Smith Douglas Homes Corp. Q2 FY2025 Earnings Call

Hello, and welcome to the Smith Douglas Homes Second Quarter 2025 Call and Webcast. Please note that this call is being recorded. I will now turn the call over to Joe Thomas. Please proceed.

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 second 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 turned in another strong operational performance in the second quarter of 2025, generating pretax income of $17.2 million and earnings of $0.26 per diluted share. Home sales revenue was $224 million for the quarter on home closings of 669, which exceeded the guidance range we gave last quarter. Home closing gross margin came in at the high end of our guidance range at 23.2%, and net new orders for the quarter totaled 736 homes. Overall, I'm proud of our company's performance this quarter despite a challenging macroeconomic backdrop for homebuilding and believe it once again demonstrates the strength of our asset-light operational model focused on turning inventory quickly. We experienced inconsistent demand trends during the quarter with stretches of solid order activity followed by periods of softness. While we believe there's a strong desire and need for new homes in our markets, affordability constraints, declining consumer confidence and lack of urgency from buyers continue to be a headwind for our industry. As a result, we remain intensely focused on operating elements that are within our control, which include making our homes as affordable as possible while giving our buyers the choice and customization they desire. Our average sales price on homes closed this quarter came in at $335,000, which is one of the lowest ASPs of our peers. We ended the second quarter with 92 active communities, a 23% increase over the second quarter of 2024, and improved our controlled lot count by 57% compared to a year ago to almost 25,000 lots. Under our asset-light strategy, which gives us operational and financial flexibility to adjust to challenging market conditions, option lots accounted for 96% of our unstarted controlled lot count at the end of the quarter. We continue to focus on growing our operations in existing markets while exploring strategic expansion opportunities where we can deploy our operating model to further increase our overall market share of new home sales and achieve better economies of scale and operating leverage. To that end, I'm happy to share that we'll be entering the Dallas-Fort Worth and the Gulf Coast of Alabama markets through greenfield start-ups. We have been working to secure several finished lot positions in DFW over the last 6 months and expect to close on our first lots and start selling by year-end. Additionally, we have been working on several opportunities to acquire lots in the greater Baldwin County area of Southern Alabama and expect to close on several land deals that would have us targeting communities opening in the second half of 2026. We believe in the long-term growth prospects of these markets and they fit nicely into the geographic footprint where we can continue to deliver first-time homebuyers affordable, high-quality personalized homes. Construction efficiency continues to be another major focus area of our company. Excluding Houston, our average cycle time at the end of the quarter was 54 days, which is down from 60 days in the second quarter of 2024. We continue to make headway in the quarter bringing our Houston division on board with these principles and look forward to then achieving cycle times closer to the company average in the near future. Despite the challenging sales backdrop, we feel our balance sheet remains in great shape with our net debt to net book capitalization ratio coming in at 12.1% at the end of the quarter. The strength of our balance sheet allows us to operate from a position of strength and remain opportunistic when market dislocations occur. With our previously announced $50 million share repurchase authorization, we also have the flexibility to buy our stock back should the opportunity present itself. As we head into the second half of the year, I feel good about our company's outlook even as the macroeconomic and interest rate environments continue to remain uneven and uncertain. We have many well-located communities in some of the best markets in the country and deliver homes at an average selling price that represents a good value. We continue to look for ways to curb costs and our build times continue to improve, which will help us turn our inventories faster. Despite the uneven sales environment in the second quarter, our can rate was actually down year-over-year at 10% for the quarter, which is a testament to the appeal of our homes in the shortened time between sales and closings. We also have several new communities opened at the start of the third quarter, which will serve as a tailwind for our sales efforts. Given these positives, I remain optimistic about the future of Smith Douglas Homes. Now I'd like to turn the call over to Russ, who will provide more detail on our financial and operational performance this quarter and give an update on our outlook for the third quarter.

