw. Our debt to book capitalization was 9.5%, and our net debt to net book capitalization was 6.9%. I am also happy to announce that we are in the final stages of finalizing an amendment to our credit facility that will, among other things, increased the total facility size by $75 million to $325 million and extend the maturity, which will be 4 years from the closing date. We appreciate all of our existing and new banking partners for their unwavering support. Our strong balance sheet and liquidity puts us in a great position to support our ongoing growth. Backlog at the end of the quarter was 791 homes with an average sales price of $341,000 and an expected gross margin of approximately 22.5%. While backlog is lower from the 1,100 homes year-over-year, reflecting a tougher selling environment this year, we did see positive momentum in our absorption pace as we progress through the quarter. Monthly sales per community improved from 2.4 in January to 3.3 in February and 3.8 in March. In April, we saw that average dip back to approximately 3 sales per community as we move further into the spring selling season. Affordability remains a key challenge for our buyers, and we've leaned into targeted incentives to support sales. In late March, we launched a $10 million forward commitment program, offering a 4.99% mortgage rate buydown in select communities, which helped boost conversion rates. In the trailing 13-week period, our total incentives and discounts have averaged just over 7%. Turning to our second quarter outlook. We expect to close between 620 and 650 homes with an average sales price between $335,000 and $340,000. Gross margin is projected to be in the range of 22.75% to 23.25%. While incentives will continue to pressure margins, we are maintaining discipline in how and where we deploy them. We ended the first quarter with 87 active communities and expect to see that number continue to grow modestly throughout the remainder of the year. We're actively opening new communities across multiple divisions and remain focused on supporting a stable and scalable growth platform. Before I conclude, I want to reiterate that while we're encouraged with our start to the year, our outlook does include several risks. As always, our ability to achieve these results will depend on maintaining an adequate pace of sales, bringing new lots and communities online as scheduled and managing cost pressures, particularly in labor and materials. Additionally, broader macroeconomic factors such as inflation, employment trends, interest rates and consumer confidence could create headwinds to demand and impact the timing or volume of sales and closings. We remain focused on executing what we can control and believe our land-light model, steady operations and financial strength position us well to navigate these challenges over the long term. With that, I'll turn the call over to the operator for questions.

[Operator Instructions] Our first question comes from the line of Michael Rehaut with JPMorgan.

This is Alex Isaac on for Mike. You mentioned on the demand side that there's some weakness in a lot of affordability challenges. I wanted to ask sort of how you would characterize the spring selling season overall and expectations for that? And also, if you feel like that demand weakness is consistent across geographies? Or more specifically -- you see more specifically in certain geographies than other geographies.

Yes. So thanks for the question. I think the spring demand has been there all along. It's just week by week. As we said, we're just solving for payments to reach affordability in each market and it seems to be across our entire footprint. Demand has been relatively the same.

It makes a lot of sense. I appreciate the color on that. And then as my follow-up question, I wanted to ask on the land side, you mentioned some land inflation. I'm just curious about any color on the land environment and your ability to find new lots, both unfinished and finished lots as well as how we should think about the land environment for the company going forward?

Yes. It's -- we've obviously been able to find deals, right? We more than doubled our controlled lot count over the last -- since we've been public. Land inflation, certainly over the prior 12 months has continued to increase. But we've always said, I think land sellers are usually when things have started to slow land sellers typically in our experience or the last ones to figure out that maybe their land isn't worth what it was previously. But we are starting to see a few cracks in the sellers out there. I think it is transitioning a bit to a buyer's market. And so you are starting to see some land prices moderate. I mean there's definitely demand out there, right? I think builders are still out looking for deals, and so we're competing every day. But the land that's in our backlog. And as we mentioned on the call, we're working off a land that the prices over the last few years have continued to increase. And so the stuff that we're closing obviously has a higher basis than what we had previously. But we are starting to see a little bit of negotiating power in some of the linkage. So hopefully, that trend continues, especially as affordability remains challenging.

Our next question comes from the line of Michael Dahl with RBC Capital Markets.

