Smith Douglas Homes Q1 2024 Earnings Call Transcript

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May 14, 2024

There are 10 speakers on the call.

Operator

Good day, everyone. My name is Emily, and I will be your conference operator for today. At this time, I would like to welcome everyone to the Smith Douglas Homes First Quarter 20 24 Earnings Call and Webcast Conference. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.

Operator

Thank you. I'd now like to hand over the call to Eddie Clyde. Eddie, you may now begin your conference.

Speaker 1

Good morning, and welcome to Smith Douglas' earnings conference call. We issued a press release this morning outlining results for the Q1 of 2024, which we will discuss on today's call and can be found on our website at investors. Smithdouglas.com or by selecting the Investor Relations link at the bottom of our homepage. Please note this call will be simultaneously webcast on the Investor Relations section of our website. Before the call begins, I would like to remind everyone that certain statements made on this call, which are not historical facts, including statements concerning future financial and operating goals and performance, are forward looking statements.

Speaker 1

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 Web site and our SEC filings. Hosting the call this morning are Greg Bennett, the company's CEO and Vice Chairman and Russ Sevendorf, our Executive Vice President and CFO. I'd now like to turn the call over to Greg.

Speaker 2

Good morning, and thank you for joining us as we go over our results for the Q1 of 2024 and provide an update on our operations. Met Douglas Homes has generated pre tax income of $21,400,000 in the first quarter

Speaker 3

and a

Speaker 2

$0.33 per diluted share. Home sales revenue came in at 189,000,000 dollars on a 13% increase in deliveries and new orders totaled 765 on a sales pace of 3.6 homes per community per month, while our cancellation rate remained low at 10.6%. Our closings and order results came in over the high end of our prior guidance as our teams did an excellent job selling and closing homes during the quarter. We continue to see favorable homebuilding conditions in our markets and thanks to low levels of existing supply and positive demand drivers including healthy job creation, in migration and new household formation. The lock in effect from higher mortgage rates continues to keep existing homeowners in place, which has pushed a greater percentage of the buyers into the new home market.

Speaker 2

We believe this dynamic will be in place for some time, creating a real opportunity for homebuilders to take market share. Our focus remains on the more affordable segments of the market, which is reflected in our average sales price of $334,000 for the quarter. We believe it is the most supply constrained segment of the market and most attractive from a buyer demographic standpoint. We cater our home offerings to entry level buyers and in the nesters who are looking for customizable home at an affordable price. This strategy is not only resulted in strong volume growth for our company over the years, but also healthy profitability as evidenced by our homebuilding gross margin of 26.1% for the quarter.

Speaker 2

We continue to employ a landline strategy with 95% of our lots controlled via option agreement at the end of Q1. Through our strong relationships with land bankers, land sellers and developers, we strive to acquire lots and adjust in time basis. This allows us to turn our inventory more quickly and focus on what we do best, which is build and sell homes. It also allows us to use our capital more efficiently and mitigate some of the risk associated with land development. Our build times in the quarter were in line with expectations at approximately 60 days.

Speaker 2

Through our Smart Builder ERP system and our team construction process, we strive to set standard of excellence for homebuilding efficiency. This is a standard that our leadership team has refined over several decades in the business and one that requires the coordination of a number of people both inside and outside the organization. We consistently look for ways to reduce cost and number of days it takes to build a home and believe our efficient approach to homebuilding is a key differentiator for our company. The net result of our affordable product focus, our land life strategy and our proprietary building process is a return on equity profile that ranks at the high end of Public Builder Peer Group. We believe our approach to homebuilding can be replicated in a number of markets throughout the Southeast and have begun to expand our footprint this quarter by contracting for lots in Central Georgia in Houston County, which includes Perry and Warner Robins and in Chattanooga, Tennessee and surrounding submarket.