Thanks, Greg. I'll now walk through our financial results for the second quarter and then provide an update on our outlook for the third quarter. We closed 669 homes during the second quarter, up 2% from 653 closings in the same quarter last year. Homebuilding revenue was $223.9 million, an increase of 1% over the prior year. Our average sales price was approximately $335,000, which is down slightly year-over-year due to slightly higher discounts and shifts in geographic and product mix. Gross margin came in at 23.2%, which was at the high end of our guidance range and compares to 26.7% in the prior year. Our lower year-over-year margin reflects the impact of higher average lot costs, which were 26% in the current quarter versus 23.9% of revenue in the year-ago period as well as rising incentives and promotional activity, which totaled 4.8% of revenue this quarter, up slightly from 4.2% a year ago. SG&A was up $2.9 million versus the prior year and was 15.5% of revenue compared to 14.5% last year, driven primarily by increased payroll and associated expenses with a sizable portion of the increase coming from the opening of new divisions over the last few quarters. Net income for the quarter was $16.4 million compared to $24.7 million in the prior year, and pretax income was $17.2 million versus $25.9 million. Adjusted net income was $12.9 million compared to $19.4 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 4.3% this quarter, which is attributable to the approximate 18% economic ownership held by the 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 $16.8 million in cash and had approximately $70 million outstanding on our unsecured revolver with $189 million available to draw. As I mentioned on our last earnings call, we finalized the amendment to our credit facility, which included, among other things, an increase in total size to $325 million and extended the maturity to May 2029. Our debt-to-book capitalization was 15.2%, and our net debt to net book capitalization was 12.1%. Backlog at the end of the quarter was 858 homes with an average sales price of $341,000 and an expected gross margin of approximately 21.5%. Monthly sales per community went from 2.8 in April to 2.4 in May and 2.8 in June. In July, we saw that average dip back to approximately 2.5 sales per community. Affordability remains a key challenge for our buyers, and we continue to lean into targeted incentives to support sales. Continuing our program from late March, we utilized forward commitments to buy down interest rates, which we believe helps boost conversion rates. During the quarter, we recognized $0.9 million of costs on forward commitments, which is recorded as an offset to revenue. We expect to continue to utilize these rate buydowns through the end of the year as we focus on a pace-over-price philosophy. Turning to our third quarter outlook, we expect to close between 725 and 775 homes with an average sales price between $330,000 and $335,000. Gross margin is projected to be in the range of 20.5% to 21.5%. While incentives will continue to pressure margins, we are maintaining discipline in how and where we deploy them. We ended the second quarter with 92 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 pleased with our results through the first half of 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 of our 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.

Your first question comes from the line of Sam Reid of Wells Fargo.

Definitely great to see the gross margin come in at the high end of the guide for the second quarter. Just curious what you're seeing from a stick-and-brick labor standpoint or either of those tailwinds relative to expectations in the quarter? And then looking to your third quarter guide, it does look like the homes you're planning to sell and close intra-quarter will be carrying a lower margin relative to your backlog. Just curious what's embedded in your gross margin assumptions from an incentive standpoint, especially as it sounds like you're stepping up finance incentives.

Yes. Sam, the sticks and bricks were flat during Q2. They're down year-to-date a little. I'll let Russ hit a little bit on the gross margin pressure.

Yes. For the third quarter, we expect to maintain incentives, particularly related to forward commitments. We've had some success with the rate buydown that we started at the end of the first quarter and continued through the second quarter. This approach has proven to drive good traffic. We have been reducing fixed rates to 4.99% and recently introduced a 5/1 ARM at 3.99%, which has also attracted traffic. Our expectation is to keep this strategy going through the third quarter, while monitoring it along the way. Fortunately, we observed a slight decrease in rates and costs for the forward commitments this past week, which is promising as we look ahead.

That's helpful. And then maybe switching gears, just touching on lots. So it looks like your controlled lot position is up almost about 60 or so percent year-over-year. Maybe just break out kind of what that looks like in your existing markets versus how much of that might have come from some of the newer markets that you're looking to enter like Dallas and the Gulf Coast. Just so we can kind of contextualize what that looks like in the context of your existing operations.

