Smith Douglas Homes Corp.: Form 10-Q for the period ended Sep 30, 2024

The following discussion and analysis provides information that we believe is relevant to an assessment and understanding of our results of operations and financial condition. You should read this analysis in conjunction with our unaudited condensed consolidated financial statements and the related notes appearing elsewhere in this Quarterly Report on Form 10-Q. In addition to historical financial information, this discussion and analysis contains statements of a forward-looking nature relating to future events or our future financial performance, based upon our current plans, expectations and beliefs involving risks and uncertainties. These statements are only predictions, and actual events or results may differ materially. In evaluating such statements, you should carefully consider the various factors identified in the Annual Report, as updated by this Quarterly Report on Form 10-Q, which could cause actual results to differ materially from those expressed in, or implied by, any forward-looking statements, including those set forth in Part I, Item 1A. Risk Factors of our Annual Report.

Company Overview

Prior to our IPO, we were one of the nation’s fastest growing private homebuilders by number of closings and are engaged in the design, construction, and sale of single-family homes in some of the highest growth and most desirable markets in the Southeastern and Southern United States. We employ an efficient land-light, production focused, and conservatively leveraged business model, which we believe results in a compelling combination of strong home closing gross margins, construction cycle times, and returns. Our communities are primarily targeted to entry-level and empty-nest homebuyers. We offer our homebuyers an attractive value proposition by providing a personalized home buying experience at affordable price points. With the goal of becoming one of the most dominant homebuilders in the Southeastern and Southern United States, we intend to grow operations within our existing footprint and to expand into new markets where we can most effectively implement our business strategy and maximize our profit and returns.

Despite continued uncertainty in the mortgage interest rate environment, we achieved strong results with 812 homes closed for a total of $277.8 million in home closing revenue for the three months ended September 30, 2024, which reflect increases of 39% in the number of homes closed and 41% in home closing revenue over the same period of the prior year. Our net new home orders and contract value of net new home orders increased by 6%.

During the nine months ended September 30, 2024 compared to the same period of the prior year, the number of homes closed increased 24%, and home closing revenue increased 26%. Our net new home orders increased 13% and contract value of net new home orders increased by 15%.

We construct most of our homes on a pre-sold basis, where our homebuyers choose their homes based on a select number of value-engineered floor plans and are offered flexibility on the selection of home options. Our SMART Builder enterprise resource planning system and efficient construction process, which we call Rteam, allows us to provide this optionality for homebuyers based on just-in-time modifications. As a result of our differentiated value proposition and efficient construction cycle times, we believe we typically achieve a high level of homebuyer satisfaction and experience low cancellation rates, which remained steady at 11% for both the three months ended September 30, 2024 and 2023.

At the core of our land-light operating strategy lies the principle and discipline of primarily acquiring finished lots from a diverse pool of third-party land developers or land bankers through the effective utilization of lot-option contracts. Our lot acquisition strategy reduces our upfront capital requirements and generally seeks to provide for “just-in-time” lot delivery, better aligning our pace of home orders and home starts. While using land bankers and third-party developers comes at an additional cost, we believe our lot acquisition strategy reduces our operational and financial risk relative to other homebuilders that own a higher percentage of their land supply. As of September 30, 2024, we had 611 owned unstarted lots in real estate inventory on our balance sheet which represented only 3.4% of our total controlled lot supply.

We believe the geographic markets in which we operate demonstrate strong population and employment growth trends, favorable migration patterns, and desirable lifestyle and weather conditions. Our operations are currently organized into eight geographical segments, of which six are reportable segments, including Alabama (which consists of both Birmingham and Huntsville), Atlanta, Charlotte, Houston, Nashville, and Raleigh. We expanded into two additional operating segments during 2024, Greenville and Central Georgia, which are included in the "Other" category for segment reporting. We believe there is significant opportunity to expand our presence in each of our respective markets.

We believe our dedication to entry-level and empty-nest homebuyers with a focus on price points that fall below FHA guidelines, our efficient construction process, and our affordable luxury sales experience caters to the desires of today’s aspiring homeowners and is resilient across economic cycles. While we expect the current housing undersupply and favorable demographic trends to provide a strong, long-term runway for future new home buying demand, there are several factors beyond our control that could have a significant impact on our business including, but not limited to, rising inflation, future increases in interest rates, availability and cost of land, labor and construction, availability of mortgage and land bank financing, macroeconomic trends and other factors described elsewhere in this Quarterly Report on Form 10-Q.

Recent Developments

IPO

We completed our IPO on January 16, 2024, through which we offered 8,846,154 shares of our Class A common stock at a price to the public of $21.00 per share, which includes the exercise in full by the underwriters of their option to purchase an additional 1,153,846 shares of our Class A common stock. The gross proceeds to us from the IPO were $185.8 million, before deducting underwriting discounts and commissions, and the net proceeds to us from the IPO were approximately $172.8 million, after deducting the underwriting discount of approximately $13.0 million.

The Transactions

The results of operations discussed in this Quarterly Report on Form 10-Q include those of Smith Douglas Holdings LLC prior to the completion of the Transactions, including the IPO. As a result, the historical consolidated financial data may not give you an accurate indication of what our actual results would have been if the transactions described in Basis of Presentation—The Transactions had been completed at the beginning of the periods presented or of what our future results of operations are likely to be. See Basis of Presentation—The Transactions.

Segments

Our operations are currently organized into eight geographical segments, of which six are reportable segments. Our reportable segments include Alabama (which consists of both Birmingham and Huntsville), Atlanta, Charlotte, Houston, Nashville, and Raleigh. We expanded into two additional operating segments during 2024, Greenville and Central Georgia, which are included in the "Other" category for segment reporting.

Key Factors Affecting Our Performance

We believe our future performance will depend on many factors, including those described in Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report, to which there have been no material changes.

