Smith Douglas Homes Corp. Q3 FY2025 Earnings Call

Good morning, and welcome to the Smith Douglas Homes Third Quarter 2025 Earnings Call and Webcast. As a reminder, this conference call is being recorded. I would now like to turn the call over to Joe Thomas, Senior Vice President, Accounting and Finance. Thank you. Please go ahead, sir.

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 third 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 home page. 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 good morning to everyone on the call today. In the third quarter of 2025, Smith Douglas Homes continued to execute on its long-term strategic plan of being the builder of choice for homebuyers in key markets throughout the South. Our operating philosophy is straightforward, but hard to replicate, thanks to our operating discipline and culture. We focus on providing our customers with quality homes at an affordable price while maintaining tight cost controls and leading cycle times. We also avoid much of the risk associated with homebuilding by controlling most of our lots and land through option agreements and by sustaining a strong balance sheet. These are key elements of Smith Douglas' strategy, and we believe they lead to superior shareholder returns over the long term. For the third quarter of 2025, we generated pretax income of $17.2 million and earnings of $0.24 per share. Home sales revenue came in at $262 million on home closings of 788 and an average selling price of $333,000. Gross margins on homes closed averaged 21% for the quarter. These results were largely in line with our previous guidance and demonstrate our ability to accurately forecast and execute on our stated objectives. Net orders for the quarter increased 15% year-over-year to 690 homes on a sales pace of 2.4 homes per community per month. Despite some tailwinds with mortgage rates trending down in the quarter, overall, demand stayed soft, which we believe is an indication that buyer psyche and consumer confidence are the main headwinds facing our industry. Financing incentives remain an important sales tool in getting buyers to move forward and purchase. And we expect this to continue into the fourth quarter. We continue to emphasize our approach of pace over price as we believe our operations run more efficiently at or near full capacity. We made further progress establishing a foothold in our new markets in the third quarter. We began vertical construction on homes in the Greenville market, started generating interest lists for our communities in the Dallas market, and expect the Gulf Coast market to be up and running in the middle of next year. These markets fit nicely into our business model and will be key contributors to our volume goals in the coming years. Cycle times in the third quarter were consistent with the second quarter at 54 days, excluding our Houston division. The efficiency of our operations is a key differentiator for our company, and it is a discipline we practice every day. It is a system senior management has developed and refined over decades in the homebuilding business and one that requires the coordination of our employees, suppliers, and trade partners. Overall, I'm pleased with how our company has performed in the third quarter and believe we made further progress towards becoming a large-scale builder in the Southeast and Southern United States. Our balance sheet is in great shape, and we have several new communities slated to open in the coming months that should give our sales efforts a boost as we head into our spring selling season. Finally, I would like to thank our team members for their continued hard work. Homebuilding is a very competitive business, particularly in uncertain times like the ones we're in today, and you've shown a willingness to go the extra mile for our homebuyers and our company's success. I truly appreciate all that you've done to make Smith Douglas a leading builder. With that, I'd like to turn the call over to Russ, who will provide more detail on our results for this quarter and give an update on our outlook for the fourth quarter.

