Forestar Group Inc. (FOR) Q3 2020 Earnings Call Transcript

Good afternoon, and welcome to Forestar's Third Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. I will now turn the call over to Jessica Hansen, Vice President of Investor Relations for D.R. Horton, the majority shareholder of Forestar.

Thank you, Sherri. We welcome each of you to the call to discuss Forestar's financial results along with current market conditions. Before we get started, today's call may include comments that constitute forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Although Forestar believes any such statements are based on reasonable assumptions, there is no assurance that actual outcomes will not be materially different. All forward-looking statements are based upon information available to Forestar on the date of this conference call, and Forestar does not undertake any obligation to publicly update or revise any forward-looking statements. Additional information about issues that could lead to material changes in performance is contained in Forestar's Annual Report on Form 10-K and subsequent quarterly reports on Form 10-Q, all of which are filed with the Securities and Exchange Commission. This afternoon's earnings release is on Forestar's website at investor.forestar.com and the 10-Q is planned to be filed mid next week. After this call, we will post an updated investor presentation to Forestar's Investor Relations site under Events & Presentations for your reference. Now, I will turn the call over to Dan Bartok, CEO of Forestar.

Thank you, Jessica, and good afternoon, everyone. In addition to Jessica, I am pleased to be joined on the call today by Jim Allen, our Chief Financial Officer, who joined the Forestar team last quarter; and by Collin Dawson, D.R. Horton's Vice President of Corporate Finance and Treasurer. To begin, we'd like to again express our gratitude to our country's dedicated field of healthcare workers and to all who are on the front lines caring for our communities. Our thoughts remain with those affected by this pandemic, and our priority continues to be the health and safety of our people and the communities that we serve. Now, we'll talk about the current environment and our quarterly results. As we indicated on our last call, our lot sales pace declined throughout the second half of March and April, as homebuilders slowed their purchases of lots to adjust to expected lower levels of home sales as a result of the pandemic. As housing market conditions improved in May and June, Forestar was able to quickly respond to the increased demand for residential lots and delivered solid third-quarter results. Our lot sales pace increased steadily throughout the quarter, resulting in third quarter lot deliveries of over 2,000 lots, an increase of 75% from the same quarter in the prior year. Even with the improvement in market conditions and demand, we remain cautious as to the impact COVID-19 may have on our operations or on the overall economy in the future. However, we believe that we are well positioned to successfully operate during changing market conditions, because of our low net leverage, strong liquidity position, low overhead model, and our relationship with D.R. Horton. We remain uniquely positioned to consolidate market share in the underserved lot development market that lacks well-capitalized and national participants. Jim will now discuss our third quarter financial results.

Thank you, Dan. In the third quarter, net income attributable to Forestar increased 46% to $10.1 million or $0.21 per diluted share, compared to $6.9 million or $0.16 per diluted share in the prior year quarter. The current quarter results included a $2.3 million income tax benefit related to the NOL carryback provisions of the recently enacted CARES Act. Forestar's third quarter revenues increased 102% from the prior year quarter to $178 million, which included $13.4 million of revenues from residential tracts sold. Residential lots sold during the quarter totaled 2,023 lots, an increase of 75% from the prior year quarter. The average lot sales price for the quarter was $79,900. 77% of lots sold in the quarter were from development projects with the remainder from lot banking. Of Forestar's total lots sold, approximately 2,000 lots were sold to D.R. Horton during the quarter. Our pre-tax income for the quarter was $10.3 million with a pre-tax profit margin of 5.8%. Our gross profit margin was 11.7% in the third quarter, and SG&A expense as a percentage of revenues was 6.3%. Our gross and pre-tax margins are expected to fluctuate due to the quarterly mix of our lot deliveries and the timing of tract sales. Dan?