Components of Results of Operations

There have been no material changes to the components of our results of operations described in Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report.

Other Factors Impacting Results of Operations

There have been no material changes to the other factors impacting our results of operations described in Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report.

Results of Operations Data

The results of operations data in the following tables for the periods presented have been derived from the unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.

Comparison of three and nine months ended September 30, 2024 and 2023

The following table sets forth our statements of income and other operating data for the periods presented (amounts in thousands):

(1) Earnings per share for the nine months ended September 30, 2024 is calculated for the period from January 11, 2024, the date of the IPO, to September 30, 2024.

(2) The cancellation rate is the total number of cancellations during the period divided by the total gross new home orders during the period.

(3) Backlog homes (period end) is the number of homes in backlog from the previous period plus the number of net new home orders generated during the current period minus the number of homes closed during the current period.

(4) A community becomes active once the model is completed or the community has its first sale. A community becomes inactive when it has fewer than two homes remaining to sell.

Home closing revenue

Home closing revenue for the three months ended September 30, 2024, was $277.8 million, an increase of $80.2 million, or 41%, from $197.6 million for the three months ended September 30, 2023. The increase in revenue was primarily attributable to increases of 39% in the number of homes closed and 1% in the ASP of homes closed. The growth in the number of homes closed as compared to the three months ended September 30, 2023 reflected increases of 13%, 51%, 86%, 213%, and 11% in our Alabama, Atlanta, Charlotte, Houston, and Raleigh homebuilding reporting segments, respectively, partially offset by a decrease of 26% in our Nashville segment.

Home closing revenue for the nine months ended September 30, 2024, was $688.0 million, an increase of $140.7 million, or 26%, from $547.3 million for the nine months ended September 30, 2023. The increase in revenue was primarily attributable to increases of 24% in the number of homes closed and 2% in the ASP of homes closed for the nine months ended September 30, 2024, respectively.

The following table sets forth our home closing revenue, number of home closings, and ASP of homes closed for the periods presented, in each of our reportable segments (dollar amounts in thousands):

Cost of home closings

Cost of home closings for the three months ended September 30, 2024, was $204.1 million, an increase of $63.6 million, or 45%, from $140.5 million for the three months ended September 30, 2023, which was primarily driven by a

39% increase in home closings and an 4% increase in the average cost of home closings. Cost of home closings for the nine months ended September 30, 2024, was $505.8 million, an increase of $116.8 million, or 30%, from $389.0 million for the nine months ended September 30, 2023, which was primarily driven by a 24% increase in home closings and a 5% increase in the average cost of home closings.

Home closing gross profit

Home closing gross profit for the three months ended September 30, 2024 was $73.7 million, an increase of $16.6 million, or 29%, from $57.1 million for the three months ended September 30, 2023. Home closing gross margin, expressed as a percentage and calculated as home closing gross profit divided by home closing revenue, was 26.5% in the three months ended September 30, 2024 compared to 28.9% in the same period in 2023. Home closing gross profit for the nine months ended September 30, 2024 was $182.2 million, an increase of $23.9 million, or 15%, from $158.3 million for the nine months ended September 30, 2023. Home closing gross margin was 26.5% in the nine months ended September 30, 2024 compared to 28.9% in the same period in 2023.

The decrease in home closing gross margin for the three and nine months ended September 30, 2024 was primarily driven by increases of 4% and 5% in the average cost of home closings, respectively, partially offset by increases of 1% and 2% in the ASP of homes closed, respectively.

Selling, general, and administrative costs

Selling, general, and administrative costs for the three months ended September 30, 2024 were $34.1 million, an increase of $11.2 million, or 49%, from $23.0 million for the three months ended September 30, 2023. Selling, general, and administrative costs for the nine months ended September 30, 2024 were $93.5 million, an increase of $28.8 million, or 45%, from $64.7 million for the nine months ended September 30, 2023.

The increase for the three and nine months ended September 30, 2024 compared to the same periods of the prior year was primarily due to an increase in sales commissions and advertising costs associated with our increase in homes closed and related home closing revenue, increased payroll and performance-based bonus compensation expenses on higher employee headcount, stock compensation expense, and additional overhead related to our Devon Street Homes Acquisition.

Equity in income from unconsolidated entities

Equity in income from unconsolidated entities consists of our portion of income from our interest in the title company in which we hold a 49% interest and which operates in certain of our markets to provide title insurance to our homebuyers. For the three and nine months ended September 30, 2024, equity in income from unconsolidated entities increased slightly from the three and nine months ended September 30, 2023, due to slightly higher title insurance revenue generated by the joint venture.

Interest expense

Interest expense is comprised of interest incurred, but not capitalized on our Prior Credit Facility, Amended Credit Facility, other borrowings, and amortization of debt issuance costs. Our interest expense increased $0.1 million to $0.6 million for the three months ended September 30, 2024 from $0.5 million for the three months ended September 30, 2023. Our interest expense increased $0.9 million to $1.9 million for the nine months ended September 30, 2024 from $1.0 million for the nine months ended September 30, 2023.

The increase in interest expense for the three and nine months ended September 30, 2024 was primarily driven by an increase in unused fees incurred on our Prior Credit Facility and Amended Credit Facility, amortization of deferred financing costs on our Amended Credit Facility, and interest on the note payable related to the Devon Street Homes Acquisition.

Other (income) expense, net

Other (income) expense, net primarily consists of interest income, credit card rebates, insurance settlements, changes in fair value of contingent consideration related to the Devon Street Homes Acquisition, and other miscellaneous income and expenses. For the three months ended September 30, 2024, other income, net increased by $0.2 million from

$49,000 to $0.2 million, which was primarily driven by an increase in interest income on our cash and cash equivalents. For the nine months ended September 30, 2024, other income, net decreased by $1.0 million, respectively, from other income, net of $0.2 million to other expense, net of $0.8 million, which was primarily driven by the change in fair value of the contingent consideration liability related to the Devon Street Homes Acquisition during the nine months ended September 30, 2024.