Thanks, Greg. I'll now walk through our financial results for the third quarter and then provide an update on our outlook for the balance of the year. We closed 788 homes during the third quarter, down 3% from 812 closings in the same quarter last year. Home closing revenue was $262 million, a 6% decrease from $277.8 million in the prior year. Our average sales price was approximately $333,000, down 2.6% year-over-year due to slightly higher discounts and shifts in geographic mix. Gross margin came in at 21%, which was at the midpoint of our guidance range and compares to 26.5% in the prior year. Our lower year-over-year margin reflects the impact of higher average lot costs, which were 27.8% of revenue in the current quarter versus 24.8% in the year-ago period. Additionally, rising incentives and promotional activity further compressed margins. Closing cost incentives, which are included in the cost of sales, totaled approximately $9,500 per closing, up from $6,600 in the year-ago period, and pricing discounts were 1.8% of revenue, up from 1.2% last year. We utilized forward commitment programs to buy down interest rates, which we believe helped boost conversion rates. During the quarter, we recognized $3.9 million in costs on forward commitments, which is recorded as an offset to revenue versus $185,000 in the year-ago period and $0.9 million in the second quarter this year. We expect to continue to utilize these rate buydowns through the end of this year to drive sales velocity as we remain committed to our pace over price philosophy. SG&A was up approximately $2 million versus the prior year and was 13.8% of revenue compared to 12.3% last year, driven primarily by lower revenue this quarter and increased payroll and associated expenses with a sizable portion of the increase coming from the opening of our new divisions. Net income for the quarter was $16.2 million compared to $37.8 million in the prior year, and pretax income was $17.2 million versus $39.6 million. Our pretax income this period includes a $1.6 million charge related to the abandonment of a lot option deal with a land seller, which is included in other income and expense. Adjusted net income was $13 million compared to $29.9 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 5.9% 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 24.6% 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 $14.8 million in cash and had $49 million outstanding on our unsecured revolver with $201 million available to draw. Our debt-to-book capitalization was 11.2%, and our net debt to book capitalization was 8.4%, down 370 basis points sequentially from the second quarter. This improvement reflects our continued discipline in managing leverage and our commitment to maintaining a strong and flexible balance sheet. In a period marked by persistent macroeconomic uncertainty, we remain focused on fortifying our financial position to ensure we can navigate market volatility and capitalize on strategic opportunities as they arise. Backlog at the end of the quarter was 760 homes with an average sales price of approximately $340,000 and an expected gross margin of approximately 20%. Monthly sales per community went from 2.5 in July to 2.8 in August and 2.0 per community in September. In October, we saw that average stay constant at 2.0 sales per community. Turning to our fourth 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 18.5% to 19.5%. While incentives will continue to pressure margins, we are maintaining discipline in how and where we deploy them. We ended the third quarter with 98 active communities and expect to see that number remain approximately in line during the fourth quarter. 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 three quarters 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 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.

Our first question comes from Sam Reid from Wells Fargo.

And also, thanks so much for all the color on the discounts and forward commitment impacts to the top line and margin line. It's very helpful color. In terms of my question, I was just hoping if you could bridge the Q3 to Q4 gross margin and talk through the composition of perhaps incremental price discounting versus forward commitments. It does obviously look like you're planning to close houses below what's in your backlog. So, I would also just be curious in terms of the mix of homes you plan to close outside of your backlog during the fourth quarter, too?

Yes, that's a good question. We are continuing to offer incentives as we approach year-end to maintain our pace over price strategy. It's crucial for our operating philosophy that we keep this pace because we generate more and lose less when operating at full capacity. We assume we'll continue to drive this pace, especially given the uncertainty in the macro environment. As Greg pointed out, it's largely a matter of confidence with our buyers. Although we've managed the rate issue for some time, it seems to be getting a bit harder to get buyers to finalize their purchases. Therefore, we will keep pushing on rates and have introduced an appealing 3.5% fixed rate on some older specifications. That's our perspective moving forward. We have noticed that the costs associated with these forward commitments have decreased slightly in recent months as overall rates have lowered. Consequently, we're assuming we'll continue to offer incentives, preparing for the worst while hoping for the best.

And then maybe just switching gears a little bit on 2026. I know you're not providing guidance, but I would appreciate any high-level commentary on where we should be thinking about community count, especially regarding all the new divisional openings. Also, could you provide some perspective on lot costs as the composition of your geographic mix changes?

Yes, absolutely. Like most builders, it’s challenging to provide guidance for 2026 given the uncertainty. However, since we went public over 18 months ago, we have significantly increased our controlled lot count, nearly tripling it. This year, we've also seen substantial growth in our community count, ending the quarter with 98 communities. This positions us well for growth next year, potentially in the 10% to 20% range for community count. While we have the communities to support that growth, it heavily depends on market conditions and timely delivery of lots by developers. It is feasible to expect community count growth of 10% to 20%. The unpredictable factor will be the absorption rate of those communities and how that translates into sales and closings. I hope that provides clarity.

