Smith Douglas Homes Corp. (NYSE:SDHC) Q4 2023 Earnings Call Transcript

Smith Douglas Homes Corp. (NYSE:SDHC) Q4 2023 Earnings Call Transcript March 20, 2024

Smith Douglas Homes Corp. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning. My name is Dennis, and I will be your conference operator today. At this time, I would like to welcome everyone to the Smith Douglas Homes Fourth Quarter and Full Year 2023 Results Conference Call. 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 Instructions] I would now like to turn the conference over to Eddy Kleid, Vice President of Finance. Please go ahead.

Eddy Kleid: Good morning, and welcome to Smith Douglas’ first earnings call as a public company. We issued a press release this morning outlining some of the 2023 results we will discuss on today’s call 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 we begin, please note that the discussion today includes forward-looking statements within the meaning of the federal securities laws, including but not limited to statements about our ability to maintain our reputation for high quality construction and customer satisfaction, our growth plan, the pursuit of strategic opportunities and our future operations and financial performance, including our outlook for the first quarter of 2024 and full year of 2024.

These and other forward-looking statements are based on management’s current assumptions and are neither promises nor guarantees and are subject to a number of risks, uncertainties and other important factors that may cause actual results to differ materially. These forward-looking statements speak only as of the date of this call, and Smith Douglas assumes no obligation to update such statements based on future developments or otherwise. We direct you to the company’s most recent SEC filings, including the factors discussed under the caption Risk Factors in our final prospectus filed with the SEC on January 10, 2024, in connection with our initial public offering. For additional discussion of important factors that could cause actual results to differ materially from those in the forward-looking statements.

The company will also discuss certain non-GAAP financial measures, including adjusted net income during today’s call. You can find a presentation of the most directly comparable GAAP measures and a reconciliation of those measures in our earnings release, which is available on our Investor Relations website. Now I’ll turn the call over to our CEO and Vice Chairman, Greg Bennett.

Greg Bennett : Thanks, Eddy. Good morning and thanks for joining Smith Douglas inaugural earnings call as a publicly traded company. With me today, I have our Founder and Executive Chairman, Tom Bradbury; and our EVP and CFO, Russ Devendorf. Before Russ and I share 2023 results and provide some color into our outlook for the Company, I want to turn it over to Tom to say a few words.

Tom Bradbury : Thank you, Greg. I’d like to take this opportunity to thank everyone involved in our IPO process for their support and believing in us as we start our journey as a public company. The demand and positive feedback we received from the investor community was humbling. I’ve been in this business for 50 years and never been more excited about all the opportunities we have in front of us to grow our business for many years to come. Having started my first homebuilding company, Colony Homes, back in 1975 and forming one of the largest southeastern regional builders at the time. I had the chance to learn a lot of lessons prior to the Colony sale to KB Home in 2003. This experience helped me set the DNA, but what I wanted to create when I started Smith Douglas Homes just over 15 years ago.

As I mentioned during the road show and what Greg will discuss here in a minute, we believe it’s our people, our processes and our systems that help make us special and set us apart from our competition. More importantly, it provides us the ability to deliver quality, affordable homes to our buyers with many options and choices. Lastly, I’d like to recognize and thank all Smith Douglas associates. I am blessed to have the opportunity to work with such professional and caring group of individuals. They are the key to our success and the heartbeat of our culture, which is defined by our mission, vision and value statement in what we call our house. We aim to enhance people’s quality of life with every home we build and everything we do from our associates, our homebuyers, our business partners and all Smith Douglas associates embrace the saying, good, better, best.

You never let it rest till the good is better and the better is best.

A builder wearing a hard hat admiring a newly constructed smart home.

