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Forestar Group Inc
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Good afternoon and welcome to Forestar’s Third Quarter 2019 Earnings Conference Call. I will now turn the call over to Jessica Hansen, Vice President of Investor Relations with D.R. Horton, the 75% majority owner of Forestar. Go ahead, please.
Thank you, Chantel. We welcome each of you to our call to discuss Forestar’s financial results along with the company’s expected growth and capital plan.
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 2018 Annual Report on Form 10-KT and most recent quarterly report on Form 10-Q, both 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 next week. After this call, we will post an updated investor presentation to Forestar’s Investor Relations site under Events and Presentations for your reference.
Now, I will turn the call over to Dan Bartok, CEO of Forestar.
Thank you, Jessica. Good afternoon, everyone. In addition to Jessica, I am pleased to be joined on the call today by Chuck Jehl, CFO of Forestar.
Our team is making great progress and delivered a solid third quarter of fiscal 2019 keeping us on track to hit our 2019 business plan. Forestar’s unique business model differentiates our company in the marketplace. Unlike other land developers, we bring a production oriented manufacturing mindset to the land development process. We are focused on short duration, fully entitled residential lot development. We develop our projects in a phase manner and typically have a signed lot purchase agreement from a known buyer prior to making any significant new investment. Our approach to land development is lower risk than other public land developers and will produce more consistent cash flow and returns when we achieve scale.
Forestar also has a unique and strategic relationship with D.R. Horton, the nation’s largest builder. Our relationship with D.R. Horton de-risks the expansion of our operating platform and allows us to have a footprint that is more geographically diverse than most public homebuilders. D.R. Horton has an immense appetite for finished lots and we are leveraging this strategic relationship to deliver top line revenue growth that is unmatched within the broader homebuilding and land development universe.
I will turn it over to Chuck now to discuss our financial results.
Thank you, Dan. In the third quarter, net income attributable to Forestar was $6.9 million or $0.16 per diluted share compared to $9.4 million or $0.22 per diluted share in the prior year quarter. Our third quarter revenues increased 274% to $88.2 million from $23.6 million in the prior year quarter. Residential lots sold during the quarter totaled 1,158 lots, an increase of 290% from the prior year quarter. Our average lot sales price for the quarter was $77,400. 62% of lots sold in the quarter were from development projects with the remainder from lot banking.
For the 9 months ended June 30, 2019, net income attributable to Forestar increased to $20.3 million or $0.48 per diluted share compared to a net loss of $3.6 million or $0.09 per diluted share in the same period of fiscal 2018. Year-to-date revenues increased 149% to $192 million from $77 million in the same period of fiscal 2018. Residential lots sold during the first 9 months of the year totaled 2,224 lots, an increase of 160% from the same period of fiscal 2018. 72% of lots sold in the current 9-month period were from development projects. Of our total lots sold, approximately 1,000 were sold to D.R. Horton during the June quarter and approximately 1,900 during the 9-month period. We are focused on generating consistent returns through our low risk, high turnover, production oriented lot manufacturing models.
Our pre-tax income for the quarter was $8.4 million, with a pre-tax profit margin of 9.5%. And our pre-tax income for the first 9 months of fiscal 2019 was $29.6 million, with a year-to-date pre-tax profit margin of 15.4%. Our gross profit margin was 14.6% in the third quarter and was 22.1% for the year-to-date period. SG&A expense as a percentage of revenues for the quarter was 9% and year-to-date SG&A expenses were 10.3% of revenues.
We currently expect our pre-tax profit margin to be approximately 10% for the full year of fiscal 2019 and in the mid to high single-digit percentage range for fiscal 2020. We expect significant quarterly fluctuations in our gross and pre-tax margins for the fourth quarter of fiscal 2019 and during fiscal 2020 due to the mix of our inventory and lot deliveries. We currently anticipate approximately two-thirds of our lot deliveries will be from lot development projects, which typically generate gross margins ranging from 14% to 22%. Our current development project portfolio is heavily weighted to shorter duration projects that were not sourced by Forestar, which will produce margins at the lower end of this range. Additionally, short-term lot and land banking projects are expected to be roughly 1/3 of lot deliveries in the fourth quarter and during fiscal 2020. Lot and land banking is expected to generate 12% to 16% annual return, with gross margins ranging from 3% to 9% because of the short duration of our current portfolio.