Our next question comes from Andrew Azzi from JPMorgan.

Backlog conversion is pretty elevated here compared to your own history and likely to remain pretty high next quarter or go higher. I would love to kind of just get some color on how you see that metric trending longer term and any structural factors there that are going on?

Yes, it's really a reflection of the current environment where competition is intense and there's a lot of inventory available. This is leading to significant discounting. As a result, we've been focusing on forward commitments, especially for our spec homes, to maintain a steady pace through our production process. Securing presales has been a bit more challenging lately because effective forward commitments typically involve a 60-day or shorter rate lock. This industry trend is pushing us towards a more spec-heavy strategy. We have introduced several presale incentives that we believe are quite competitive, aiming to shift back towards our presale strategy. Our main focus remains on preselling, but the environment is necessitating a greater reliance on specs. Consequently, we are seeing higher backlog conversions. Over the past quarter, we've concentrated on channeling incentives into presales through our lot reservation processes. We anticipate moving back to a presale focus as conditions improve, and with a diminishing emphasis on specs in the industry, our strategy remains intact. We are presale-oriented, though the competitive landscape has nudged us towards more specs.

That makes sense. And then obviously, you've seen a lot of growth in your active communities and controlled lots. Could you provide any detail on kind of the geographic distribution of those and how you're prioritizing market expansion?

Yes. As we mentioned when we went public, we aim to enter markets where we can achieve scale. Our approach involves operating in R-team philosophy geographic pods, each consisting of 200 closings. We strive to have at least 400 closings per division, with some larger markets like Atlanta, Houston, and Dallas exceeding that number. We are focused on establishing at least two full R-teams in those areas. We are particularly concentrating on markets like Charlotte, the Carolinas, and Nashville, where we have not yet reached that necessary scale. We've also opened new divisions, including a divisionalized Central Georgia, which targets areas south of I-20 in Atlanta, and we've made significant staffing increases in Chattanooga. Recently, we entered the Dallas market as well as the Gulf Coast of Alabama. We will continue to seek additional market share in areas where we already have established 2 full R-teams.

Our next question comes from Mike Dahl from RBC.

You've actually got Stephen Mea on for Mike Dahl today. The granular monthly and quarter-to-date demand trend discussion was all super helpful. Looking ahead, I wanted to ask what you all have built into your assumptions for the fourth quarter, more so the extent of how November, December may compare to what you've been seeing in October and how you see the balance of the quarter sort of shaking out against your historical seasonal patterns.

We haven't really changed our assumptions for the rest of the year. It's still a tough environment, but we are noticing some positive signs. Overall, it's decent; we have traffic, and people are still looking for homes. However, conversions are somewhat challenging, which is why we're focusing on incentives. We're not making any further assumptions about an increase in sales velocity. It's uncertain whether that will happen, and we're continuing to emphasize incentives. We're achieving our fair share, but it's difficult to predict at this time, and it's more of a week-to-week situation.

No, that makes sense. Thank you for the insight. My second question is more general regarding permitting. You've mentioned before that there are sometimes delays at certain municipal levels, depending on the location. I'd like to know how that has been progressing for you across your markets today, and if there have been any changes in that trend, especially considering the recent enthusiasm for potential relief in housing.

Yes. Thanks for the question. I'll take that up. We continue to see challenges and delays in permitting, both on getting final plan approval to start projects and then getting final sign-off on completing projects. And it's pretty widespread. It's across all our markets. I wouldn't say it's in any market more so than another, but we do see it less prevalent in the areas that may be truly outside of the metros that are a little hungry for having some stimulation from housing, but in more of the central metro markets, we're still seeing a lot of delays.