Speaker 2

We plan to initially leverage our expansive Atlanta division operations as we build out our teams in these markets until we eventually drive enough scale to create separate divisions. As we've discussed in the past, our plan is to expand our geographic footprint both organically and through strategic M and A if the opportunity presents itself. Our integration of Devon Street Homes in Houston is progressing as the team has embraced the Smith Douglas way of doing business and we couldn't be more pleased with how it has been going. Overall, we feel good about the current state of our operations and we saw solid and improving sales and traffic trends throughout the Q1. Thus far, order trends have remained good through April May, although slightly below the absorption pace we saw in March.

Speaker 2

That said, while buyers appear to have adjusted to the idea of rates will likely be higher for longer and our ability to offer financing incentives has been a key factor to addressing affordability concerns. We remain cautiously optimistic about the strength of the housing market and the general economic conditions for the balance of the year. With that, I'd like to turn the call over to Russ, who will provide some additional color on our results this quarter and update our outlook.

Speaker 4

Thanks, Greg. I'm going to highlight some of our results for the Q1 and conclude my remarks with our expectations and outlook for the Q2 and full year of 2024. As Greg mentioned, we finished the quarter with $189,000,000 of revenue on 566 closings for an average sales price on closed homes of 334,000 dollars Our gross margin for the quarter was 26.1 percent and SG and A was 14.6 percent of revenue. We finished with $21,400,000 of pre tax income. Given the nature of our Upsea organizational structure, our reported net income is $20,500,000 which reflects an effective tax rate of 4.3% on the face of our financial statements.

Speaker 4

It should be noted that this income tax expense is attributable to Smith Douglas Homes Corp, which controls the 17.3 percent economic ownership of our public shareholders and Smith Douglas Holdings LLC and not the non controlling interest, which is the 82.7 percent economic ownership controlled by our continuing equity owners as documented in the footnotes of our financial statements. Our adjusted net income, which is a non GAAP measure that we believe is useful given our organizational structure, was 16,100,000 dollars and assumes a 25% blended federal and state effective tax rate as if we had 100 percent public ownership operating as a Subchapter C Corporation. We believe adjusted net income is a useful metric because it allows management and investors to evaluate our operating performance and comparability more effectively to industry peers that may have a more traditional organizational and tax structure. Our cost of sales for the period includes the amortization of approximately $100,000 of purchase accounting costs attributable to the acquisition of our Houston operations, Devon Street Homes. Additionally, SG and A for the period includes a one time expense approximately $100,000 related to the write off of loan costs attributable to our amended and upsized unsecured credit facility that we closed concurrent with our IPO and $900,000 of non cash stock compensation expense related to the staking grants we made to all of our full time employees at the time of our IPO in January.

Speaker 4

We finished the quarter with over 14,000 total controlled lots, an increase of 86% over the Q1 of 2023 and just over 10% from our prior year end. Our Corporate Investment Committee, which meets every week to review and approve new land deals, continues to remain busy as we focus on increasing market share and driving scale throughout our existing footprint. True to our landline operating philosophy, only 693 of our controlled lots were owned, unstarted, meaning that 95% of our controlled lots were either work in process or under option. In a normalized market, we would expect our lot supply to stay within a targeted range between 3.5 to 5.5 year supply calculated based on our forecasted closings over a rolling 12 month period. We finished the Q1 with 11 10 homes in backlog with an average selling price of 340 $3,000 and expected gross margin on those homes of approximately 26.5%.

Speaker 4

As we sit here today, we are currently operating out of 71 active communities versus 70 at the end of the quarter. Looking at our balance sheet, we ended the quarter with approximately $33,000,000 of cash and no borrowings under our $250,000,000 revolving credit facility. We finished with $333,000,000 of total members and stockholders' equity, which includes $116,000,000 of net proceeds from our IPO after underwriting and professional fees. Our debt to book capitalization was 1.3% and our net debt to book capitalization was negative 9.4%. We had approximately $188,000,000 available on our unsecured credit facility and are well positioned to execute on our growth strategy as Greg previously mentioned.