It's too early to predict the ultimate impact of the pandemic on the economy and on future market prices and terms for residential lots. In the second half of March and April, we worked with our customers to adjust lot sales contracts to delay the timing of takedowns as builders adjusted to fewer home sales as a result of the pandemic. Since then housing market conditions have improved and the velocity of our lot sales increased throughout the quarter. We have not seen broad-based home price reductions, and therefore, we have not experienced any material changes to the pricing of our finished lots. As we manage through these evolving market conditions, we will continue to work closely with each D.R. Horton division and our other builder customers on a project-by-project basis to balance our finished lot prices and absorptions to maximize the returns on our inventory investments. Although we temporarily restricted our land purchase activity in late March, April, and May, we have now returned to more normalized levels of land and lot development investment. We also paused our hiring efforts during that time but are back to recruiting and hiring for the further expansion of Forestar's operations. We are pleased with the progress we have made so far building out our local teams and are really excited to continue doing so. As we noted last quarter, due to the uncertainty in the U.S. economy and our business operations from COVID-19, we withdrew our guidance for fiscal 2020 and 2021. Although we don't yet have enough visibility to reinstate full guidance today, based on today's market conditions, we now expect to deliver between 8,700 and 9,000 lots for the full year of fiscal 2020 and to grow our lot deliveries to a range of 10,500 and 11,500 lots in fiscal 2021. We plan to provide more guidance for fiscal 2021 when we have sufficient visibility in the market conditions.

During the third quarter, investments in lots land and development totaled $230 million, of which $100 million was for land, and $130 million was for land development. For the nine months ended June, investments in lots land and development totaled $730 million. Forestar's lot position at June 30 was 50,700 lots, of which 38,300 lots are owned and 12,400 lots are controlled through purchase contracts. 14,100 or 37% of Forestar's owned lots are under contract to sell to D.R. Horton, representing approximately $1 billion of future Forestar revenue. Another 15,500 of Forestar's owned lots are subject to a right of first offer to D.R. Horton under the master supply agreement. Forestar is targeting a three to four-year owned inventory of land and lots. Jim?

Forestar remains focused on maintaining a strong balance sheet with ample liquidity and modest leverage. At June 30, we had approximately $700 million of liquidity, including $350 million of unrestricted cash and approximately $350 million of available capacity on our revolving credit facility. Debt at June 30 totaled $641 million with no senior note maturities until fiscal 2024. Our net debt-to-capital ratio at quarter end was 25.2%. At June 30, stockholders' equity was $846 million and book value per share was $17.61, up 6% from one year ago. Dan?

Forestar is uniquely positioned to consolidate market share in the highly fragmented lot development industry through housing market and economic cycles. At scale, we continue to expect our operating model to produce financial results and returns that are similar to or better than most mid-cap homebuilders, with long-term pre-tax profit margins of approximately 10%. Before we turn to questions, I'd like to briefly touch on Forestar's investment highlights again from my perspective. We have a unique lot manufacturing business model, very different than a typical land developer. We have no unentitled land. We are focused on developing lots for affordably priced housing. We have an experienced management team that knows how to navigate through market cycles. We have a strong balance sheet and liquidity position with low net leverage. We are profitable at current operating levels and continue to expect to manage our business at an SG&A percentage lower than a typical homebuilder. And most importantly, we have a unique competitive advantage due to our relationship with D.R. Horton, which derisks the expansion of our operating platform and allows us to have a footprint that is more geographically diverse than most public homebuilders. In closing and as I've already mentioned, Forestar is extremely well positioned to operate through uncertain economic conditions because of our low net leverage, strong liquidity position, low overhead model, and relationship with D.R. Horton. Sherri, at this time we'll now open up the line for questions.

Thank you. Our first question is from John Lovallo with Bank of America. Please proceed.

Thank you for taking my questions tonight. Dan, if I understood the outlook correctly, the forecast for 10,000 deliveries in 2020 has changed. The new guidance is between 8,700 and 9,000, down from the previous 10,000. It also seems like the guidance for 2021 has been slightly reduced. Is this a matter of conservatism due to the current uncertain environment, or is there something else we should be aware of?

Well, clearly, I think the market conditions are uncertain. We did take a little pause in buying land and took our foot off the gas on lot development but really returned to normal conditions. But yes, I would say that primarily it's really uncertainty as we look forward.

Okay. That's helpful. And then on the G&A side, it looks like that was pretty flat sequentially despite the uptick in revenue. Were there costs that you were able to pull out that were sort of one-time in nature, if you will, or in other words that will kind of come back in as we proceed to the next couple of quarters, or is that level sort of sustainable?

I think that we are continuing the hiring. Obviously, we slowed up our hiring during that quarter as compared to prior quarters. So I think that as we continue to build out our platform you'll see some increase in the total dollars of G&A as compared to the same prior trend. And obviously as a percentage of revenue, I think as we've said many times it could be lumpy from month-to-month and quarter-to-quarter, but we think we're on a pretty good trend right now.

