Forestar Group Inc

NYSE:FOR

Earnings Call Transcript 2023-Q1

[Operator]

Good afternoon, and welcome to Forestar’s First Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]

I will now turn the call over to Katie Smith, Director of Finance and Investor Relations for Forestar.

[Katie Smith, Director of Finance and Investor Relations]

Thank you, John, and good afternoon, everyone and welcome to the call to discuss Forestar’s first quarter results. Thank you for joining us.

Before we get started, today’s call includes 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 we do not undertake any obligation to update or revise any forward-looking statements publicly.

Additional information about factors that could lead to material changes and performance is contained in Forestar’s annual report on Form 10-K. Our earnings release is on our website at investor.forestar.com and we plan to file our 10-Q tomorrow. After this call, we will post an updated Investor Presentation to our Investor Relations site under Events & Presentations for your reference.

Now, I will turn the call over to Dan Bartok, our CEO.

[Dan Bartok, Chief Executive Officer]

Thank you, Katie. Good afternoon, everyone. As always, we appreciate your interest in Forestar and taking the time to discuss our first quarter results. In addition to Katie, I am pleased to be joined on the call today by Jim Allen, our Chief Financial Officer and Mark Walker, our Chief Operating Officer.

Mortgage rates rose at a record pace during 2022, as a result housing affordability has been severely impacted. New home sales fell 15% in November from a year ago and December housing starts were down 25% from a year ago. Despite those headwinds resulting in a revenue decline of nearly 50%. Our gross profit margin increased 390 basis points to 21.9%, and our pre-tax profit margin was 12.9%.

The real story here is the transformation that Forestar has undergone over the past five years. We have become the largest pure play residential lot manufacturing company in the United States. We have built a platform and assembled a team that is flexible and focused. We have further strengthened our balance sheet and look to be opportunistic in ways that will continue to build shareholder value. We have a strategic relationship with D.R. Horton, America's largest builder, and we have positioned ourselves to expand our customer base as we consolidate market share.

The housing market is going through a period of transition. We are disciplined and have been proactively reducing land acquisition over the past 18-months. We have been staging development activity at our projects to be prepared for when the plan for residential lots increases. Our flexibility enables us to quickly adjust to meet the needs of our customers. We continue to strive to maximize returns, while we plan and prepare to return to periods of rapid growth.

Having a growth plan is one thing, but we have the capital structure, the operational flexibility, a strong customer relationship, and most importantly, the team execute that plan. Forestar is better positioned than ever to serve current and new customers and consolidate market share.

Jim will now discuss our first quarter financial results in more detail.

[Jim Allen, Chief Financial Officer]

Thank you, Dan. In the first quarter, net income attributable to Forestar was $20.8 million or $0.42 per diluted share, compared to $40.5 million or $0.81 per diluted share in the prior year quarter. Consolidated revenues for the quarter totaled $216.7 million, compared to $407.6 million during the first quarter of 2022.

We sold 2,263 lots during the quarter with an average sales price of $90,100. We expect continued quarterly fluctuations in our average sales price based on the geographic location and lot size mix of our deliveries. We expect demand for residential lots will continue to be impacted in the coming months as homebuilders align starts to a new sales pace.

Our pre-tax income for the quarter totaled $27.9 million, compared to $53.5 million in the first quarter of last year. Our pre-tax profit margin of 12.9% was 20 basis points lower than last year, driven by reduced operating leverage. Our gross profit margin was 21.9%, representing an improvement of 390 basis points over the prior year period.

In the first quarter, SG&A expense was $22.9 million or 10.6% as a percentage of revenues, compared to $21.5 million in the prior year quarter. While our SG&A expense as a percentage of revenue was higher than we would like, the absolute dollars were down 3% sequentially and has decreased for the last three quarters. We will continue to focus on controlling our SG&A costs, while ensuring that our infrastructure supports our business. Mark?