Sure. There hasn't been anything new from the Gulf Coast yet. However, in Dallas, we have around 600 lots available. We've seen significant growth in Chattanooga over the past 6 to 12 months, which is part of our Atlanta division, but we are considering it as a possible standalone division in the future. Central Georgia, which we divisionalized about 6 months ago, is another area of growth, distinct from Atlanta due to its rapid expansion. Specifically, Middle Georgia, which includes Perry, is located south of I-20 in the Atlanta market, and we have acquired a substantial number of lots there. Additionally, we launched the Greenville division last year and continue to secure lots there as well. Overall, we are experiencing good distribution of growth throughout the company's footprint. In Houston, we remain focused on growth, with nearly 400 closings last year, and we believe this market can become another 1,000 unit opportunity for us in the coming years. We are consistently adding lots, providing a diverse growth presence across the company. I hope this gives you a clearer picture of some of the new areas we are entering.

Your next question comes from the line of Mike Dahl of RBC Capital Markets.

You have Stephen Mea here instead of Mike Dahl today. I wanted to start by checking in on your thoughts for the full year's outlook. The guidance for the third quarter is certainly helpful, and I want to acknowledge the volatility in the current macroeconomic environment. However, I was hoping you could share your perspective on the homes target of around 3,000 to 3,100 that you mentioned last quarter and whether that remains a relevant benchmark. Additionally, any further details on your outlook for the remainder of the year would be appreciated.

Sure. Yes. We feel much more confident about providing guidance for Q3. Given the current environment, predicting too far ahead is challenging. We aim for 3,000, which is certainly achievable, as we have the necessary lot positions and community count. Ultimately, it will depend on demand. As Greg mentioned, we focus on a pace-over-price strategy, so finding the right pricing is crucial for clearing inventory and boosting sales. While 3,000 is our target, exceeding that would be fantastic. Success will largely depend on demand and the broader macro environment. We believe we achieved a good balance this quarter and have begun utilizing incentives to drive traffic. Interestingly, we observed a significant increase in traffic and sales just last week, possibly influenced by rate changes. We'll see how things progress, but hitting our target remains a priority.

That's super helpful. I appreciate the context there. Secondly, I had a question on the land side. You mentioned last quarter that you were starting to see some cracks in sellers out there. So I was wondering kind of from a higher level, what your current view of the kind of land landscape is and what may have changed from last quarter to this quarter and your overall views on that.

We are noticing some softness in the land market. There hasn't been much of a price pullback, but we are seeing a shift towards better negotiating terms. The land values are still stable, though there is a significant amount of retrading happening right now, which I expect will continue until the end of the year.

The next question comes from the line of Andrew Azzi of JPMorgan.

Could you provide an update on your expectations for community count growth? While I know you haven't specifically guided to 3,000, hitting that number would suggest a strong year-over-year growth and a solid closing in the fourth quarter. I would like to hear any additional insights you can share on this topic.

Sure. Look, I might have provided a somewhat cautious guide in response to the last question. However, it's important to have goals, right? So reaching 3,000 is a target we aspire to. Regarding community count, we are keeping track. It's worth noting that in some of our communities, particularly in Houston, we have different lot sizes for similar products. This might mean that our community counts could be slightly inflated since we consider a few communities with varied lot sizes as separate entities. Typically, when there are multiple single-family lot sizes, the absorption pace isn't the same. I just wanted to point that out. We do anticipate moderate growth in community count for the second half of the year. As for the fourth quarter, we have certain expectations, and our inventory levels are a bit higher than usual. While we primarily operate as a presale builder, we maintain our inventory closely and are ramping up our pace with incentives aimed at meeting our absorption targets and closing numbers. Hopefully, this provides some additional insight.

I wanted to follow up on your decision to enter the DFW market. I see this as a positive move, but considering the current inventory situation and the possibility of oversupply, what influenced that decision? Also, what is your strategy moving forward with greenfield projects in DFW and other markets?

Yes, I'll take that. If we entered Houston, part of that message was that it serves as a launch pad for us across Texas with DFW in our sights. We've actually been on the ground in DFW for several months now, working on some opportunities and being opportunistic where possible. We feel like we've secured some really good positions there. We understand the current dynamics in that market, but we believe that, as in any of our markets, we're in a strong position with the lots we've secured.

Yes, I would add that with our business model, we maintain a conservative balance sheet. We see a great opportunity to acquire finished lots and are noticing some dislocation in the market. As mentioned, some builders are facing challenges. We believe this is an opportune time for us, even if there may be some ongoing weakness. With our balance sheet and long-term approach, we are confident we will succeed. It feels like the right moment to invest, as we can acquire finished lots with low deposits, which minimizes risk and allows us to capitalize on the opportunities available.