Speaker 4

Now I'd like to summarize our outlook for the Q2 and full year for 2024. We anticipate our 2nd quarter home closings to finish between 60 between $335,000 $340,000 with gross margin in the range of 25.5% to 26.5%. For the full year 2024, we reiterate our prior guidance of projected total home closings between 2,600 and 2,800 homes and now expect our average selling price to range between $338,000 to $343,000 We project home closing gross margin to finish between 25.75 percent to 26.75 percent inclusive of any purchase accounting adjustments from our Devon Street acquisition, which we expect to be less than 25 basis points of revenue given our final purchase price allocation. Additionally, we expect our SG and A expense ratio to be in the range of 13.75 percent 14.25 percent for the full year, which includes approximately 4.2% for internal and external sales commissions. We believe the primary risk to our projections are around our ability to maintain sales pace and bring our new communities and lots online.

Speaker 4

As I mentioned on our prior call, we continue to see some delays with municipalities on permitting and flats. Macroeconomic factors primarily around jobs, inflation and interest rates could also have unforeseen impacts to our numbers. With that, I'd like to turn the call over to the operator for instructions on Q and A.

Operator

Thank you. We are now opening the floor for question and answer session. Our first question comes from Sam Reid from Wells Fargo. Your line is now open.

Speaker 5

Awesome. Thanks so much guys. I wanted to unpack the order trends you highlighted on April May in a bit more detail. I think you mentioned the absorption rate might have been a bit below what you saw in March.

Speaker 6

So can you just give us a sense as

Speaker 5

to how this compares to what you've seen in a typical April, May period? And then along those lines, kind of any sense as to what foot traffic might be looking like in your model homes relative to expectations?

Speaker 7

Yes. I'll give you some of the specific numbers through the quarter and kind of what we're seeing and then maybe Greg can give you some color just on how this plays into typical seasonality. So through the Q1, we saw sales and traffic trends continue to improve throughout the quarter. And again, part of that, I believe, is seasonal as we got deeper into the selling season. So March was the strongest quarter strongest month.

Speaker 7

It was about a 4x I think we had 4 sales per month. February was about 3.6 and then January was just slightly lower. And so then moving into April, we were back down to a 3.6 sales per community. And May is trending very consistent with what we saw in April. So it's still good, right?

Speaker 7

The traffic is still good, but March was March did pop a bit. But again, it's hard to say, at least from my perspective, that's just kind of a little more seasonality where maybe we kind of peaked in March and as we get through selling season it's coming back a bit. But we had some rates were a little bumpy, but traffic trends have been good throughout the quarter and they continue to foot traffic is real good. So Greg, if you get

Speaker 2

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

Speaker 5

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

Speaker 5

Just want to make sure I fully understand that. Thanks a ton.

Speaker 7

Yes. Thanks, Sam. The margin really we finished our purchase accounting. So when we had our call, we were about a week from finalizing our 10 ks. And so we did finalize some purchase accounting.

Speaker 7

We had some changes to our goodwill number on Devon Street in that last week subsequent to our call. And so we now think based on the final purchase price allocation that that impact or those headwinds from purchase accounting are going to be less than what we had originally guided to. So it's I think we had said something about 50 basis points. Now I think it's going to be 25 basis points or less. We did book a little more goodwill, which reduces the allocation to the real estate inventory.

Speaker 7

So yes, I think the margin when you roll all that together, our gross margin guidance really hasn't changed from last period, our guidance last time. So we do think kind of like we said 25.75% to 26.75%. I think somewhere in there, 26% range would as we sit here today, I think that's kind of if you took the midpoint, I think that's a fair estimate. But we'll see. We still have some sales in closings that we've got to continue to fill with backlog to get to our numbers, but where we sit today.

Speaker 7

And as we mentioned or as I mentioned on the call, our backlog margin is 26.5% right now. So we feel good about it. Anything can happen with the additional sales and that we need to get to fill out the year, but hopefully that answers your question.