Finally, the build-out of our platform infrastructure will require increased SG&A cost, but will support our ability to achieve scale. We are focused on managing our SG&A efficiently, while building out our infrastructure adequately to support our significant growth. At scale, we believe we can manage our business at an SG&A level lower than a typical midsize homebuilder. Dan?
Our underwriting criteria for new development projects includes a minimum 15% annual pretax return on inventory and a return of our initial cash investment within 36 months. During the quarter, our investments in lot, land and development, totaled $260 million, of which $180 million was for land and $80 million was for land development. During the 9 months ended June 30, we invested $680 million, and we now expect to invest a total of approximately $900 million in land and land development in fiscal 2019. Within our existing capital base, our preliminary expectation for fiscal 2020 land and development investment is approximately $900 million, subject to market condition. Potential land and development investments in excess of $900 million next year will be dependent on the timing and the size of future capital raise. Forestar’s currently operating in 50 markets and 20 states, which is an increase of 30 markets and 9 states from just 1 year ago. We are more diversified today and in more markets than many homebuilders.
We are very pleased with our recruiting efforts to date, and now have 10 division offices open. We have a tremendous opportunity for growth through our existing markets and our relationship with D.R. Horton. At June 30, Forestar owned and controlled approximately 37,400 lots, of which 4,500 are finished. 24,100 of these lots, or 64% were under contract to sell or subject to a right of first offer to D.R. Horton, under the master supply agreement. At scale, we expect to have a 3 to 4-year inventory of land and lots. Chuck?
While we grow our platform and scale rapidly, we are focused on maintaining sufficient liquidity and modest leverage. At June 30, we had approximately $580 million of liquidity, including $220 million of unrestricted cash and approximately $360 million of available capacity on our revolving credit facility. Our net debt to capital ratio at quarter end was 25.3%. During the quarter, we issued $350 million of 8% senior unsecured notes due in 2024, putting us in a strong position to look to deliver expected growth in both fiscal 2019 and 2020, as well as at least 20% revenue growth in fiscal 2021.
Subject to market conditions, we expect to opportunistically access the equity and debt capital markets to provide additional capital for long-term growth, while managing to a net leverage ratio of 40% or less. At June 30, our stockholders’ equity was $695 million and book value per share was $16.56, up 12% from a year ago. Dan?
Thank you, Chuck. Forestar’s positioned and preparing for exponential growth. We are on track to grow our fiscal 2019 deliveries to 4,000 lots, generating between $320 million and $350 million of revenue. We expect to deliver 10,000 lots, generating $700 million to $800 million of revenue in fiscal 2020. In addition, we are uniquely positioned to consolidate market share in the highly fragmented lot development industry through housing market and economic cycles. We expect our operating model to produce financial results and returns that are similar to or better than most small and mid-cap homebuilders, with long-term pretax profit margins of approximately 10%.
As Chuck indicated earlier, we currently expect our pretax profit margin to be approximately 10% for the full year of fiscal 2019, and in a mid- to high single-digit percentage range for fiscal 2020. We anticipate getting back to our long-term target of approximately 10% by fiscal 2021.
Before we turn to questions, I’d like to summarize Forestar’s investment highlights from my perspective. We have a unique lot manufacturing business model, very different from a typical land developer. We have a strategic relationship with D.R. Horton, the nation’s largest builder. We are in a significant growth trajectory. We are geographically diversified. We are focused on developing lots for the affordably priced houses, the heart of the market. We have an experienced management team that is excited about our opportunity. And we have a strong balance sheet and liquidity position. To prove simply, we are positioned for success.
Chantal, at this time, we will now open up the line for questions.
I will now be conducting a question-and-answer session. [Operator Instructions] Your first question comes from John Lovallo, Bank of America. Go ahead please.