Provision for income taxes

After consummation of the IPO, Smith Douglas Homes Corp. became subject to U.S. federal, state, and local income taxes with respect to its allocable share of taxable income of Smith Douglas Holdings LLC assessed at the prevailing corporate tax rates. Smith Douglas Holdings LLC operates as a limited liability company and is treated as a partnership for income tax purposes. Accordingly, it incurs no significant liability for federal or state income taxes, since the taxable income or loss is passed through to its members.

Net income

The following table sets forth net income by reportable segment for the periods presented (in thousands):

(1) Other primarily includes homebuilding operations in non-reportable segments, corporate overhead costs, such as payroll and benefits, business insurance, information technology, office costs, outside professional services and travel costs, and certain other amounts that are not allocated to the reportable segments.

Net income for the three months ended September 30, 2024 increased by $3.9 million, or 11% from the same period of the prior year. The increase was primarily due to an increase of $16.6 million in home closing gross profit, partially offset by an increase of $11.2 million in selling, general and administrative costs due to higher commissions and advertising costs and $1.8 million of income tax expense incurred for the three months ended September 30, 2024 as a result of our IPO and Reorganization Transactions.

Net income for the nine months ended September 30, 2024 decreased by $10.5 million, or 11% from the same period of the prior year. The decrease was primarily due to an increase of $28.8 million in selling, general and administrative costs due to higher commissions and advertising costs and $3.8 million of income tax expense incurred for the nine months ended September 30, 2024 as a result of our IPO and Reorganization Transactions, partially offset by an increase in home closing gross profit of $23.9 million.

Alabama: The $0.3 million and $6.8 million increases in net income for the three and nine months ended September 30, 2024 compared to the same periods in the prior year were primarily due to an increase in home closing revenue and gross profit due to increases in homes closed of 13% and 56%, respectively, and increases in ASP of homes closed of 1% and 2%, respectively, partially offset by increases in selling, general, and administrative costs.

Atlanta: The $7.6 million increase in net income for the three months ended September 30, 2024 compared to the same period in the prior year was primarily due to a 51% increase in homes closed partially offset by a 5% increase in the average cost of homes closed and additional selling, general and administrative costs associated with increased home closing revenue. The $2.7 million decrease in net income for the nine months ended September 30, 2024 compared to the same period in the prior year was primarily due to a slight decrease in home closings of 1%, partially offset by an increase in ASP of homes closed of 6%.

Charlotte: Net income in Charlotte increased $2.8 million and $2.5 million, respectively, for the three and nine months ended September 30, 2024 compared to the same periods of the prior year due to slight increases in home closing gross profit of 86% and 33%, respectively, offset by increases in selling, general, and administrative costs of 43% and 26%, respectively.

Houston: Net income in Houston increased $3.4 million and $10.2 million for the three and nine months ended September 30, 2024 compared to the same periods of the prior year, which is primarily due to the prior year only reflecting results of operations for a partial year beginning with the Devon Street Homes Acquisition which occurred on July 31, 2023.

Nashville: The $2.1 million and $4.7 million decreases in net income for the three and nine months ended September 30, 2024 compared to the same periods in the prior year were primarily due to decreases in the number of homes closed of 26% and 19%, respectively, and increases in the average cost of homes closed of 12% and 6%, respectively.

Raleigh: The $1.0 million and $3.9 million decreases in net income for the three and nine months ended September 30, 2024 compared to the same periods in the prior year were primarily due to decreases in home closing gross profit of 5% and 10%, respectively, and increases in selling, general, and administrative costs of 20% and 17%, respectively.

Backlog homes

The following table sets forth our backlog homes and contract value and ASP of backlog homes by reportable segment for the periods presented, along with their period-to-period change (dollar amounts in thousands):

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Controlled lots

The following table sets forth our total controlled lots, which includes both our owned and optioned lots, by reportable segment as of the periods set forth below:

(1) Includes homes under construction and owned lots.

Non-GAAP Financial Measures

In addition to our results determined in accordance with GAAP, we have provided information in this Quarterly Report on Form 10-Q relating to “adjusted home closing gross profit,” “adjusted home closing gross margin,” “adjusted net income,” “EBITDA”, “EBITDA margin”, “adjusted EBITDA”, “adjusted EBITDA margin”, and “net debt-to-net book capitalization.” We believe these non-GAAP financial measures are useful in evaluating our operating performance.

We report our financial results in accordance with GAAP. However, management believes that certain non-GAAP financial measures provide users of our financial information with additional useful information in evaluating our performance and to more readily compare these financial measures between past and future periods. There are limitations to the use of the non-GAAP financial measures presented in this Quarterly Report on Form 10-Q. For example, our non-GAAP financial measures may not be comparable to similarly titled measures of other companies. Other companies, including companies in our industry, may calculate non-GAAP financial measures differently than we do, limiting the usefulness of those measures for comparative purposes.

Adjusted home closing gross profit and adjusted home closing gross margin

Adjusted home closing gross profit and adjusted home closing gross margin are non-GAAP financial measures used by management as supplemental measures in evaluating operating performance. We define adjusted home closing gross profit as home closing revenue less cost of home closings, excluding capitalized interest charged to cost of home closings, impairment charges and adjustments resulting from the application of purchase accounting included in cost of sales, if applicable. We define adjusted home closing gross margin as adjusted home closing gross profit as a percentage of home closing revenue. Management believes this information is meaningful because it isolates the impact that capitalized interest has on home closing gross margin. However, because adjusted home closing gross profit and adjusted home closing gross margin information excludes capitalized interest, which has real economic effects and could impact our results of operations, the utility of adjusted home closing gross profit and adjusted home closing gross margin information as a measure of our operating performance may be limited. In addition, other companies may not calculate adjusted home closing gross profit and adjusted home closing margin information in the same manner we do. Accordingly, adjusted home closing gross profit and adjusted home closing gross margin information should be considered only as a supplement to home closing gross profit and home closing gross margin information as a measure of our performance.