The next question comes from the line of Rafe Jadrosich of Bank of America.

First, I wanted to inquire about the SG&A run rate following the DFW and Gulf Coast entries. Will there be any additional investment needed as you expand into these new markets? Also, considering your efficient building strategy, how do we assess when these markets will achieve scale and when you can implement the R team? At what delivery levels do you need to reach before that run rate is realized?

Sure, as we mentioned earlier, about half of the year-over-year increase in SG&A is attributable to our new divisions. The main factor here is payroll and headcount costs, which are significant during a greenfield start-up as we establish a local presence. The initial expenditure is moderate, roughly $1 million to a couple of million dollars in the first year before we start seeing substantial sales. During a greenfield start-up, our goal is to reach a run rate of around 200 closings within the first two years, aligned with our RT model and geographic strategy. Typically, it takes about two years to become profitable, with hopes of breakeven within the first 12 to 18 months. We aspire to add another R team approximately every 18 months, ideally leading to 400 units. We aim to enter markets where we can establish at least two full R teams. For Dallas, being the largest market in the country, we hope to achieve 1,000 deliveries within five years, similar to our strategy in Houston following the acquisition. This reflects our overall strategic approach and financial planning.

That's really helpful. And then when we look at the backlog is obviously down quite a bit year-over-year. Like how do you think about the percentage of spec going forward here? Like where has it been historically? Where was it in the quarter? And like how do we think about it going forward and like your comfort level in spec shifting to a little bit more spec versus BTO?

Historically, before COVID, we were over 70 percent in presales compared to specs, and typically, before we start construction, we have contracts on over 90 percent of our homes. Currently, our focus continues to be heavily on presales, but the market is driving us to have higher levels of specs due to what we're seeing from our competitors and the opportunities for buyers in terms of incentives. Right now, we're around 50 to 60 percent in presales, but we're actively working on strategies to boost those numbers. While our backlog has decreased, we have higher inventory levels due to increased sales at a higher spec rate. Backlog turnover has risen, and we’re seeing more spec sales. Given our guidance for the third quarter and my cautious outlook for the latter half of the year, I believe we can achieve our targets. Our primary focus will always be on presales, but we're currently adjusting to market trends. We aim to return to higher presale levels as the market conditions hopefully improve.

And your next question comes from the line of Jay McCanless of Wedbush.

Sorry about that. So Russ, if you don't mind, I heard the June and the July absorption numbers, but could you give the April and May, please?

Joe is pulling it up. I think April was 3, if I recall, because I think we gave that on the last. I think it was 2.8 and 2.5 Yes.

I think it was 2.8 in April, 2.4 in May.

Yes, it was higher in April. It trended down to flat in May and continued in that direction through the summer. However, I'm having difficulty getting accurate information. It's taking Joe some time to gather the numbers. We'll follow up when Joe has them ready.

Yes, I'll follow up afterwards. No problem on that. And then I guess the next question I had, so with the loose kind of 3,000 closing number you called out, that's what, almost 970, 980 you're going to need to close in the fourth quarter. Does that feel achievable? And do you think you're going to have to lean into the incentives and hit the gross margin to sell some of this excess spec inventory? Is that kind of how you guys are thinking about the rest of the year?

Yes, definitely. We're focusing more on pace than on price. It’s a matter of using incentives as needed to drive that pace. As I mentioned, it’s not an issue of community count or construction; our cycle times are actually improving, thanks to our operators in the field. The goal is to reach a price that stimulates demand. We're aiming for $3,000, and it could potentially be $2,900. Ultimately, it will depend on price and incentives, which is why I haven't addressed margin, as it's tough to determine what that margin will be to achieve the necessary pace, but that's where our focus is.

I think it's worth calling out.

And Jay just circling back, it was 2.8 in April, 2.4 in May.

In June, it appears that the number was 2.8. There was an increase in June, and then we have the figures we provided for July and August, or just July.