Greg Bennett : Thanks, Tom. Before I get into our 2023 results, I first wanted to give a brief overview of Smith Douglas and the key components of our strategy that we believe set us apart from the competition for those who may not have had the opportunity to hear our pitch during the IPO. Smith Douglas was founded in Atlanta in 2008. As Tom mentioned, he immediately set about employing the lessons he had learned over the course of his career, building a company that not only excelled in building high quality homes, but also one that aim to deliver outsized returns on capital. There are several keys to achieving these goals. The first was the establishment of a culture that emphasized integrity, teamwork and accountability. We believe we hold ourselves to a higher standard at Smith Douglas, and this is reflected in the homes that we build and the operational success that we’ve achieved.

These core tenants are the foundation of our company and continue to guide the way we do business to this day. Our organization is only as good as its people and culture, and we believe we have the best in the business. The second key to our success was our mandate in building affordable long-lasting homes that our customers are excited to live in. Despite our focus on affordability, we pride ourselves on building differentiated homes that allow for personalization according to a buyer’s wants and needs. And we established a reputation for quality, construction and high levels of customer satisfaction in our markets, and we intend on maintaining the reputation into the future. Another key to our success has been our emphasis on operational efficiency.

Through the implementation of our SMART Builder and Rteam platforms, we have been able to streamline the process of building and closing homes, leading the cycle times and inventory turnover rates that are some of the best in the industry. This requires the coordinated efforts of everyone involved in the homebuilding process, both internal and external to our organization, and we are proud of the operational machine that we have built. The final pillar of our strategy was to establish and maintain a landline balance sheet. One of the important lessons from the last downturn was that much of the risk and potential for financial ruin in this business stem from carrying and developing land, so we strive to take ownership of our lots in a just in time manner.

This strategy not only limits our operational and financial risk, it also leads to enhanced returns on capital. We also believe this moves out some of the variability that is associated with our industry. Since our founding in 2008, we went on to expand our operations into Raleigh, Birmingham, Huntsville, Nashville, Charlotte and most recently Houston, demonstrating that the operational philosophies are repeatable and scalable, while delivering outsized growth, profit margins and returns. We believe we can continue to grow in a profitable manner through organic expansion within our existing markets and through additional M&A activity. In terms of our performance in 2023, Smith Douglas delivered pretax income of $123 million. Home sales revenue grew by just over 1% year-over-year due to a 4% increase in home closings, partially offset by a 3% decrease in average sales price.

Our home closing gross margin came in at 28.3%. Net orders for the year were up 2,368, up 23% year-over-year and ended the year with 912 homes in backlog with a contract value of $311 million, a 20% increase over the previous year. Our cycle times are currently running around 60 to 65 days across all of our divisions outside of Houston, which we acquired last July. For 2023, our inventory turnover was 3.4 times, excluding the effect of our Houston acquisition. We continue to integrate Houston on our platform and processes and are targeting midyear having it fully operational on our SMART Builder ERP system. We are pleased with the performance thus far and look forward to increasing our market share. Overall, I would characterize the current new home sales environment in our markets as good, with strong housing fundamentals and healthy consumer confidence being somewhat tempered by affordability concerns.

We continue to see motivated and engaged buyers at all of our communities and believe our ability to offer high quality differentiated homes at a reasonable price point remains a competitive advantage for our company. Before I turn the call over to Russ, I want to emphasize that we run our company with a long-term focus and not in a manner that prioritizes meaning external quarterly projections. Homebuilding is not a linear business, and oftentimes, what may benefit the company in the short-term may not be beneficial in the long-term goals of the company. We have been and will continue to be focused on creating value for stakeholders over the long-term and hope to attract investors with similar mindsets. With that, I’d like to turn the call over to Russ.

Russ Devendorf : Thanks, Greg. As many of you know, we were the first company to IPO on the New York Stock Exchange in 2024. We priced at $21 a share, which was at the high end of our range and were more than 15 times oversubscribed. We raised just over $172 million in net proceeds, of which $125 million were primary proceeds with the balance going to our selling shareholders. The total outstanding share count after consummating the IPO is 51.3 million shares of which 42.4 million are Class B shares held by our continuing equity owners with the balance being our Class A shares that represent our public float. As Greg and Tom mentioned, we are extremely excited and appreciative of the support we received during the roadshow. Prior to our IPO, we were structured as an LLC and flow-through entity for tax purposes.