The following table presents a reconciliation of adjusted home closing gross profit and adjusted home closing gross margin to the GAAP financial measure of home closing gross profit and home closing gross margin for each of the periods indicated (amounts in thousands):

(1) Home closing gross profit is home closing revenue less cost of home closings.

(2) Calculated as a percentage of home closing revenue.

Our adjusted home closing gross profit increased while adjusted home closing gross margin decreased from both the three and nine months ended September 30, 2023 to the same periods in 2024. The increase in adjusted home closing gross profit primarily results from increases in home closings of 39% and 24%, respectively. The decrease in adjusted home closing gross margin is driven by increases in the average cost of home closings of 4% and 5%, respectively, partially offset by increases in the ASP of homes closed of 1% and 2%, respectively.

Adjusted net income

Adjusted net income is not a measure of net income or net income margin as determined by GAAP. Adjusted net income is a supplemental non-GAAP financial measure used by management and external users of our consolidated financial statements, such as industry analysts, investors, lenders, and rating agencies. We define adjusted net income as net income adjusted for the tax impact using a 24.5% federal and state blended tax rate (assuming 100% public ownership to adjust for the impact of taxes on earnings attributable to Smith Douglas Holdings LLC as if Smith Douglas Holdings LLC was a subchapter C corporation in the periods presented).

Management believes adjusted net income is useful because it allows management to more effectively evaluate our operating performance and comparability to industry peers who record income tax expense on their income before tax as opposed to the income of Smith Douglas Holdings LLC not being taxed at the entity level and, therefore, not reflecting a charge against earnings for income tax expense. Adjusted net income should not be considered as an alternative to, or more meaningful than, net income or any other measure as determined in accordance with GAAP. Our computation of adjusted net income may not be comparable to adjusted net income of other companies. We present adjusted net income because we believe it provides useful information regarding our comparability to peers.

The following table presents a reconciliation of adjusted net income to the GAAP financial measure of net income for each of the periods indicated (in thousands):

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(1) For the three and nine months ended September 30, 2024 and 2023, our tax expenses assumes a 24.5% federal and state blended tax rate (assuming 100% public ownership to adjust for the impact of taxes on earnings attributable to Smith Douglas Holdings LLC as if Smith Douglas Holdings LLC was a subchapter C corporation in the periods presented).

EBITDA, EBITDA margin, adjusted EBITDA, and adjusted EBITDA margin

EBITDA, EBITDA margin, adjusted EBITDA, and adjusted EBITDA margin are not measures of net income or net income margin as determined by GAAP. EBITDA and adjusted EBITDA are supplemental non-GAAP financial measures used by management and external users of our consolidated financial statements, such as industry analysts, investors, lenders, and rating agencies. We define EBITDA as net income before (i) interest income, (ii) capitalized interest charged to cost of home closings, (iii) interest expense, (iv) income tax expense, and (v) depreciation. We define EBITDA margin as EBITDA as a percentage of home closing revenue. We define adjusted EBITDA as net income before (i) interest income, (ii) capitalized interest charged to cost of home closings, (iii) interest expense, (iv) income tax expense, (v) depreciation, (vi) adjustments resulting from the application of purchase accounting included in cost of sales, and (vii) adjustments resulting from the application of purchase accounting included in other (income) expense, net. We define adjusted EBITDA margin as adjusted EBITDA as a percentage of home closing revenue.

Management believes EBITDA, EBITDA margin, adjusted EBITDA, and adjusted EBITDA margin are useful because they allow management to more effectively evaluate our operating performance and compare our results of operations from period to period without regard to our financing methods or capital structure, or other items that impact comparability of financial results from period to period. EBITDA, EBITDA margin, adjusted EBITDA, and adjusted EBITDA margin should not be considered as alternatives to, or more meaningful than, net income, net income margin, or any other measure as determined in accordance with GAAP. Our computation of EBITDA, EBITDA margin, adjusted EBITDA, and adjusted EBITDA margin may not be comparable to EBITDA, EBITDA margin, adjusted EBITDA, and adjusted EBITDA margin of other companies. We present EBITDA, EBITDA margin, adjusted EBITDA, and adjusted EBITDA margin because we believe they provide useful information regarding the factors and trends affecting our business.

The following table presents a reconciliation of EBITDA, EBITDA margin, adjusted EBITDA, and adjusted EBITDA margin to the GAAP financial measure of net income and net income margin for each of the periods indicated:

(1) Calculated as a percentage of home closing revenue.

Our EBITDA and adjusted EBITDA increased from the three months ended September 30, 2023 to the same period in 2024, primarily as a result of a 11% increase in net income and $1.8 million increase in provision for income taxes after our IPO and Reorganization Transactions. EBITDA margin and adjusted EBITDA margin decreased from the three months ended September 30, 2023 to the same period in 2024, primarily as a result of a 2.4% decrease in home closing gross margin.

For the nine months ended September 30, 2024 compared to the same period in 2023, EBITDA, EBITDA margin, adjusted EBITDA, and adjusted EBITDA margin decreased primarily as a result of a decrease in net income of 11% partially offset by an increase in interest expense of $0.9 million and an increase in provision for income taxes of $3.8 million. A decrease in home closing margin of 2.4% also contributed to the decreases in EBITDA margin and adjusted EBITDA margin.