[Mark Walker, Chief Operating Officer]

As for current market conditions, we are starting to see greater contractor availability with front-end trades and continue to stage development on a project-by-project basis. Despite single family home starts falling, roughly 25% in December from a year ago, our cost to develop a residential lot continued to decline. Materials like Concrete, Cement and Transformers are still challenging to secure. However, our teams are relentless problem solvers and they continue to navigate this environment exceptionally well. We will continue to be proactive and work with our trade partners to develop cost -- control development costs.

We evaluate each project and the surrounding market conditions as we determine the appropriate pricing and sales pace to maximize returns. We remain focused on developing lots for homes at affordable price points demonstrated by our average sale price of roughly $90,000. Over the past 12 months, our inventory balance has grown only 5%. Despite elongated development timelines, and inflationary pressures further demonstrating discipline and strategic inventory management. Jim?

[Jim Allen, Chief Financial Officer]

7% of our first quarter deliveries were sold to customers other than D.R. Horton, compared to 11% in the prior year quarter. In the trailing 12-months 16% of our deliveries were sold to other customers and we continue to target selling 30% of our lots to customers other than D.R. Horton over the intermediate term. Additionally, Forestar’s lots sold to D.R. Horton continue to grow as a percentage of D.R. Horton starts year-over-year and sequentially.

Approximately one out of every five homes that D.R. Horton starts is on a lot developed by Forestar. Our mutually stated goal is for one out of every three homes that D.R. Horton sells to be built on a lot developed by us. Katie?

[Katie Smith, Director of Finance and Investor Relations]

Forestar’s underwriting criteria for new development projects including minimum 15% pre-tax return on average inventory and a return of the initial cash investment within 36-months. During the first quarter, we invested $237 million in land and land development, a reduction of 38%, compared to the prior year quarter. $205 million was for land development and $32 million was for land. As land prices continue to increase across most of our footprint during 18-months, we proactively started to reduce our land investment in anticipation of the slower housing market and primarily focus on the phase development of land that we already own.

We are working with land sellers to extend closing dates and in certain cases we have opted to terminate contracts. Our unique operating model allows us to adjust the pace of development based on market conditions and we remain intensely focused on managing our development in phases as we strive to deliver finished blocks at a pace that matches market demand consistent with our emphasis on capital efficiency. Mark?

[Mark Walker, Chief Operating Officer]

Forestar's loss position as of December 31 was 82,300 lots, of which 61,500 lots are owned and 20,800 are controlled through purchase contracts. Our lot position decreased by 7,800 lots or 9% sequentially and by 21,000 lots or 20% year-over-year. We incurred $2.4 million of option deposits and due diligence write-offs in the quarter.

At quarter end, we had 7,600 finished lots on hand. The majority of our owned lots were placed under contract to purchase from land sellers prior to 2021, resulting in an attractive cost basis and we had no inventory impairments during the quarter. We are continuing to target a three to four-year owned inventory of land and lots.

30% of our owned lots are under contract to sell, representing approximately $1.5 billion of future revenue. These contracts of $148 million of hard earnest money deposits associated with them. Another 29% of our owned lots are subject to a right of first offer to D.R. Horton based off executive purchase and sale agreements. Jim?

[Jim Allen, Chief Financial Officer]

We are maintaining a strong balance sheet with significant liquidity and modest leverage and we plan to maintain our disciplined approach when investing capital to enhance the long-term value of Forestar. We ended the quarter with over $580 million of liquidity, including approximately $215 million of unrestricted cash and $365 million of available capacity on our revolving credit facility after the reduction for outstanding letters of credit.

Total debt at December 31 was $706 million with no senior note maturities until fiscal 2026. Our net debt to capital ratio at December 31 was 28.7%, down from 33.9% in the prior year period. We ended the year with $1.2 billion of stockholders' equity and our book value per share increased to $24.50, up 15% from a year ago.

Forestar’s capital structure is one of our biggest competitive advantages. Most traditional land developers are encumbered by project level financing, which makes it more difficult to react to the market, while also adding complexity and administrative costs. Our strong liquidity and corporate level financing enable us to operate effectively through changing economic conditions and positions us to be strategic when attractive opportunities present themselves. We have significant flexibility to navigate the upcoming year. Katie?