You guys have actually got Stephen Mea on for Mike today. I wanted to start the outlook beyond 2Q. I appreciate the macro outlook, I've gotten a lot murkier since we last spoke, but I just wanted to get a sense of how you guys are kind of formally thinking about the guideposts you guys have been giving us for the full year, I believe those are [Technical Difficulty] homes just kind of beyond the second quarter, what do you guys kind of have in and how are you guys thinking about that?

Yes. I wish we had the perfect crystal ball. It's kind of the reason that we didn't really give specific guidance, I think when we talked towards the end of last year and going back a little bit and when the Fed started to cut rates, we were hopeful that, that would help with affordability. But as we moved in the first quarter, clearly, the mortgage rates were not in our favor, right? They peaked in January. And they're still -- looking today, I think the 10-year yield is back up to about 4.5%. So affordability is a challenge. Like Greg said, you're seeing people need homes. There's demand out there. As it relates to full year guidance, that's why we really kind of pulled it off. It's very -- it's really kind of a day-to-day thing as we just kind of navigate what's happening with more of the macro environment. We certainly have the communities and the lots to get to our 3,000, 3,100 closing target. So that's clearly the objective. A lot is going to depend on how the balance of selling season shakes out and where we see the kind of the demand for the back half of the year really more so the affordability and what we're able to do. We're trying to balance margins with really balance our incentives and try to find that kind of appropriate mix. So look, our target without giving specifics or definitive guidance, we're certainly targeting that 3,000, 3,100. Like I said, I think we can get there, but it's really going to be more of a macro story.

No, definitely appreciate that. And I also appreciate all the color. And I wanted to jump ship to Houston and kind of the expansions you guys have been making recently. It's great to hear that there's further progress year-to-date? And I guess, just the acquisition on like the R-team integration in Houston, but I think it will be helpful for everyone in terms of framing the story, like if there's any further color you can provide on that progress? And any potential time frame you may have for milestones there within Houston and the other expansion areas would be really helpful.

Yes. Thanks for the question. We are seeing really big improvements in cycle time in Houston. We're up and running in R-team process across the footprint. We are, I think implemented on a 70-day schedule currently that we've rolled out. We're not executing to a 70-day schedule quite yet, but our goal is to be there by the end of this year. So yes, and that's from a high point of cycle times near 200 days when we closed on that acquisition. So I'd say there's been quite a bit of improvement there.

Our next question comes from the line of Jay McCanless with Wedbush.

So 3 questions for me. I guess, could you talk a little bit about what you've seen so far in May in terms of demand and pricing power?

I think it's been pretty consistent with April. We haven't seen any real shift. Like I said, people are still coming into the sales office. We're seeing traffic, but it's still a challenging environment from an affordability perspective. And then even from a competitive perspective, when you see a lot of new homebuilders offering some pretty big incentives that we're in and a lot more spec inventory on the ground. So it's challenging, but like I said, I don't see a huge difference from what we've seen in April.

And so not to harp on it, but are you guys pulling the fiscal '25 guidance? Or do you still think you can hit some of the targets that you laid out last quarter?

Yes. Look, I think for the last question, it's really -- like I said, we've got the community count. We've got the lots in place. We're not -- we didn't want to comment specifically on it. I think our target is still to get to that 3,000, 3,100, that's our goal. And if the macro environment remains -- gets a little bit better, remains steady, I think we have a good shot at hitting it. It's just -- it's really stuff that's out of our control, right? So I think some of our competitors, some of the other new builders have pulled back on some guidance. It's just -- it's still a little bit early to tell based on where things are moving. Obviously, this new administration, there's been some -- quite a bit of choppiness from a macro perspective. So I'll be honest, I mean it's difficult to forecast in this environment, right? But look, our goal, and like I said, we still have a good shot at getting to our 3,000-plus target.

Got it. And then the last question for me. I'm sure you guys saw the news on Landsea yesterday. Any comments you might make on that and any impact that could have on Smith Douglas?

No. I mean we don't -- we wouldn't comment on somebody else's transaction traditionally. But the only thing I would say is, look, it's [ Apollo ]. So it does show some pretty good support from a pretty good backer that clearly, they see some opportunity to make an investment of that size and homebuilding space. So we like to see that. And it won't -- no impact from our standpoint. We don't see Landsea or New Home in our markets.

And our final question comes from the line of Rafe Jadrosich with Bank of America.