Net debt-to-net book capitalization

Net debt-to-net book capitalization is a supplemental measure of our leverage that is not required by, or presented in accordance with, GAAP and should not be considered as an alternative to debt-to-book capitalization or any other measure derived in accordance with GAAP. We caution investors that amounts presented in accordance with our definition of net debt-to-net book capitalization may not be comparable to similar measures disclosed by our competitors because not all companies and analysts calculate this non-GAAP financial measure in the same manner. We present this non-GAAP financial measure because we consider it to be an important supplemental measure of our leverage and believe it is frequently used by securities analysts, investors, and other interested parties in the evaluation of companies in our industry.

We define net debt-to-net book capitalization as:

• Total debt, less cash and cash equivalents, divided by
• Total debt, less cash and cash equivalents, plus stockholders’ equity.

This non-GAAP financial measure has limitations as an analytical tool in that it subtracts cash and cash equivalents and therefore may imply that the Company has less debt than the most comparable measure determined in accordance with GAAP. Because of this limitation, this non-GAAP financial measure should be considered along with other financial measures presented in accordance with GAAP. The presentation of this non-GAAP financial measure is not intended to be considered in isolation or as a substitute for, or superior to, financial information prepared and presented in accordance with GAAP. We have reconciled this non-GAAP financial measure with the most directly comparable GAAP financial measure in the following table:

Liquidity and Capital Resources

IPO

On January 16, 2024, in connection with our IPO, we issued and sold 8,846,154 shares of our Class A common stock at a price to the public of $21.00 per share, resulting in gross proceeds to us of approximately $185.8 million and net proceeds to us of approximately $172.8 million, after deducting the underwriting discount of approximately $13.0 million. We used the net proceeds from the IPO to: (i) purchase 6,410,257 newly issued LLC Interests for approximately $125.2 million directly from Smith Douglas Holdings LLC at a price per unit equal to the IPO price per share of Class A common stock less the underwriting discount; and (ii) purchase 2,435,897 LLC Interests from the Continuing Equity Owners on a pro rata basis for $47.6 million in aggregate at a price per unit equal to the IPO price per share of Class A common stock less the underwriting discount).

We only retained the net proceeds that were used to purchase newly issued LLC Interests from Smith Douglas Holdings LLC, which, in turn, Smith Douglas Holdings LLC used as follows: (i) to repay approximately $84.0 million of borrowings outstanding under our Prior Credit Facility as part of the Refinancing, (ii) redeem all outstanding Class C Units and Class D Units of Smith Douglas Holdings LLC at par aggregating $2.6 million, (iii) repay $0.9 million in notes payable to related parties, and (iv) the remainder for general corporate purposes. We may also use a portion of the net proceeds to acquire or invest in businesses, products, services, or technologies; however, we do not have agreements or commitments for any material acquisitions or investments at this time.

Overview

As of September 30, 2024, we had $23.7 million of cash and cash equivalents. We believe existing cash and cash equivalents, availability under our Amended Credit Facility and positive cash flows from operations will be sufficient to support working capital and capital expenditure requirements for at least the next 12 months. We have historically generated cash and fund our operations primarily from cash flows from operating activities as well as availability under our credit facilities and other borrowings. We exercise strict controls and have a prudent strategy for our cash management, including those related to cash outlays for lot acquisitions and deposits on lot-option contracts. We require multiple party account control and authorization for payments. We competitively bid each phase of the development and construction process and closely manage production schedules and payments. Land acquisitions are reviewed and analyzed by our senior management team and ultimately approved by our Chief Executive Officer and Chief Financial Officer. Additionally, our land-light business model reduces our upfront capital requirements and generally provides for “just-in-time” lot delivery, which better aligns our pace of home orders and home starts. Our principal uses of cash include deposits on lot-option contracts, acquisition of finished lots, home construction, operating expenses, and the payment of interest and routine liabilities.

In the coming 12 months, our primary funding needs will revolve around the construction of homes, acquisition of finished lots under new and existing contracts, and operating expenses. Additionally, we may seek to use our capital to enter new markets through acquisition or greenfield startup if we believe such markets fit our business model. To address these short-term liquidity requirements, we anticipate relying on our existing cash and cash equivalents, as well as the net cash flows generated by our operations and availability under our Amended Credit Facility.

However, the opportunity to purchase substantially finished lots in desired locations is becoming increasingly more competitive. As a result, we remain open to seeking additional capital if necessary to enhance our liquidity position, further enable the acquisition of additional finished lot inventory in anticipation of improving market conditions and the competitive landscape and fortify our long-term capital structure.

Looking beyond the next 12 months, our primary funding needs will continue to center around home construction, finished lot acquisitions necessary to maintain a minimum four-year lot supply, growing active community count, growth into new and existing markets, and interest payments on our Amended Credit Facility. We expect our existing cash reserves, along with generated cash flows and availability under our Amended Credit Facility, will be sufficient to fund our ongoing operational activities and provide the necessary capital for future lot purchases and related growth strategies.

To the extent our current liquidity is insufficient to fund future activities, we may need to raise additional funds, such as refinancing or securing new secured or unsecured debt, common and preferred equity, disposing of certain assets to fund our operations, and/or other public or private sources of capital. If we raise additional funds by issuing equity securities, the ownership of our existing stockholders will be diluted. The incurrence of additional debt financing would result in debt service obligations, and any future instruments governing such debt could provide for operating and financing covenants that could restrict our operations. We cannot assure you that we could obtain refinancing or additional financing on favorable terms or at all. See Part I, Item 1A. Risk Factors—General Risk Factors—Access to financing sources may not be available on favorable terms, or at all, especially in light of current market conditions, which could adversely affect our ability to maximize our returns of our Annual Report.

