Earnings Call Transcript - SDHC Q1 2025

Operator, Operator

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. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. Thank you. I would now like to turn the call over to Joe Thomas, SVP of Accounting and Finance. Please go ahead.

Joe Thomas, SVP of Accounting and Finance

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 filing. 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 filing. 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 would now like to turn the call over to Greg.

Greg Bennett, CEO and Vice Chairman

Thanks, Joe, and good morning to everyone. Smith Douglas Homes hosted another quarter of strong profitability to start the year, generating pre-tax 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 am 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 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 provide monthly payments that would fit our buyers’ needs. While there are many factors that affect our business that 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 our balance sheets, while the remainder was tied up through options and land banking agreements. This land strategy gives us some degree of flexibility with respect to our lot takedown timing, if 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 timeframe between sale and close. At the end of the first quarter, our cycle times averaged 56 days, excluding Houston. We also made further progress during the quarter getting the Houston division and their trade partners on board with The Rteam platform, and we expect to see build times move closer to the company average over time. A third factor we focus on at Smith Douglas is limiting the amount of spec inventory for sale in our communities. We believe our business runs better when we pre-sell 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 in our communities, which we believe 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 would 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.

Russ Devendorf, Executive Vice President and CFO

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 pre-tax 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 the $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 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 D members, which is shown as income attributable to non-controlling interests 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, increase the total facility size by $75 million to $325 million and extend the maturity, which will be four 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 progressed 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 three sales per community as we move further into the spring selling season. Affordability remains a key challenge for our buyers, and we have leaned into targeted incentives to support sales. In late March, we launched a $10 million forward commitment program offering a 4.99% mortgage rate buy-down 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 landline 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, Operator

Thank you. Our first question comes from the line of Michael Rehaut with JPMorgan. Please go ahead.

Alex Isaac, Analyst

Hi. Good morning. This is Alex Isaac on for Mike. Thanks for taking my question. You mentioned on the demand side that there’s some weakness and a lot of affordability challenges. I wanted to ask how you would characterize the spring and summer season overall and your expectations for that? Also, do you feel like that demand weakness is consistent across geographies or do you see it more specifically in certain geographies than others?

Greg Bennett, CEO and Vice Chairman

Yeah. 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. It seems to be across our entire footprint, demand has been relatively the same.

Alex Isaac, Analyst

That makes a lot of sense. I appreciate the color on that. And then, as my follow-up question, I wanted to ask about 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?

Greg Bennett, CEO and Vice Chairman

We have been successful in finding deals and have more than doubled our controlled lot count since going public. Land prices have continued to rise over the past year. Historically, land sellers are often the last to realize that their land may not be worth as much as before, but we are beginning to see some signs of this. The market is shifting towards favoring buyers, and we are observing some moderation in land prices. There is still demand, as builders are actively seeking deals, and we face competition daily. However, the land in our backlog has a higher cost basis than what we had previously. We are starting to gain some negotiating power in certain land deals, and we hope this trend continues, particularly as affordability remains a challenge.

Alex Isaac, Analyst

That makes a lot of sense. I appreciate all the help.

Greg Bennett, CEO and Vice Chairman

Sure.

Operator, Operator

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

Stephen Mea, Analyst

Hey. Good morning, everyone. You guys actually got Stephen Mea on for Mike today. Thanks for taking my question.

Greg Bennett, CEO and Vice Chairman

Sure.

Stephen Mea, Analyst

I wanted to start with the outlook beyond Q2. I appreciate the macro outlook has gotten a lot murkier since we last spoke, but I just wanted to get a sense of how you guys are formally thinking about the guideposts you’ve been giving us for the full year. I believe it was around 3,200 homes, just beyond the second quarter. What do you guys have in mind? How are you guys thinking about that? Thanks.

Russ Devendorf, Executive Vice President and CFO

I wish we had a perfect crystal ball. That’s why we didn’t provide specific guidance. When we discussed this at the end of last year and as the Fed began to cut rates, we were optimistic that it would improve affordability. However, as we entered the first quarter, mortgage rates were not favorable and peaked in January. Currently, the 10-year yield is around 4.5%, making affordability a challenge. As Greg mentioned, there is still demand for homes. Regarding our full-year guidance, this is why we chose not to set it. It's really a day-to-day situation as we navigate the macro environment. We have the communities and lots needed to achieve our target of 3,300 closings. A lot will depend on how the selling season progresses and the demand in the latter half of the year, particularly concerning affordability and our response. We are working to balance margins with our incentives to find the right mix. While I can’t provide specific guidance, we are aiming for that 3,300 target and I believe we can reach it, but it heavily relies on the broader economic conditions.