Hey, guys. Thank you for taking my question. The first one is, the pretax margin outlook for 10% for fiscal year ‘19, it seems pretty conservative, particularly given what you guys have done year-to-date and then considering that in the fourth quarter, you’re only expecting a mix of about 1/3 lot and banking revenue. So I’m just curious if there’s some degree of conservatism built in there, or if we think about SG&A growth, I mean, are you expecting a pretty substantial ramp in the fourth quarter? Any help on that would be appreciated.
Good question, John. Chuck, you want to answer that one?
Yes. Hi, John. How are you doing? As we outlined in our scripted comments, there’s multiple reasons why we expect to have significant fluctuations in our margins this year and into fiscal 2020. But the 14.6% that we had in the quarter, the gross margin, this is a result of mix of both lot and land – development projects and lot banking mix in the quarter. And we’re coming in at the low end of the range as we previously provided. So there’ll be significant quarterly fluctuations in each quarter.
And the reason the gross margin has kind of changed a little bit, if you recall, we had talked about 16% to 24% as a lot development project range, we’ve now adjusted that in our scripted comments, and you’ll see it in the presentation that’s posted, to 14% to 22%, of which we believe here over the next year or so, we’re going to be towards the low end of that, call it maybe 14% to 16%, and that change was because there’s more shorter duration projects in Forestar’s current portfolio than what was originally anticipated. Those are just the projects that are coming to fruition first and that the lots are being delivered in. And as a reminder, most of what Forestar’s doing today has been sourced by D.R. Horton. So there’s more upside in the gross margin down the road as more deliveries come from lots that are sourced by Forestar.
Okay. Yes, that’s helpful. Okay and then maybe just sticking with margin here. If we think about SG&A, clearly, it’s difficult to model this on a percentage of sales basis. If we just think over the next couple of quarters sequentially, I mean should we be increasing SG&A sequentially by a few million dollars as kind of a base line? Or how should we think about that?
Yes. And, John, it’s Chuck. As we mentioned in our scripted comments, we’re going to continue investing in our infrastructure to build out our teams across the markets, and so, yes. I mean but we believe that as a developer, we can scale our SG&A and you know we had 9.5% in the quarter, and believe we can scale that further over time and as we grow the business.
As we look at an actual model, though, we would agree with your assessment of just adding a few million dollars tied to your revenue growth along the way, and just realizing that they’re building out the infrastructure they need to support the significant future growth.
Okay, great. And then if I could squeeze one more in here. The stock has performed exceptionally well despite the expectation that you’re going to issue equity to fund the business and ultimately de-consolidate D.R. Horton over time. What are your thoughts on the timing around starting to fund the business? I mean the best time to raise capital is when you don’t need it, any thoughts on that?
Well, we have been preparing to be ready to access the equity market as market conditions permit and we now have 5 sell side equity analysts covering the company, and we have been actively meeting with analysts and investors to get our story and investment thesis out more broadly. As we mentioned in the prepared remarks, we have adequate capital liquidity to deliver on our business plan through fiscal ‘21, but we still expect to opportunistically access the equity and debt markets in the future to provide additional capital. We’re just evaluating it on an almost daily basis to try to determine when the right time to do this is.
Okay, thanks guys
Thank you
Your next question comes from Ryan Gilbert, BTIG go ahead please
Hi, thanks guys. Good afternoon.
Hello
So as you’re expanding into new markets, I’m just wondering if you can comment on the competitive landscape. So who are you competing [with these lots]? Is it other homebuilders-type equity, other land developing companies? So, yes, I just would be really interested in hearing you talk about the competitive landscape.
So as we’re going in new markets, often we’re really leveraging the D.R. Horton platform that’s in existence. So often these are transactions they’ve been working on for a while. As we stated before, we come back behind them, we underwrite them and then we close on that transaction. So in many cases, our market entries are somewhat teed up for us, which makes it easy. But as a whole, as we’re looking at Forestar source transactions, I’d say we’re competing with other land developers that are smaller as well as the homebuilding industry. We’re generally targeting a transaction that’s slightly larger than what most homebuilders are comfortable with, which I think is giving us a competitive advantage.