Prior Credit Facility

On October 28, 2021, certain of our wholly-owned subsidiaries entered into a $175.0 million unsecured revolving credit facility with Wells Fargo Bank, National Association, as administrative agent for the Lenders, as amended on December 19, 2022, and as amended concurrently with the consummation of the IPO to the Amended Credit Facility. Smith Douglas Holdings LLC and Smith Douglas Homes Corp. were not parties to the Prior Credit Facility. Concurrently with the consummation of the IPO, we repaid the Prior Credit Facility.

Amended Credit Facility

Concurrently with the consummation of the IPO and pursuant to the Refinancing, Smith Douglas Holdings LLC and certain of its wholly-owned subsidiaries entered into the Amended Credit Facility, which amended and replaced the Prior Credit Facility, and conducted the Debt Repayment, pursuant to which we used a portion of the net proceeds from the IPO to repay the $84.0 million outstanding under our Prior Credit Facility. Smith Douglas Homes Corp. is not a party to the Amended Credit Facility.

The Amended Credit Facility, among other things, increases the aggregate principal amount of our revolving credit commitments to $250.0 million and extends the maturity date to January 16, 2027, provided that the borrowers may request a one-year extension of its maturity date. The Amended Credit Facility also includes a $100.0 million accordion feature, subject to additional commitments, and provides that up to $20.0 million may be used for letters of credit.

The borrowings and letters of credit outstanding under the Amended Credit Facility may not exceed the borrowing base as defined in the Amended Credit Facility. The borrowing base primarily consists of a percentage of commercial land, land held for development, lots under development and finished lots held by Smith Douglas Holdings LLC and certain of its wholly-owned subsidiaries.

Borrowings under the Amended Credit Facility bear interest, at the borrower’s option, at either a base rate or SOFR (which may be a daily simple rate or based on 1-, 3- or 6-month interest periods, in each case at the borrower’s option), plus an applicable margin. The applicable margin will range from 2.35% to 3.00% based on our leverage ratio as determined in accordance with a pricing grid defined in the Amended Credit Facility and is subject to a floor of 0.00%. Interest is payable in arrears on the last business day of each month or at the end of each 1-, 3- or 6-month interest period, as applicable.

The Amended Credit Facility is unsecured. Upon the occurrence of certain triggers set forth in the Amended Credit Facility, Smith Douglas Homes Corp. may be required to provide a guarantee of the obligations of Smith Douglas Holdings LLC and the other borrowers under the Amended Credit Facility.

The Amended Credit Facility contains certain financial covenants, among others, including requirements to maintain (i) a minimum tangible net worth equal to the sum of (a) $130.0 million, (b) 32.5% of positive pre-tax income earned in any fiscal quarter after June 30, 2023, (c) 75% of the equity proceeds of Smith Douglas Homes Corp. and its subsidiaries from the IPO and (d) 50% of new equity proceeds of Smith Douglas Homes Corp. and its subsidiaries after the IPO, (ii) a maximum leverage ratio of 60%, (iii) a minimum ratio of EBITDA to interest incurred of 2.00 to 1.00, and (iv) a minimum liquidity requirement of $15.0 million. The Amended Credit Facility also contains various covenants that, among other restrictions, limit the ability of Smith Douglas Homes LLC and the other borrowers to incur additional debt and to make certain investments and distributions. Additionally, the Amended Credit Facility contains certain covenants that restrict certain activities of Smith Douglas Homes Corp. The Amended Credit Facility also contains customary events of default relating to, among other things, failure to make payments, breach of covenants and breach of representations. If an event of default occurs and is continuing, the borrowers may be required immediately to repay all amounts outstanding under the Amended Credit Facility. As of September 30, 2024, we were in compliance with all covenants related to the Amended Credit Facility.

As of September 30, 2024, there were no outstanding borrowings or letters of credit under the Amended Credit Facility.

The foregoing description of the Amended Credit Facility is qualified in its entirety by reference to the Amended Credit Facility, a copy of which is filed as an exhibit to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2024.

Additional liquidity requirements

We are a holding company and have no material assets other than our ownership of LLC Interests. We have no independent means of generating revenue. The Smith Douglas LLC Agreement provides for the payment of certain distributions to the Continuing Equity Owners and to us in amounts sufficient to cover the income taxes imposed on such members with respect to the allocation of taxable income from Smith Douglas Holdings LLC as well as to cover our obligations under the Tax Receivable Agreement and other administrative expenses.

Regarding the ability of Smith Douglas Holdings LLC to make distributions to us, the terms of their financing arrangements (including the Amended Credit Facility) contain covenants that may restrict Smith Douglas Holdings LLC or its subsidiaries from paying such distributions, subject to certain exceptions. Further, Smith Douglas Holdings LLC is generally prohibited under Delaware law from making a distribution to a member to the extent that, at the time of the distribution, after giving effect to the distribution, liabilities of Smith Douglas Holdings LLC (with certain exceptions), as applicable, exceed the fair value of its assets.

In addition, under the Tax Receivable Agreement, we are required to make cash payments to the Continuing Equity Owners equal to 85% of the tax benefits, if any, that we actually realize (or in certain circumstances are deemed to realize), as a result of (i) Basis Adjustments; (ii) Section 704(c) Allocations; and (iii) certain tax benefits (such as interest deductions) arising from payments made under the Tax Receivable Agreement. We expect the amount of the cash payments that we will be required to make under the Tax Receivable Agreement will be significant. The actual amount and timing of any payments under the Tax Receivable Agreement will vary depending upon a number of factors, including the timing of redemptions or exchanges by the Continuing Equity Owners, the amount of gain recognized by the Continuing Equity Owners, the amount and timing of the taxable income we generate in the future, and the federal tax rates then applicable. Any payments made by us to the Continuing Equity Owners under the Tax Receivable Agreement will generally reduce the amount of overall cash flow that might have otherwise been available to us.