Speaker 5

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

Speaker 3

Thanks, Sam. Thanks, Sam.

Operator

Our next question comes from Mike Dahl from RBC. Your line is now open.

Speaker 3

Hi, it's actually Chris Kwan on for Mike. Just a follow-up on the gross margin comments. I think I said it seems like outside of Devon Street, not much changes. How are you guys thinking about pricing and incentives into the rest of this year? Kind of what's being baked in, in terms of your guide last quarter or this quarter?

Speaker 3

Has there been any changes there? Just if you could talk a little bit on that, that would be helpful.

Speaker 2

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

Speaker 3

Got it. Okay. So no change

Speaker 4

in the back half and

Speaker 3

it sounds like so far this quarter, your quarter to date it's been stable?

Speaker 7

Yes, it's been consistent. We've what we saw in the Q1 has trended through this part of the second quarter. And as we as we sit here today, don't expect much change in that. But I think a lot is going to be dependent on rates and what happens. I mean it's also an election year, so we'll see.

Speaker 7

But like we mentioned 26.5% is what we're sitting with our backlog, which takes up a good portion of what we'll close for, if not all of that through the balance of the year. So we've already got a good portion of that baked. But yes, I think as current sales trends are pretty consistent with what we've been seeing. I don't expect much change in discount.

Speaker 3

Got it. Okay. Appreciate that. And just as a follow-up, I was hoping you guys could touch on your community count growth outlook. Has there been any changes there?

Speaker 3

I know you guys announced kind of new entrants to new markets. So just relative to your expectation, has there been any changes in community out ramp, whether that be delays or kind of new openings?

Speaker 7

Yes. As we sit here today, no changes from what we discussed on the roadshow. I can't remember. I think expect to end somewhere in the 70s, mid to high 70s, maybe we'll get to 80. But we had expected community count to peak a bit and then maybe pull back through the Q4.

Speaker 7

But like I said, our expectations are consistent with what we thought coming into the beginning of the year.

Speaker 3

Understood. Appreciate all the color.

Speaker 7

Yes. Thanks, Chris.

Operator

Our next question comes from Ralph Giacic from Bank of America. Your line is now open.

Speaker 8

Hi, good morning. It's Rafe. Thanks for taking my questions.

Speaker 7

Hey, Rafe. How are you doing?

Speaker 8

The first, I just want to Russ, I just wanted to clarify. I think you said the gross margin in your backlog was 26.5%. Did I get that right? Yes, 26.5%. Got it.

Speaker 8

So the just for the gross margin, how long will that take you? Is that basically is your backlog probably 1 or 2 quarters out? Just how much of that is how long will that backlog carry you this year?

Speaker 7

Yes. So if you do the math, so we closed 566, you've got there's 1100 in backlog. So yes, the next couple of quarters that will go through if not and stuff we're selling today, what we've continued to sell in the second quarter is stuff that will close that we sold earlier would close kind of end of quarter into next quarter. So, yes, most of that should be through Q3.

Speaker 8

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

Speaker 7

Yes. It's been pretty consistent. Yes.

Speaker 3

Got it. Okay.

Speaker 8

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

Speaker 8

And then just what level of inflation are you assuming in your guidance?

Speaker 2

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

Speaker 2

So there is a great deal of pressure on those.

Speaker 8

Got it. That's helpful. But not something that flows through P and L until 'twenty five or it sounds like second half of 'twenty five?

Speaker 2

Yes, it would be back half of 'twenty five.

Speaker 8

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

Speaker 7

Yes, sure. Margins are coming in better than we probably anticipated. Part of that is due to the purchase accounting. So we did not allocate as much to inventory which would have been a drag on some of the margins that we'd see over the really the 1st 12 months as we work through their work in process and some of the lots that they had on the books. But it's coming around, it's in the mid-20s, 24%, 25% range in Houston.