[Katie Smith, Director of Finance and Investor Relations]

Consistent with our last earnings call and as a result of the current market certainties, we are not providing guidance for fiscal 2023 at this time. We will reevaluate providing annual guidance when we have sufficient visibility into market conditions. We have been very strategic and disciplined and we are well positioned to adapt quickly to the short-term challenges that are before us and the housing industry.

Dan, I will hand it back to you for closing remarks.

[Dan Bartok, Chief Executive Officer]

Thank you, Katie. Forestar will continue facing difficult comparisons to our fiscal 2022 results as the housing industry adjusts throughout 2023. We have made remarkable progress building Forestar’s platform, which enabled us to maintain strong returns and margins during a challenging quarter. While we cannot control the macroeconomic backdrop or directly influence the demand for housing, we can and will stay focused on strengthening our platform and increasing operational efficiencies to drive future growth.

We are closely monitoring each market submarket and project as we strive to balance pace and price to maximize returns. We are the market leader in a highly fragmented and undercapitalized industry and are optimistic about Forestar’s ability to continue to execute well, consolidate market share in any operating environment.

I would like to add on to Jim's earlier comment about our capital structure being a big competitive advantage, because it is our team that is our biggest advantage. I could not be more proud than to be a part of this team. Their knowledge and experience and the way that they have dealt with the challenges of this past year are truly remarkable.

Looking forward, we continue to believe that D.R. Horton and many other homebuilders will shift their focus towards buying finished lots from third-party developers. Instead of self-developing. With our broad geographic footprint, attractive land positions, strong balance sheet, and most importantly, our experienced team.

Forestar is well positioned to be the last supplier of choice to homebuilders. We are planning for the long-term and have a track record of solid execution. We proactively and methodically started to implement our downturn playbook over 18-months ago by adjusting our pace of new land acquisition in preparation for today's current environment.

When appropriate, we will leverage our platform and balance sheet to take advantage of opportunities to build shareholder value. Our flexibility enables us to quickly adjust to meet the needs of our customers. Our team has managed through market cycles before and we are well positioned to navigate these challenging market conditions.

John, at this time, we'll now open up the line for questions.

[Operator]

Thank you. [Operator Instructions] Our first question is from Truman Patterson with Wolfe Research. Please proceed.

[Truman Patterson, Wolfe Research]

Hey, good afternoon, everyone and thanks for taking my questions. First, you all been trending close to 20% of Horton starts or orders over the past year? You mentioned your stated goal of supplying about a third of their lot needs. Do you think you all continue to increase that percentage throughout 2023? Or given the current housing backdrop, do you kind of run into a steady state, digest the current environment, see where home and lot prices ultimately settle?

[Dan Bartok, Chief Executive Officer]

Yes. Thanks, Truman. Thanks for the question. It will be an interesting year. I think everybody is looking forward to seeing how it plays out. I don't expect that our market share within Horton will decrease. I expect that it will increase, but is that going to be going from one out of five homes to one out of four during this year, that would probably be pretty aggressive. But I do expect to continue to see some increase in our market share within Horton.

[Truman Patterson, Wolfe Research]

Okay, okay, got you. And then are you all actually seeing any opportunities to buy discounted land or distressed deals? Or is it still just a bit too early? I got the impression on the call that perhaps you're not ready to deploy capital yet and maybe there's some further downside?

[Dan Bartok, Chief Executive Officer]

Yes. We're starting to see opportunities more particularly though in deals that we may have either passed on before or where somebody outbidder’s and now those deals are coming back around when they've been dropped. But as far as seeing anything that I would call distressed or severely discounted, I haven't really seen that yet, but we're looking hard for them.

[Truman Patterson, Wolfe Research]

Got you. Understood. And then one final from me, which markets do you think have the greatest lock constraints and we'll just say are lease acceptable, the potential impairments in the industry in which markets are maybe more oversupplied and more at risk. I'm asking because right now new home pricing we just made is kind of down about 10% from the peak nationwide?