Our corporate structure following the IPO is commonly referred to as an Umbrella partnership – C Corporation or Up-C structure. In short, we chose a structure for some of the tax advantages it will potentially offer the continuing equity owners and the company in the future. We encourage our shareholders and future investors to read our organizational structure section in our final perspectives filed with the SEC on January 10, 2024 for additional information. As Greg mentioned, we generated $123 million of income in 2023. Our adjusted net income, which is a non-GAAP measure that we believe is useful given our organizational structure, was $92.4 million and assumes a 25% blended federal and state effective tax rate as if we were on 100% 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. Concurrent with our IPO, we also closed on our amended and restated unsecured credit facility. We are excited to add three new lending partners and appreciative of the existing lenders who have supported us over the years. We upsized our facility from $175 million to $250 million and extended the maturity to January of 2027. Additionally, the facility has an accordion feature that allows us to increase the total facility size to $350 million as needed. We used a portion of the IPO proceeds to pay off all outstanding debt under the prior facility and as of today continue to have no outstandings on the line.

We believe the IPO proceeds at our new credit facility provide us with sufficient liquidity to pursue our growth plan of expanding our existing markets and pursuing other potential strategic opportunities. We finished 2023 with 12,800 total controlled lots, an increase of 48% over 2022. True to our landline operating philosophy, only 524 of our controlled lots were unstarted, meaning that 96% 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 our targeted range between 3.5 to 5.5 years of supply calculated based on our forecasted closings over a rolling 12-month period. As we previously reported in our release earlier this month, year-to-date February new orders and closings were 484 and 335 homes respectively.

Our backlog at the end of February was 1,061 homes. We are currently operating out of 68 active selling communities. We expect our first quarter 2024 net new orders to finish at or above 750 homes compared to 664 in first quarter of 2023 and home closings to finish between 540 and 560 homes compared to 500 closings in the first quarter of 2023. For the full year 2024, we are projecting total home closings between 2,600 and 2,800 homes. We expect our average selling price to range between $340,000 to $345,000 and home closing gross margin to finish between 25.25% to 26.25%, including an approximate 50 basis point impact from purchase accounting related to our Houston acquisition. We believe the primary risk to our projections are around our ability to maintain sales pace and bring our new communities and lots online.

We continue to see some delays in municipalities on [indiscernible]. Macroeconomic factors primarily around jobs, inflation and interest rates could also have unforeseen impacts to our numbers. As mentioned during our roadshow, we are focused on building a sustainable legacy homebuilding business that will thrive for decades to come. We are thankful for those shareholders that come along for the ride and intend to be transparent and investor friendly as we navigate life as a public company. With that, I’d like to turn the call over to the operator for instructions on Q&A.

Operator: [Operator Instructions] And your first question is from the line of Michael Rehaut with JPMorgan.

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Q&A Session

Andrew Azzi: This is Andrew Azzi on for Mike. Good morning. Russ, I just wanted to ask, as you think about your ambitious long-term closings goal between organic growth in your current markets, expansion in new markets and M&A, which lever are you expecting to focus on to see the most opportunity in the short- and long-term?

Russ Devendorf: As we talk about on the roadshow, we think the easiest path for growth is in our existing footprint. There’s definitely plenty of opportunity in our markets to gain market share, especially with the additional capital and putting that to work. And we’re seeing a lot of new deals come through our investment committee every week, so that’s very positive. On the flip side, from an M&A perspective, there are a lot of opportunities out there. So we’re looking at things, we see a lot of things come across our desk, but we’re going to be, we’re not just going to jump on something to grow top line. It’s got to be the right fit for us. Clearly, we’re focused on the southern half of the U.S., the southern markets, we’d love to fill in some adjacent markets that fit within our strategy.