Our next question comes from Rafe Jadrosich from Bank of America.

Could you provide the specification versus build-to-order mix in your deliveries? Additionally, what is currently in the backlog? Also, is there any information on whether there is a margin difference between specification and build-to-order at this time?

Yes. I need to check on the exact percentage and don’t want to provide incorrect information. However, I believe there was a higher number of spec homes compared to presale ones in Q4 from a closings standpoint. It might be around 50-50, but it probably leans more towards spec. This reflects the current environment. Regarding the backlog, I need to look at the specifics, but considering its size, there’s likely more presale homes sitting in it, although not by a significant margin. Most of the specs in the backlog are probably no more than 60 days old. We aim to secure contracts on our homes during the process, particularly for finished specs. Even when we start a project, we work to get a contract in place before what we refer to as the line in the sand, which is essentially when drywall is installed. Historically, while we have been focused on presales (around 70% presale and 30% spec), over 90% of our homes had contracts prior to reaching the line in the sand. This shows a significant presale focus before that point. However, the environment has shifted somewhat. The market is changing, and we are starting to see spec levels decrease among other builders, which will also influence our situation. I believe this trend will revert to our advantage over time.

With regard to the growth in community count for next year, how should we view the SG&A run rate moving forward? Should we consider that SG&A will increase in line with the growth in community count? I am trying to grasp the implications of the new market expansion.

Yes. We're currently in the budgeting process, so I can't provide a specific answer. However, I can say that we will continue to leverage our fixed overhead, as we have all the necessary support infrastructure in place, including corporate support, HR, legal, and finance. This allows us to manage a significant volume of operations above our current levels. Additionally, our variable SG&A expenses, such as commissions and community-level marketing, will generally align with community count and sales starts and closings. I anticipate some leverage as we move into next year.

Our next question comes from Paul Przybylski from Wolfe Research.

Thanks for the monthly order cadence. I was wondering if you could add some further color. How did incentives flow monthly through the quarter? And then regarding your forward commitment, how is the spread? Have you maintained that spread to market or widened it or tried to contract it? And then again, with absorptions at 2 in September and October, do you have a minimum absorption pace you're targeting?

Yes. I'll address the last question, which is straightforward. More absorptions are expected this spring selling season, where we anticipate a higher pace. If we could achieve 2.5 to 3 for the quarter, that would be reasonable, while 2.5 to 3.5 would be a better estimate for Q4. We are actively working to increase our absorption pace, though it may affect our margins. In Q3, we leaned into forward commitments, and costs certainly decreased as interest rates dropped, which benefited us with lower costs for these commitments. However, we also increased incentives to encourage absorption, which meant that any gains were somewhat offset by these higher incentives, especially for older inventory. We are focused on selling off aged specifications quickly. Last week, we experienced a nice uptick in absorption pace, which I had not mentioned in my opening comments. Incentives definitely increased during the quarter. We'll see how the remainder of the year unfolds, but our approach is to prioritize pace over price, and we will continue utilizing incentives to drive that pace.

Okay. And then I guess, as you look at your consumer mix, you've got entry-level some downsizers, active adults, however you want to define it. Are you seeing any shifts there? I mean what I'm really asking, I guess, are you seeing any type of hesitation or cancellations with the downsizers or active adults because they just can't sell their home for what they're looking to get out of it?

Yes, we are definitely noticing a significant number of buyers, and as a result, we have a number of specifications impacted by contingencies that aren't being completed. I've recently heard that for the first time in a long while, new homes are priced lower than resales, which is creating challenges. The move-up buyer isn't a large group for us, but the move-down buyer is quite significant, and they are still facing difficulties.

We have no further questions. I would like to turn the call back over to Greg Bennett for closing remarks.

Thank you, everyone, for joining us today and your interest in Smith Douglas. Hope you have a great day and look forward to visiting after Q4.

This concludes today's conference call. Thank you for your participation. You may now disconnect.