So John for reference, their employee count at the end of June was 128, which was only up seven people during the quarter, which reflects the hiring pause that they took. If you look at December to March, their head count was actually up closer to 25 or 30 people.

Got it. That's helpful. If I could squeeze one more in here. Dan, I think you had mentioned 146 sales, lot sales from April 1st to April 23rd, which would imply somewhere around 940 or 950 per month in May and June. Is there anything that would stop you guys from doing above that level in the next quarter here on a monthly basis?

I don't think there's anything that stops us. We do have the developed lots on the ground. Clearly, it was a quarter that was hurt in the early part of the quarter, but now I feel good about where we stand on a go-forward basis. The inventory is there and the lots following those are under development.

Great. Thanks very much, guys.

Our next question is from Ryan Gilbert with BTIG. Please proceed.

Thanks, guys. So I guess just building on the last question there, I think one of the themes over the last couple of months has been the pickup in demand that we've seen has been, I think, a lot stronger than many of us have expected, including homebuilders. And so you're seeing homebuilders really start to accelerate their land development, land acquisition activities from demand. And at the same time, it seems like you also paused land acquisition, development activities and now are I guess trying to reaccelerate that. So I'm just wondering about or I guess, if you could just talk about the opportunity that you're seeing to really meet that stronger demand for lots from homebuilders as they try to meet homebuyer demand? And then the extent that you can reaccelerate your own land development land acquisition activities, and then maybe just thinking about the original pre-COVID guidance around $1 billion of land spend if that's still, it seems like based on the third quarter spend that should still be on the table that. Yes, if you could just talk about that, that would be really helpful. Thanks.

Starting with your last point, yes, it’s still somewhat unpredictable, but I’m optimistic about regaining our original planned spending on land and development for the year. I believe that $1 billion aligns with our expectations. To clarify, once we acquire a piece of land, it typically takes about a year before we can realize any revenue from it. Therefore, I don’t anticipate that the brief pause we took will significantly affect the near term. We have a substantial inventory with over 36,000 lots owned and more than 50,000 controlled. I feel confident that we can meet demand as it arises. It’s an unusual situation with the current market conditions, especially considering the economy and the impact of COVID. However, I believe we are well-prepared to satisfy that demand if it materializes.

And Ryan, their monthly land lot and development will be broken out in a presentation that's on the website after the call. But just for reference, all in they spent $52 million in April, $56 million in May, and that jumped up to $119 million in June. So they really did tone it back, really mainly on the land purchase side and still spent decently in development dollars, but then picked it back up in June.

Okay. Got it. And I guess just following up there, are you seeing higher demand from builders materializing? Or is this still an event that's still to be determined?

I'd say that today we are seeing higher demand not only from Horton, but as we talked about third-party builders before. I think my phone is ringing more now than it ever has as we're looking for positions. So I feel really good about where we are. I think we're really well positioned. So yes, I feel good.

Okay. Great. And then just lastly the sequential drop in gross margin, I think was a little surprising just given it looks like the land banking percentage was down sequentially. Could you talk about what drove that sequential debt?

It's really just a function of the tract sale in the quarter. So if you think about a tract sales similarly to lot banking in that they're underwriting it to a return not to a gross margin and they didn't hold that tract sale for very long, and so the gross margin was pretty low, but the return was attractive.

Got it. Okay. Thanks very much.

Our next question is from Truman Patterson with Wells Fargo. Please proceed.

Hey, good afternoon. This is actually Trevor Allinson on for Truman. Thank you for taking my question. My first question was given the strong homebuilder demand we have seen recently, we've been hearing about potential constraints when it comes to labor and equipment for development over the next coming quarters. Are you anticipating any increased competition and therefore increased cost for development in the back half of the year?

At this point, we're not. Most of the development that we are undertaking right now has already been contracted for. Actually, as all the other developers and builders kind of hit the stop button, we did a pause and did some repricing, but continued developing. And I think that we actually got some price concessions for some future development. Will things increase later in the year? They may. The good news for us is that even if costs go up most of those lots haven't been priced yet. So we should be able to account for that in our pricing policy.

Okay. Great. And second, given the strong demand again that we've been seeing, we would expect given builders' thirst for lots at a time that lots would be selling at more of a premium, are you actually seeing any changes in lot prices? And do you have any lots that aren't already spoken for in a contract? And is there any difference in pricing between those lots and the lots you've got under contract?