Okay, great. And then can you talk about your progress backing up your [indiscernible] the new market? And how many markets do you think are going to be backed by predominantly [indiscernible] by the end of ‘19, and then maybe by the end of ‘20?
Well, we’ve made a lot of progress. I think right now we have 10 offices open. We started with 4. We started Houston, Dallas, Austin and Atlanta. We now have 4 offices in Florida. We have Charlotte. We have Phoenix. We have outstanding offers now to open additional offices. So, I’d say we’re at 10 now, and I expect that number to be greater within the next 90 days as we build out this platform. We’re really looking to kind of have that base of offices open within the next 90 days. That will probably give us kind of the hub-and-spoke to really grow from that point forward.
Okay, great. And then if I can also sneak one more in. Great growth in lot count. And I think what really stuck out was the number of lots that you now control that are not under right of first offer or under contract with D.R. Horton. And so, I’m wondering, if it looks like it’s a little over 13,000 lots in your third quarter, so I’m wondering if you can talk about what’s driving that growth rate.
Well, some of it is the success of starting to do some Forestar source transactions, so that as we’re closing those deals, although we’ve identified them as a potential buyer and/or other builders as potential buyers, we don’t have that contract signed at the exact date that we’re closing on, on those transactions. So, some of it is really beginning to take hold of sourcing their own transaction.
Yes, Ryan. And this is Chuck. So about 8,600 of those lots in the 37,400, are controlled lots so that we have under purchase contract or option contract that we’ve not closed on yet.
Great thank you.
Thank you. Your next question comes from Truman Patterson, Wells Fargo. Go ahead please.
Hi good afternoon guys. Just wanted to follow up on the lot count. You guys had about 29,000 owned as of the quarter end. Where do you think that can get to by year-end? Your total lot count, I believe you guys mentioned $900 million in land and developments spend. And as we are thinking about that going forward, there was a lot of market volatility in the back half of ‘18 and even early ‘19. Do you think this improved your ability to find available lots the past 6 months, either through less competition or more willing landholders to sell? Is there more willingness?
Again, most of our current transactions are things that Horton has tied up prior to us taking assignment of those contracts. So, they’re projects that have been in the works for quite a while? I think, as you know, we’re only closing on projects that are pretty much shovel-ready. So, it takes some time to get those underwritten and put into place. But kind of to try to address your question, I think we are seeing, we’re seeing willing sellers. We’re obviously focused on that affordable price point. But overall, we’re seeing the market act pretty favorably to us. As far as the number of lots at year-end, as I said, I think we’re targeting that 3 to 4 years of inventory. We’re looking I think that we’ve given some guidance on about 10,000 lots for next year. So, I think you can do the math.
And Truman, I think what’s really exciting about what the Forestar team’s already done to date is that 37,400 lots, they already own and control more lots than quite a few public homebuilders. So, they’re in a very unique position with product that is for affordably priced housing, which is where not only D.R. Horton’s been with Express for the last 5 years, but now the other builders are all talking about moving the same direction. So, there’s just an immense appetite in the market today for the price point of lots that Forestar’s focused on delivering.
Okay. Okay, great. Thanks, guys. And then looking out at your 2020 guidance of 10,000 lots delivered, if you will, is there any way you could help us think about that with the guidepost, because clearly that’s a very large ramp from the 4,000 that you should deliver this year. But any kind of near-term guidepost, first quarter, that we should be thinking about to know that you all are on track either the lots that you guys deliver in the first quarter or potentially maybe finished lots at the end of your fiscal fourth quarter, just something to help analysts track your performance, if you will.
Yes. Truman, this is Chuck. So, we’ve got about 4,500 finished lots as of 9/30, in the portfolio. And as we think about it, we’re not going to give guidance on a quarterly basis for deliveries or going forward. If it’s on a significant ramp and we’ve got a lot of lots and projects under development, and have really been over the last 18 months building for this and this ramp and the increased lot velocity.
The choppiness, Truman, is really more driven to the mix and what the revenues and the pretax profit margins and gross margins that go along with that looks like. As it pertains to just lot deliveries, we would expect that to be a pretty continual just ramp quarter to quarter to quarter.