Additionally, in the event we declare any cash dividends, we intend to cause Smith Douglas Holdings LLC to make distributions to us in amounts sufficient to fund such cash dividends declared by us to our stockholders. Deterioration in the financial condition, earnings, or cash flow of Smith Douglas Holdings LLC for any reason could limit or impair their ability to pay such distributions.

If we do not have sufficient funds to pay taxes or other liabilities or to fund our operations, we may have to borrow funds, which could materially adversely affect our liquidity and financial condition and subject us to various restrictions imposed by any such lenders. To the extent we are unable to make payments under the Tax Receivable Agreement for any reason, such payments generally will be deferred and will accrue interest until paid; provided, however, that nonpayment for a specified period may constitute a material breach of a material obligation under the Tax Receivable Agreement and therefore accelerate payments due under the Tax Receivable Agreement. In addition, if Smith Douglas Holdings LLC does not have sufficient funds to make distributions, our ability to declare and pay cash dividends will also be restricted or impaired.

See Part I—Item 1A. Risk Factors—Risks Related to our Organizational Structure and Part III, Item 13. Certain Relationships and Related Transactions, and Director Independence of our Annual Report.

Cash flows from operating, investing, and financing activities – comparison for the nine months ended September 30, 2024 and 2023

The following table summarizes our cash flows for the periods presented (in thousands):

44

Operating activities

We generated approximately $13.7 million and $55.0 million in net cash from operating activities for the nine months ended September 30, 2024 and 2023, respectively. Operating cash flows for the nine months ended September 30, 2024 benefited from cash generated by net income of $83.0 million, non-cash operating expenses of $7.9 million, and a $6.2 million increase in accounts payable, which were partially offset by a $61.5 million increase in real estate inventory and $23.1 million increase in deposits on real estate under option or contract. Operating cash flows for the nine months ended September 30, 2023 benefited from cash generated by net income of $93.5 million and non-cash operating expenses of $2.8 million, which were primarily offset by a $34.3 million increase in real estate inventory and $6.5 million increase in deposits on real estate under option or contract.

Investing activities

We used approximately $3.8 million and $75.6 million in net cash in investing activities for the nine months ended September 30, 2024 and 2023, respectively. The net cash used in investing activities during the nine months ended September 30, 2024 was primarily due to purchases of property and equipment and investments in unconsolidated entities. The net cash used in investing activities during the nine months ended September 30, 2023 was primarily due to $74.9 million used to fund the Devon Street Homes Acquisition.

Financing activities

Net cash (used in) provided by financing activities was approximately $(5.9) million and $1.5 million for the nine months ended September 30, 2024 and 2023, respectively. The $7.4 million increase in cash used in financing activities was primarily attributable to net proceeds from the IPO and Reorganization Transactions of $115.7 million and a $30.9 million decrease in distributions to members of Smith Douglas Holdings LLC, partially offset by a $127.0 million increase in net repayments under revolving credit facility and a $23.3 million increase in net cash used in in real estate not owned transactions.

Material Cash Commitments

There have been no material changes to the material cash commitments described in Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report.

Off-Balance Sheet Arrangements

While using land bankers and third-party developers as part of our land-light operating strategy comes at an additional cost, we believe our lot acquisition strategy reduces our operating and financial risk relative to other homebuilders that own and develop a higher percentage of their land supply. As of September 30, 2024, we had 611 owned unstarted lots in real estate inventory on our balance sheet which represented only 3.4% of our total controlled lot supply.

Under the umbrella of our land-light strategy, we generally seek to avoid engaging in land development. Where possible, we prefer to work with third-party developers that will sell us finished lots under lot-option contracts. In situations where we cannot find a developer partner, we will work with third-party land bankers. Under these land bank arrangements, we typically assign the land or lots we have under contract to the land banker. The land banker will acquire the land or lots directly, and if land development is necessary, we will simultaneously enter into a development agreement to complete the lots for the land banker. Additionally, we will enter a lot-option contract to acquire the finished lots on a takedown to match our projected sales absorption and starts pace. Typically, we are required to put up a deposit ranging between 5-20% on our lot-option contracts.

Our asset-light and capital efficient lot acquisition strategy is intended to avoid the financial commitments and risks associated with direct land ownership and land development by allowing us to control a significant number of lots for a relatively low capital cost. These option contracts generally allow us, at our option, to forfeit our right to purchase the lots controlled by these option contracts for any reason, and our sole legal obligation and economic loss as a result of such forfeitures is limited to the amount of the deposits paid pursuant to such option contracts and, in the case of land bank option contracts, any related fees paid to the land bank partner. We do not have any financial guarantees and we typically do not guarantee lot purchases on a specific performance basis under these agreements. In certain circumstances, we may have a completion obligation under development agreements with land bankers where we may be at-risk for certain cost overruns.

As of September 30, 2024, we had $73.9 million of non-refundable cash deposits under land and lot-option contracts pertaining to 9,572 lots with a remaining aggregate purchase price of approximately $612.8 million.

Surety Bonds and Letters of Credit

From time to time, we may enter into surety bond and letter of credit arrangements with local municipalities, government agencies and developers. These arrangements relate to certain performance or maintenance-related obligations. As of September 30, 2024, there were no outstanding letters of credit. Surety bonds do not have stated expiration dates, rather, we are released from the bonds as the contractual performance is completed. These bonds, which totaled $32.7 million and $26.1 million as of September 30, 2024 and December 31, 2023, respectively, are typically outstanding over a period of approximately one to five years depending on the pace of development. If banks were to decline to issue letters of credit or surety companies were to decline to issue surety bonds, our ability to operate could be restricted and could have an adverse effect on our business and results of operations.