I'd love to have that August number already if you got that, that would be a good one. So it's actually encouraging, I think, that you guys are saying that if you give a little more on incentives that the consumer is responding because some of your larger competitors have talked about how even if they did lean in and put more incentives in, it's not making the consumer react. So maybe talk a little bit, if you could, about what type of uptick you're seeing when you do lean into the incentive because that's different from what we've been hearing from some of your larger competitors.

Yes. For us, we weren’t heavy users initially. Our first forward commitments occurred at the end of Q1, which we extended into Q2 due to an increase in traffic. We believe we are seeing a slightly better conversion rate, although I can’t specify the exact figures. We are actively monitoring the situation and regularly communicating with the field to understand what strategies are effective. We aim to educate our sales teams on the benefits of utilizing these incentives. Recently, we introduced the ARM product, which offers a $3.99 rate, making it crucial for our buyers to qualify at that rate. We are also covering closing costs, providing a zero-cost option alongside the $3.99 rate, which presents a very appealing opportunity. As we mentioned last quarter, some of the market challenges seem to stem from consumer confidence. However, we hope that as conditions stabilize, consumers will start to feel better in the latter part of the year. These incentives appear to be beneficial for us, and we will keep monitoring their impact and continue to promote them as long as we see positive results.

Okay. That's great. And then the last one for me. I know you all talked about your stick and brick. It sounds like that's a little better. But I think there is the looming threat potentially of higher lumber prices depending on what happens with this Canadian softwood lumber agreement. I guess, are you all seeing any pricing letters from your suppliers? Are you all starting to see anecdotally any signs of lumber prices starting to move up? And if so, when do you think it might hit your income statement?

Jay, this is Greg. We've not seen any letters presently. So there's a lot of discussion around tariffs. There's a lot of discussion about potential. But as of the present moment, we've not had any notifications of impact.

Your next question comes from the line of Alex Barron of Housing Research Center.

Congratulations on the reduction in the build times. I was curious on that subject, if there's anything you can share on how you've been able to achieve those reductions? And do you feel like there's any further potential? Or do you feel like that's as good as it gets?

Yes, we've got a stated goal company-wide that we want to be at days on our build. So yes, we still believe there's opportunity. The pace over price is our lever that we use with our trays to help drive our waste and our cost. So they know they're getting a commitment of starts, and that allows us to be more reliable in our assembly process.

Your next question comes from the line of Paul Przybylski of Wolfe Research.

I guess you've got the 2 new greenfields you just announced, but could you give us an update on what you're seeing with respect to the M&A environment and your appetite for M&A given current volatility and how you would even go about underwriting a deal given the unknowns out there?

Yes, that's a great question. There are definitely M&A opportunities available, and we are always on the lookout and evaluating them. However, we prefer to focus on greenfield expansions. We feel confident in our ability to establish new divisions through this method. Although it takes some time to fully ramp up, we are patient, and our majority shareholders are as well. We're not approaching this as a quick endeavor; it's a long-term strategy. Our main goal is to build a sustainable company while maintaining the culture that has contributed to our success, which is easier to achieve through greenfields. Additionally, the leaders of these new operations will be internal employees who have a long history with the company and understand our practices well. We believe in promoting from within, as it is the most effective approach for us. That said, if we encounter a truly attractive opportunity with a good deal, we would consider it. While there are opportunities out there, it's challenging to justify paying a high premium in the current market. M&A activities are still not cheap; although things are becoming a bit more reasonable, we remain focused on our growth strategy for now.

Okay. And then I guess kind of related to that, have you made any changes to your current land underwriting standards? Have you pushed up your hurdle rates? And along with that, have you seen any change in financing costs given the volatility from the keeps up off balance sheet?

Yes. On the latter part, really not a lot of term changes, but we are focused on our mature divisions, we want to maintain pace, and we're underwriting based on our ability to maintain pace and market share. And then on our newer divisions, maybe our underwriting is a touch softer, but we're still very conservative as we look to those new markets, knowing that we've got to ramp up. So not any real change overall to underwriting, but we're totally aware of the market conditions.

And with that, I'd now like to hand the call back to Greg Bennett for final remarks.

Thank you, everyone, for joining us today on behalf of Smith Douglas and the whole management group. We appreciate your interest and your involvement today. Have a great day.

Thank you for attending today's call. You may now disconnect. Goodbye.