[Dan Bartok, Chief Executive Officer]

I don't really see that any market is oversupplied. Again, nothing at all compared to what we saw back in ’07, ‘08 timeframe. So I think it's still really hard to get lots entitled and they get lots developed. So again, I don't see anything being oversupplied. I think as far as riskiest markets, I think it's the ones that ran up the most and are probably going to be a little slower to bounce back. And the ones I would point to would be, I think the ones that you hear on everybody talk about, right, which is Arizona, Denver. And we kind of got out of the Northwest, so we kind of missed some of the stuff that happened up in in Salt Lake and Washington in Boise. But I'd say for us, probably the two that we look at most carefully are Arizona and Colorado.

[Truman Patterson, Wolfe Research]

Perfect. Thank you all. Appreciate the time.

[Dan Bartok, Chief Executive Officer]

Great. Thanks, Truman.

[Operator]

Okay. The next question is coming from Carl Reichardt with BTIG. Please proceed.

[Carl Reichardt, BTIG]

Thanks. Good afternoon, everybody. Thanks for taking my question. I just wanted to follow-up on Truman’s. You have $90,000 on a sort of average revenue per lot rate this quarter. Obviously, the markets change to some degree, the Southeast has remained reasonably decent Texas has been good, the West has slowed a lot. As you're thinking about your mix of deliveries in 2023, recognizing you're not giving guidance? Do you think it's going to adjust appreciably from what it was in ’22 geographically speaking?

[Dan Bartok, Chief Executive Officer]

It's always challenging that what product mix is going to sell and what dates $90,000 I think is probably the highest we've hit on a quarter, but we also had some sales in the West. We sold our last lots up in the Seattle market. Again, we might reenter that market when it's more attractively priced again. And then we had some other Western type sales that maybe skewed that number a little higher than usual So I would expect overall our ASP will probably not increase from $90,000, but will probably trend down a little bit this year.

[Carl Reichardt, BTIG]

All right. Thanks, Dan. And then regarding your comments on the potential for opportunities, you talked about some builders may be looking more at finished lot transactions as opposed to doing self-development. Besides deals that you passed on before that are now coming back to the market. Is there any sense that you're seeing now some of those vertically integrated builders want to move towards not developing their own given they sort of need it for margin?

And are you seeing other developers out there not looking at new deals? So not only dropping deals, but just effectively disappearing from the market at all. That kind of firm level distress yet?

[Dan Bartok, Chief Executive Officer]

Yes. I think, I clearly, I've seen that the smaller developers are having a hard time getting new financing on new projects. And are probably negotiating with their banks on their existing deals, that's my sense. We are seeing some developers that have put a couple packages together, but again, I don't feel it. I don't think they're feeling overly stressed yet. That may happen. I think, I guess, we'll see what happens here with the spring selling season about to begin. But we are definitely seeing a slow up in transactions by developers.

As far as builders, the conversations over the last couple of months have been interesting. People are looking for positions in areas that they're not in yet. But I think everybody is getting ready to pull the trigger. Again, I think we're going to really see over the next eight to 12 weeks what happens with sales and therefore builders desire to ramp up starts again.

[Carl Reichardt, BTIG]

Okay, great. I appreciate it, Dan. Thanks very much. Thanks all.

[Dan Bartok, Chief Executive Officer]

Thanks, Carl.

[Operator]

Okay. The next question is coming from Anthony Pettinari with Citigroup. Please proceed with your question.

[Asher Sohnen, Citigroup]

Hi, this is Asher Sohnen on for Anthony. Thanks for taking my question. So ASP per lot rose 2% quarter-over-quarter, which seems somewhat out of line with what we're seeing in terms of home prices of what they're doing? So is that largely due to delivery of loss with prior pricing, kind of, already put under contract in the time of those deliveries? And then if so, was there any renegotiation of prices between you and builders baked into that number? And then if not, should we start to expect like renegotiations to be a price headwind over the balance of the year?