Critical Accounting Policies and Estimates

In preparing our financial statements in conformity with U.S. GAAP, we must make decisions that impact the reported amounts of assets, liabilities, revenue, expenses, and related disclosures. Such decisions include the selection of the appropriate accounting principles to be applied and the assumptions on which to base accounting estimates. In reaching such decisions, we apply judgments based on our understanding and analysis of the relevant circumstances, historical experience, and business valuations. Actual amounts could differ from those estimated at the time the consolidated financial statements are prepared.

Our significant accounting policies are described in Note 1—Description of the business and summary of significant accounting policies to our accompanying unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. Some of those significant accounting policies require us to make difficult, subjective, or complex judgments or estimates. An accounting estimate is considered to be critical if it meets both of the following criteria: (i) the estimate requires assumptions about matters that are highly uncertain at the time the accounting estimate is made, and (ii) different estimates reasonably could have been used, or changes in the estimate that are reasonably likely to occur from period to period may have a material impact on the presentation of our financial condition, changes in financial condition, or results of operations. There have been no material changes to the Company’s critical accounting estimates since our Annual Report, except as described below.

Income Taxes

After consummation of the IPO, Smith Douglas Homes Corp. became subject to U.S. federal, state, and local income taxes with respect to its allocable share of taxable income of Smith Douglas Holdings LLC assessed at the prevailing corporate tax rates. Smith Douglas Holdings LLC operates as a limited liability company and is treated as a partnership for income tax purposes. Accordingly, it incurs no significant liability for federal or state income taxes since the taxable income or loss is passed through to its members.

In calculating the provision for interim income taxes, in accordance with ASC Topic 740, Income Taxes, an estimated annual effective tax rate is applied to year-to-date ordinary income. At the end of each interim period, we estimate the effective tax rate expected to be applicable for the full fiscal year. This differs from the method utilized at the end of an annual period.

For annual periods, income taxes are accounted for using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. In assessing the realizability of deferred tax assets, we consider whether it is more-likely-than-not that the deferred tax assets will be realized. Deferred tax assets and liabilities are calculated by applying existing tax laws and the rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in the year of the enacted rate change.

We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authority, based on the technical merits of the position. As of September 30, 2024 and December 31, 2023, there were no known items which would result in a significant accrual for uncertain tax positions.

Non-controlling interests

After the IPO and Reorganization Transactions, we are the sole managing member of Smith Douglas Holdings LLC. The non-controlling interests in the unaudited condensed consolidated statement of income for the three and nine months ended September 30, 2024 represent the portion of earnings attributable to the economic interest in Smith Douglas Holdings LLC held by the Continuing Equity Owners. The non-controlling interests in the unaudited condensed consolidated balance sheet as of September 30, 2024 represent the portion of the net assets of the Company attributable to the Continuing Equity Owners, based on the portion of the LLC Interests owned by such unit holders. As of September 30, 2024, the non-controlling interests were 82.7%.

Recent Accounting Pronouncements

For information regarding recent accounting pronouncements, see Note 1—Description of the business and summary of significant accounting policies to our unaudited condensed consolidated financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q.

JOBS Act

We qualify as an “emerging growth company” pursuant to the provisions of the JOBS Act, enacted on April 5, 2012. Section 102 of the JOBS Act provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. We are choosing to “opt out” of this provision and, as a result, we will adopt new or revised accounting standards upon or prior to required public company adoption dates. This decision to opt out of the extended transition period under the JOBS Act is irrevocable.

We are in the process of evaluating the benefits of relying on other exemptions and reduced reporting requirements provided by the JOBS Act. Subject to certain conditions set forth in the JOBS Act, if as an emerging growth company we choose to rely on such exemptions, we may not be required to, among other things, (i) provide an auditor’s attestation report on our systems of internal controls over financial reporting pursuant to Section 404, (ii) provide all of the compensation disclosure that may be required of non-emerging growth public companies under the Dodd-Frank Act, (iii) comply with the requirement of the PCAOB regarding the communication of critical audit matters in the auditor’s report on the financial statements, and (iv) disclose certain executive compensation-related items, such as the correlation between executive compensation and performance and comparisons of the Chief Executive Officer’s compensation to median employee compensation. These exemptions will apply until we no longer meet the requirements of being an emerging growth company. We will remain an emerging growth company until the earlier of (i) the last day of the fiscal year (a) following the fifth anniversary of the completion of our initial public offering, (b) in which we have total annual gross revenue of at least $1.235 billion or (c) in which we are deemed to be a large accelerated filer, which means the market value of our common stock that is held by non-affiliates exceeds $700.0 million as of the last business day of our prior second fiscal quarter, and (ii) the date on which we have issued more than $1 billion in non-convertible debt during the prior three-year period.

We are exposed to market risk from changes in interest rates and inflation. These market risks arise in the normal course of business. During the three months ended September 30, 2024, there have been no material changes to the information included under Part II, Item 7A, Quantitative and Qualitative Disclosures About Market Risk, in our Annual Report on Form 10-K for the year ended December 31, 2023.

Limitations on effectiveness of controls and procedures

In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs.

Evaluation of disclosure controls and procedures

Our management, with the participation of our principal executive officer and principal financial officer, evaluated, as of the end of the period covered by this Quarterly Report on Form 10‑Q, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a‑15(e) and 15d‑15(e) under the Exchange Act). Based on that evaluation, our principal executive officer and principal financial officer concluded that, as of September 30, 2024, our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in internal control over financial reporting

There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended September 30, 2024 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

In addition to the other information set forth in this report, you should carefully consider the factors discussed under Part I, Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2023. These factors could materially adversely affect our business, financial condition, liquidity, results of operations and capital position, and could cause our actual results to differ materially from our historical results or the results contemplated by any forward-looking statements contained in this Quarterly Report on Form 10-Q. There have been no material changes in the risks affecting the Company since the filing of our Annual Report on Form 10-K for the year ended December 31, 2023.