Speaker 7

And that's with us pushing more volume. Prior to us acquiring Devon Street, they were probably a little more focused on margin. But I'd tell you, we've implemented some of our sales tools. We're pushing down our ERP, our CRM tool. We're really pushing leads and doing more marketing in Houston and so we couldn't be more happy with how that's progressed from both the sales side and the strength of sales.

Speaker 7

And I think Houston just in general has been good through this selling season. But we've been really pleased with how well in addition to pushing volume that we've been able to hold some pretty good margins. So it's really a credit to that team. And again, as Greg said, they've really embraced the Smith Douglas way of doing business. And so we're couldn't go as probably couldn't have gone any better.

Speaker 7

So real happy with it.

Speaker 8

It.

Operator

Our next question comes from Alex Barron from Housing Research Center. Your line is now open.

Speaker 6

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

Speaker 7

Yes. So on a basic and I won't get and we can take it offline, but I'll give you a high level. On a basic EPS calculation, you're taking the public shares against just the income allocated to Smith Douglas Homes Corp. So on the face of the financials. So that calculation is based on that.

Speaker 7

And then when you look at the dilution, the diluted EPS takes into account if the B shares converted to A shares and so there is a calculation that actually takes a different estimate. So it's a little complicated on the face of the financials, but Alex we can walk you through the details offline.

Speaker 6

Okay. I'll call you guys afterwards to go through that. And in terms of incentives right now, what have you guys seen after the end of the quarter?

Speaker 9

Have you

Speaker 6

guys maintained the incentives roughly the same or been able to decrease or had to increase given that rates kind of went up a little bit in April?

Speaker 2

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

Speaker 6

Okay, great. Thank you.

Speaker 2

Thanks.

Operator

Our next question comes from Jay McCanless from Wedbush. Your line is now open.

Speaker 8

Yes, it

Speaker 9

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

Speaker 9

What was going on with some of the older legacy Smith Douglas markets?

Speaker 7

Yes. We were about flat, few closings down when you exclude Houston. But I think it's a couple of things. Atlanta last year came in with a really strong quarter and then we've gapped out in some communities specifically in Nashville. So that's it's nothing it's not a demand thing I would say.

Speaker 7

Yes, it's flat gaps in getting kind of our plots and timing of communities coming online. So that's what's going on there. Like we said, we reiterated the 26 to 2,800. So we're hoping that we're getting community count back up. But as I mentioned we're still seeing and as Greg mentioned we're still seeing that has always been outside of market risk, just timing of developments been the other risks that we've been most concerned with.

Speaker 7

Got it. Okay.

Speaker 9

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

Speaker 7

Part of it's just trying to be a little conservative. We don't want to disappoint you guys. But yes, look, we just I think it's mostly that. And then as we talked about just filling out the rest of the year in terms of the sales and what we still need to sell and close, We feel pretty good. Like we said, incentives, we're staying pretty consistent.

Speaker 7

But we do want to and we're pleasantly surprised with Houston, but I do feel like in order to continue to drive scale, to drive some volume as we look into the back half of the year and into next year, in addition to the land and lot costs that we're seeing, I think maybe there's a little margin compression there as we try and drive a little more volume, right, and keep our cycle times moving and our teams full. So that's just generally where I see some margin compression. But yes, for Q2, we should I'd be surprised if we're not at 26% or better.

Speaker 9

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

Speaker 2

Yes. Good morning, Jay. It's gone really well. Tom and I were able to travel to Houston a few weeks ago and we launched with a complete trade force there in Houston and kind of had a standing room only group there to roll out to with our trades and it's been really welcomed. We did a lot of Q and A there and seems to be well embraced.

Speaker 2

We've had our sales processes converted over here in the past couple of months and I would say things are going better than we could have anticipated and we're optimistic that will be very strong by the end of the year. Okay, great. That's all I had. Thanks guys.

Speaker 3

Thanks, Jay. Thanks.

Operator

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

Speaker 2

Yes. Thank you. So that will conclude our call today. We want to thank you for joining us.

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