Stephen Mea, Analyst

Definitely appreciate that. I also appreciate all the color. Thanks for that. And I wanted to jump 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 since the acquisition on the Rteam integration in Houston. But I think it would 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 timeframe you may have for milestones there within Houston and the other expansion areas, which we really also think?

Greg Bennett, CEO and Vice Chairman

Yeah. Thanks for the question. We are seeing really big improvements in cycle time in Houston. We’re up and running in our arching process across the footprint. We are currently on a 70-day schedule 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, yeah, and that’s from a high point of cycle time near 200 days when we closed on that acquisition. So I’d say there’s been quite a bit of improvement there.

Stephen Mea, Analyst

Yeah. Absolutely. Thanks. Thanks for the question, guys. I will pass on. Thanks, Greg.

Operator, Operator

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

Jay McCanless, Analyst

Thanks. Good morning, everyone. So three 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?

Greg Bennett, CEO and Vice Chairman

I think it’s been pretty consistent with April. We haven’t seen any real shift. People are still coming into the sales office, and we’re seeing traffic, but it remains a challenging environment regarding affordability. Additionally, from a competitive standpoint, many new homebuilders are offering significant incentives and there’s a lot more spec inventory available. So it’s challenging, but I don’t see a substantial difference from what we observed in April.

Jay McCanless, Analyst

Okay. And so not to harp on it, but are you guys pulling the fiscal 2025 guidance or do you still think you can hit some of the targets that you laid out last quarter?

Greg Bennett, CEO and Vice Chairman

I think regarding the last question, we have the community count and the lots ready. We prefer not to comment specifically, but our target remains at 3,000 to 3,100. If the macro environment improves and stabilizes, we believe we have a good chance of achieving that goal. However, there are factors beyond our control. Some of our competitors and new builders have reduced their guidance, and it is still early to assess the situation given the current dynamics. The new administration has introduced some volatility from a macro standpoint, making forecasting challenging in this environment. Nonetheless, our goal remains, and we still feel optimistic about reaching our target of over 3,000.

Jay McCanless, Analyst

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

Greg Bennett, CEO and Vice Chairman

No, we typically don’t comment on others' transactions, but I would say that it's Apollo backing this move, which indicates strong support from a reputable investor who clearly sees an opportunity in the homebuilding sector. We find that encouraging, and it won’t affect us as we don’t have any presence of Lance or New Home in our markets.

Jay McCanless, Analyst

Okay. Great. Thanks, Greg.

Greg Bennett, CEO and Vice Chairman

Sure.

Operator, Operator

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

Rafe Jadrosich, Analyst

Hi. Good morning. It’s Rafe. Thanks for taking my question. 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?

Russ Devendorf, Executive Vice President and CFO

Yeah. 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. Yeah.

Rafe Jadrosich, Analyst

Okay. The backlog is down over 25% year-over-year, yet you have managed to increase deliveries. The backlog conversion has significantly improved this past year. Where do you see that going from here? Is there more potential to further enhance backlog conversion, and is there a limit to that? You will need to replenish the backlog with new orders to keep increasing deliveries.

Russ Devendorf, Executive Vice President and CFO

That's a great observation. There are a few factors at play. Our cycle times are getting better, but we've started with more specifications than last year. So even though our backlog is down, we actually have a similar amount of inventory, if not slightly more. As Greg mentioned, there is demand; people are visiting our sales offices, and we're seeing traffic. However, it requires higher incentives to encourage conversions, which is why our margins are experiencing a slight decline. Despite that, we're still achieving strong closing numbers. While our backlog is lower and our business model traditionally emphasizes pre-sales, we still have sufficient inventory. We're operating effectively across the board and are taking a careful approach to pricing. Our aim isn’t to indiscriminately fill our spec inventory. As we observe potential slowdowns in certain communities, we can adjust our incentives to help move the inventory. In summary, we can certainly increase our backlog conversion rate as we continue to make adjustments and manage the speculative inventory in those communities.

Rafe Jadrosich, Analyst

Okay. That’s helpful. Appreciate all the color, guys.

Greg Bennett, CEO and Vice Chairman

Thank you.

Russ Devendorf, Executive Vice President and CFO

Yeah. Thanks, Rafe.

Operator, Operator

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

Greg Bennett, CEO and Vice Chairman

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.

Operator, Operator

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