To the extent that we have lots under contract, obviously, we're not seeing any change in those. We're definitely seeing some increased demand and some pricing power in lots that we have on the ground that are ready to be delivered today, and we're taking advantage of that where we can.

Okay, great. Thank you.

Our next question is from Anthony Pettinari with Citi. Please proceed.

Hey. Good afternoon. Builders have talked about hold and delays anywhere between a couple of days to a couple of weeks to their cycle times from orders to deliveries. In terms of your time frame maybe from initial capital outlay, maybe the first phase delivery, has COVID or kind of COVID-related restrictions pushed out the cycle times at all? Or do you anticipate that going forward?

Well, we really haven't seen any push-out as of right now. And actually what we saw is a little, maybe, acceleration in development time as other builders kind of stopped development projects. We were able to pick up multiple crews on certain sites, which allowed us to develop faster. But I also don't see that as a long-term change. I think it was kind of a blip here over the last few months and will probably continue, maybe for another couple of months. In the long term, I think we have really good relationships with our contractors, leveraging a little bit in some cases Horton's relationships with our site contractors. And I don't really see any increased development times at this point.

Okay. That's helpful. And then just following on the last question maybe. I think a lot has been made of kind of post-COVID de-urbanization as a trend. And I'm just wondering if you've seen that sort of manifest itself in greater interest in specific types of lots or price points or sizes or geographies in terms of mix. Is this recovery kind of playing out, maybe, differently than what you were expecting pre-COVID? Or is it maybe too soon to know?

Well, I don't think it changes our strategy at all. I mean, we have been focused on kind of the suburban affordable price points. I think that if the de-urbanization trends continue, I think we're well positioned to capitalize on that, because that is really where our land and lot positions are at.

Okay. That's helpful. I’ll turn it over.

And our next question is from Michael Rehaut with JPMorgan. Please proceed.

Hi. This is Elad Hillman on for Mike. Congrats on the quarter. I hope you all are doing well. And thanks for taking my question. My first question was just the higher mix of deliveries on development projects this quarter. I know it's still volatile quarter-to-quarter, that 77%. But I was just curious, within the new guidance that you gave, are you still expecting it to sort of come out to two-thirds development projects over the next couple of years?

Well, I think it will vary from quarter to quarter, but at this point, I think that that is probably still good guidance as two-thirds, one-third.

Okay. Great. And my second question is just on, if you could provide a little more color on the residential tract sales this quarter. What was the thought process behind that if demand was pretty strong in May and June? And how should we think about the level of residential tract sales, for the rest of the year and next year?

Well, it's really not our core business of selling off tracts. This particular situation was a land parcel we tied up that was actually adjacent to a D.R. Horton property. And we were trying to figure out a way to co-develop. It ended up being much more complicated. And as we figured it out over a few month periods, we thought the best execution was for us to just sell that parcel and move on. So I think we only held it for a couple of months, but made a good return on it. And it just seemed to be really getting rid of the complexity of we're trying to have things that are shovel-ready. And really move our inventory quickly. And we knew that that one wasn't going to fit that box. So it was time to move on.

And so the tract sales will be lumpy. Don't expect them every quarter. As Dan said, not part of their core business. But they could still have some here and there.

Okay. Great. Thank you.

And we do have a follow-up question from Ryan Gilbert with BTIG. Please proceed.

Hey, thanks, everyone. I would like to get an update on your progress in developing the corporate and back-office functions, so you can start depending on the shared services agreement a bit less and the timeline for having a fully established corporate office. Thank you.

We have made significant progress. Bringing Jim on board has been a major advantage for us, and he is beginning to assemble a team that will help reduce our dependence on the Horton back office. There are certain aspects we plan to maintain, such as investor relations, human resources, and IT, as long as that is feasible. Overall, we are continuing to advance in other areas, although I do not have a specific timeline at this moment. Nevertheless, we are making good progress.

Great. Thank you.

We have reached the end of our Q&A session. I would like to turn the call back over to Dan Bartok for closing remarks.

Thank you, Sherri. So thank you everyone on the Forestar team for your focus and hard work. We look forward to working together to continue growing and improving our operations over the coming years. We appreciate everyone's time on the call today and look forward to speaking with you again in November to share our year-end results. Thank you.

Thank you. This does conclude today's conference. You may disconnect your lines at this time. And thank you for your participation.