Okay. Got it. So, kind of ignoring seasonality, you should continue to increase your lot sales through each quarter of next year. Okay. Thanks, guys.
Yes. I’d just add on to that a little bit. I mean, I wouldn’t expect every quarter to be greater than the quarter before. We’re still doing quite a bit of lot banking in this near term as we’re kind of rolling that money into lot development projects. But I would see a pretty steady pace during the year. But I wouldn’t let one down quarter, if we happen to have one, really read anything into that.
Okay. Okay thank you.
Yes, thank you.
Thank you. Your final question comes from Megan McGrath, Buckingham Research Group. Go ahead please.
Good evening thanks for taking my question. I guess I just wanted to make sure I interpreted your comments correctly around land development spend and the potential to access the equity or debt market. So, I’m going to say what I think you said, and then you can tell me if it’s right. You said you expect to spend around $900 million on land development next year, which should fund your 2024 forecast and at least 20% growth in 2021. And if you want to grow faster than that, you may access the debt and equity markets? Is that the right interpretation of that you said?
Not exactly. I would say that I mean it’s not far off. But with our current capital base, we’re very comfortable investing that $900 next year in land and in land development costs, and providing a little bit of growth from there. For us to really grow substantially beyond those numbers, though, we again, we’re trying to keep a very conservative balance sheet. We would expect to raise some additional equity and some debt beyond that, to really continue that ramp beyond our 2021 projections.
Okay. Thank you for that clarification. And then just a question around the lot banking versus development lots, I know, Jessica, you talked about having a higher percentage of quick-turn lots. I think that’s not the lot banking, just regular old quick turn lot. Is the lot banking percentage for this quarter and your outlook, higher than it originally was? And if I think about that 10,000 lots in 2020, what’s the message that you want investors to know about that lot banking? My concern is that they would think that it’s sort of a lower quality delivery of a lot, than what they had been expecting in terms of the other, so just development lot.
Yes. I guess my first answer to that you asked a couple questions in there. But as far as is lot banking running a little higher percentage than we originally anticipated, my answer to that is yes. We began doing some lot banking as a way to get some strong returns on our cash rather than it sitting in the bank while we look for longer term opportunities. So, and I’d say it’s been a very successful program for us. It’s gotten us in to some new markets. It’s helped us make some relationships. We’re very pleased with the success of that. But because of the really short-term nature of lot banking, I think as we said, roughly 3 to 9 months is kind of the average hold for that, it’s only producing a gross margin in that 3% to 9% range, because we’re generally looking at a 12% to 15% annualized return on those investments. Then as to the lot development projects, I think Jessica’s response was that we’re doing a little shorter duration. And we originally kind of gave some guidance on what the lot development project looked at. We took somewhat of a typical deal at that point in time. Although, in reality, what we’re doing is a little shorter term, even lot development projects, quicker turn deals, than maybe we originally kind of guesstimated. I think it de-risks us by having shorter term projects. But again, the gross margins are going to be a little bit lighter because of the shorter term nature of that project.
But they were all underwritten to a minimum 15% return. And as Forestar came out of the gates when we introduced the call it new Forestar, they are focused first and foremost on return. So, this mix today of what they are doing as they are growing their long-term business, which ultimately will be less lot banking, more lot development, at higher gross margin is to maximize return.
Great. Thanks very much.
Thank you.
Thank you. We do have one final follow-up from Ryan Gilbert, BTIG. Go ahead please.
Thanks, guys. Wonder if you can comment on interest from other builders other than D.R. Horton like to buy lots from you. Have you noticed a change in builder interest in 2019?
The interest has always been strong from other builders. I won’t say every builder, but the phone continues to ring from other builders wanting to do business with us. They are bringing us some transactions. We are talking with them. And in some of the Forestar source transactions, we are actively working with them on some lot programs. So I would say that the level of interest has increased, because from my seat it’s been pretty strong from the beginning. It hasn’t fallen off either, so.
Okay, thank you.
Thank you. There are no further questions at this time. I will now hand back to yourself, Dan.
Thank you, Chantel. Thank you to 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. And 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.