It's Rafe. Russ, can you just -- on the second quarter gross margin guidance relative to where you came in, in the first quarter, which I think was pretty solid. Is the quarter-over-quarter decline just higher incentives and that's related to that forward commitment?

Yes. That's, I think, a good part of it. And to the extent that we may do a little bit more, but that's definitely a driver, yes.

Okay. And then when the backlog year-over-year is down, I think, over 25% here, but you've been able to continue to grow deliveries. Can you -- the backlog conversion has obviously improved a lot over the last year. Where can that go from here? Do you still see additional opportunity to drive the backlog conversion higher? And is there sort of a cap to that? Will you have to sort of refill the backlog with more orders to continue to grow deliveries?

Yes. And that's a great point. We -- there's a couple of things there. Our cycle times are improving. But yes, we came in with a few more specs than we had last year. So even though backlog is down, we actually had as much, if not a little bit more inventory. And so we're able to, like Rick said and we've said, there are -- there is demand there. So there are people coming into the sales offices. We're getting traffic, but it's just taking higher incentives to get people to convert. And so that's why margins are dipping a bit, but we're still able to get some pretty good closing numbers. And so even though backlog is down, and we're traditionally and obviously, our business model is focusing on presales. We've still got the inventory. We're clicking on pretty much all cylinders from an operating perspective. And so we're really just taking a measured approach to how we're pricing, and we don't want to get -- we're not looking to fill up a whole bunch of spec inventory. And so as we start to see maybe a few more specs or a little bit of slowness in a community here or there, we'll turn the dial on incentives and kind of move the inventory. So that's a long way of saying, yes, we can definitely increase that backlog conversion rate because we'll just continue to turn the dial in and just move some more of that speculative inventory that's sitting in some of those communities.

Okay. That's helpful. And then is there any just update on the mortgage JV that you have right now? Any plans to change that relationship?

No. Actually, I'd tell you, it continues to get better every week. It's part of the reason that really, and it's been very helpful and pushing out some of these, a very consistent message on the incentive side. And so we were using through our partner, which is loanDepot, using them for our forward commitments and just pushing out a consistent message. We are now fully licensed in all of our markets. We've got loan officers that have been operating in all of our markets, and our capture continues to get better. And I want to say last week, our capture was 56% for our mortgage partner. And so obviously, that's -- our goal is to be at 90-plus percent. But we were still using -- we were not using our Ridgeland brand yet in Atlanta because we had just gotten licensed, and that's obviously our biggest market. But in everywhere else, capture has been very good, and we think it will continue to improve. So looking forward to it.

And I think the operator said I'm the last one, so if I could sneak one more in here.

Sure, yes.

In your core markets, are you seeing a pullback in starts from competition? Or have you adjusted the starts pace at all? And obviously, some of the larger public builders that have already reported. On a year-over-year basis, we've seen starts down a lot. I'm just wondering if some of the standing, kind of sitting finished spec inventory out there from competitors. Do you think that's a problem right now or an issue? And is there any sign that that's sort of improving and there's been an adjustment on the start side?

Yes. Right. I'll take that. We have not had an interruption and starts on our side. We are hearing discussion about slowing starts from competitors and probably seeing a little bit of evidence of that. We went in to tag on to Russ's backlog question -- previous question. We pushed start in the end of 2024 to be certain that we kept our machine running that as the kind of environment around rates, and we know how we ended Q4 with sales last year. It built some inventory, but that inventory coming into the year drove a lot of conversion for us in Q1. We've grown backlog since the beginning of the year, and we continue to push starts every day. We're hitting on our starts actually ahead of our starts budget for the year. And I've been refreshed to see the past 2 weeks that we've outpaced with our presales in our orders. So I'm optimistic that we'll continue to be able to build on our model and that our presales will overtake the inventory that we've built. And our cycle times, as we said, helps us to be able to convert that buyer quickly.

And this does conclude our Q&A session. I will now turn the call back over to Greg Bennett, CEO, for closing remarks.

Yes. Thank you, Tina. Thank you, everyone, for joining us. I appreciate all the interest in Smith Douglas and hope to speak again next quarter.

Ladies and gentlemen, that concludes today's call. Thank you all for joining, and you may now disconnect.