[Jim Allen, Chief Financial Officer]

Well. This is Jim Allen. With respect to the $90,100 ASP for the quarter, I think the increase there probably had more to do with mix than anything as Dan mentioned. I guess with respect to renegotiating and what [Multiple Speakers]

[Dan Bartok, Chief Executive Officer]

Renegotiating, we're seeing builders come to us looking for some flexibility with terms, not so much pricing, but maybe their takedown. So pricing right now has held pretty steady. The other thing that we mentioned is $90,100 for an ASP, it puts us in a sweet spot we think for affordable pricing where builders want to be with highest demand is in the marketplace. So we had not seen that yet on the pricing side, but we have that builders come back to us and want to talk about terms.

[Katie Smith, Director of Finance and Investor Relations]

This is Dave. I'd add on to that too, when a builder comes to us and wants to renegotiate a takedown, we're typically getting something in return for that. So whether it be a larger earnest money deposit or a higher escalator on those lots. So there is a little bit of an offset, as far as price whenever we do decide to extend a takedown schedule.

[Asher Sohnen, Citigroup]

Great. That's really helpful. And then just sort of following up on that Dan, so as you sort of write up new contracts for lots that are sort of coming through the pipeline that haven't been contracted yet. What has pricing look like trending there? Is it sort of still stable, kind of, following underlying land prices not yet coming down? Or are you starting to have to give up a little bit price there?

[Dan Bartok, Chief Executive Officer]

I think we look at that project-by-project, market-by-market. They all have unique characteristics. So when we set pricing for finished lots, we're looking at all the intangibles for each market, but right now our pricing is up steady.

[Asher Sohnen, Citigroup]

Great. That's good to hear and very helpful. Thank you, I'll turn it over.

[Operator]

Our next question is from Mike Rehaut with JPMorgan. Please proceed with your question.

[Doug Wardlaw, JPMorgan]

Hi guys, Doug Wardlaw on for Mike. Last quarter you guys mentioned that you weren't any closer to any potential impairments after the quarter. And I was just curious after this most recent quarter of that mindset has changed? And if not, how do you envision the rest of the year going in terms of maybe getting to, kind of, the warnings on a potential impairment?

[Dan Bartok, Chief Executive Officer]

Well, we regularly review and monitor projects for indicators of impairment. We had no impairments for the quarter. We did write-off some due diligence costs and earnest money related to deals that we decided not to close on. At this point, as Mark said, our margins and our pricing has held up pretty well. We've seen a little bit of compression in margin, which we expected. Probably a little bit early to say what to expect for the rest of the year that will be in a more contingent on general market conditions and what happens with rates. But at this point, we don't see widespread impairments. We may have isolated impairments as we go through the year, but we don't see it at this point on a widespread basis.

[Doug Wardlaw, JPMorgan]

Great, thanks. And with that, I'm just following up on what you said in terms of margins. So relative to your expectations at the end of 4Q, you haven't seen more and less of the margin compression you expected?

[Dan Bartok, Chief Executive Officer]

Sequentially, gross margin came down a little bit this quarter, but it's held up pretty well. Our pricing has held up well. We have lost operating leverage due to reduced volume. So we've certainly, have a higher SG&A as a percentage of revenue than we'd like. But as I said earlier, our SG&A expense was down 3% sequentially and has decreased for the last three quarters.

[Katie Smith, Director of Finance and Investor Relations]

Gross margin for this quarter is pretty much in line with what we expected.

[Dan Bartok, Chief Executive Officer]

Yes.

[Doug Wardlaw, JPMorgan]

Great. Thank you.

[Operator]

We have reached the end of the question-and-answer session. And I will now turn the call over to Dan Bartok for closing remarks.

[Dan Bartok, Chief Executive Officer]

Thank you, John. Thank you to everyone on the Forestar team for your focus and hard work. I'm proud of the results the team achieved this quarter. We will stay disciplined, flexible and opportunistic as we continue to consolidate market share in fiscal 2023. We appreciate everyone's time on the call today and look forward to speaking with you again in April to share our second quarter results. Thank you.

[Operator]

This concludes today's conference and you may disconnect your lines at this time. Thank you for your participation.