So look, I’d tell you, if we see something we like, we’re going to go after it. But right now, we see the opportunity. The present opportunity is just within our existing markets. But look, I hate to say, but something could pop-up next week that we see and we go after it. So we’re open as long as it fits.

Andrew Azzi: Thanks for that. And then I believe you guys said that demand was looking good, kind of similar to what we’re hearing from some of the other builders. I mean, would you characterize demand as being somewhat consistent with normal seasonality? Obviously, historicals are a bit limited, but or is it more something maybe stronger than typical this time of year?

Greg Bennett: No. Thanks for the question. Yes, I would relate it more to a more seasonal, more like the usual spring momentum going into the spring selling season. Just nothing outside of the normal spring activity.

Russ Devendorf: Yes. The one thing I would add is when we were on the roadshow, we had just come off December and rates had pulled back end of November, early December. And I think we probably saw a little bit of pull through in December, because December kicked off really strong and we were feeling like that was spring selling season was here already. January was good, I think progressively through the quarter things got better, but I do think we had a little bit of an initial bump in December and some pull through and then it kind of like Greg said, it kind of got back to what we’d say is a normal seasonality, normal market.

Operator: Your next question is from the line of [indiscernible] with Bank of America.

Unidentified Analyst : Just starting out, Russ, can you just help sort of bridge us from the 28% plus, the really strong 28% plus gross margin in ’23 to the guidance of 25.25% to 26.25%? And then what’s embedded in that outlook in terms of land inflation, labor inflation and materials?

Russ Devendorf: Yes, sure. Good question. So let me highlight where we were in fourth quarter, and I know we didn’t provide specific fourth quarter. Just touching on the release for a second, we gave full year results. We’re still going through a couple of things on our audit. We’re going to file our 10-K April 1, and so apologize for being a little light on Q4, but Q4 gross margin was 26.7% and then if you add back interest and we had some purchase accounting, we were 27.5%. So we saw gross margin progressively throughout the year start to drift down a little bit, which we expected. So we did. We finished at 28.3% and then our projection for this year, like I said it was 25.25% to 26.25%. That includes 50 basis points right now, what we estimate about 50 basis points of purchase accounting.

So you know if you add back purchase accounting and what we would say is looking at us on a more normalized basis, it’s that 25.75% to 26.75%. So I think that’s pretty consistent with what we’ve thought going into this year and what we thought during the roadshow. And like we said, most of that is all coming from compression, the margin compression is coming from increase in land costs. Our vertical costs have remained pretty steady, and in some cases, it gets better. It just depends on what line item you look at. Some cases, it gets a little bit worse. But really, the pressures that we’re seeing, and we continue to see this when we see new land deals coming through investment committee, is it’s primarily on the land cost side. That’s where there’s a ton of competition, builders are pushing.

You can see what’s happening just in the M&A market, right? Flocks are looking to grow and so that’s where the land compression or the margin compression will where we coming from. So, if I had to tell you like that number from 28.3% to our estimates going into next year, I’d say it’s all going to be on that landline item.

Unidentified Analyst : And then sort of following up on that, can you talk about how much you used land banking versus optioning directly from the developer? And then are you seeing any changes there in terms of the additional cost from using land banking? Is it more difficult to find bankers? Or are you still finding a lot of opportunities?

Russ Devendorf: Yes. The percentage of our deals that are going to land bankers are increasing. And that’s it’s primarily due to the fact that I think number one, if it’s a traditional land seller or Joe Farmer, he just he wants to get out, move on. I think financing is becoming more difficult maybe for some of these land sellers or developers and so they don’t want to hold the land. They’d rather just say, hey, I just want to flip it. I kind of want to get out. And that’s fine with us. We’ve got plenty of land bank opportunities with our partners. We talk to folks every day. Our existing partners are great. There’s plenty of capacity. We’re looking at some other opportunities to put a more programmatic deal in place, and hopefully make the process a bit simpler and also help maybe bring some of the cost down.