Forestar Group Inc

NYSE:FOR

Earnings Call Transcript 2019-Q4

[Operator]

Good afternoon, and welcome to Forestar's Fourth Quarter 2019 Earnings Conference Call. [Operator Instructions] 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 owner of Forestar.

[Jessica Hansen, executive]

Thank you, Darryl. We welcome each of you to our call to discuss Forestar's financial results, along with the company's expected growth and capital plans.

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 the 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 Forestar's 10-K is planned to be filed in about 2 weeks. After this call, we will post an updated investor presentation to Forestar's Investor Relations site -- excuse me, Investor Relations site under events and presentations for your reference.

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

[Daniel Bartok, executive]

Thank you, Jessica, and good afternoon, everyone. Before we talk about the business and our results for the quarter and full year, I want to address the 8-K that we filed yesterday. Chuck Jehl, Forestar's CFO since 2015 has decided to leave the company to pursue other opportunities. Chuck played a key role for many years on the Forestar team and helped us begin the transition into the lot manufacturer that we are today. We wish him all the best in his future endeavors.

As noted in the 8-K, Chuck's resignation was not a result of any issue, concern or disagreement with the company's strategy, operations, accounting, financial reporting or our internal controls. Consistency and transparency in our financial reporting are extremely high priorities for the Forestar team. We're evaluating our alternatives to fill the CFO role, and I'm confident in our ability to fulfill Forestar's obligations as a public company and our responsibilities to our shareholders.

Additionally, D.R. Horton currently provides us accounting, financial reporting and treasury support through the shared services agreement between our 2 companies. Under that agreement and on a temporary basis, D.R. Horton's CFO, Bill Wheat; and Controller, Aron Odum have taken on our principal financial and accounting officer roles. Now let's move on to the business and our results.

Our team is making great progress and finished the year in a strong position. For the year, we delivered results that exceeded all of our fiscal 2019 guidance metrics that we have shared in our prior communications. We will discuss these results in detail. But first, I'd like to remind everyone about Forestar's unique business model and how it differentiates our company in the marketplace.

Unlike other land developers, we bring a production-oriented focus, returns-focused manufacturing mindset to the land development process. We are focused on short duration, fully entitled residential lot development. We develop our projects in a phased manner and typically have a signed purchase agreement from a known buyer prior to making any significant new investments. Our approach to land development is lower risk than other public land developers and will produce more consistent cash flow and returns while 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 derisks 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 the strategic relationship to deliver top line revenue growth that is unmatched within the broader homebuilding and land development universe.

I'll turn it over to Jessica now to discuss some of our financial highlights.

[Jessica Hansen, executive]

Thank you, Dan. In the fourth quarter, net income attributable to Forestar was $12.7 million or $0.30 per diluted share compared to $54.9 million or $1.31 per diluted share in the prior year quarter. Forestar's fourth quarter revenues increased 634% to $236.3 million from $32.2 million in the prior year quarter.

Residential lots sold during the quarter totaled 1,908 lots, an increase of 351% from the prior year quarter. The average lot sales price for the quarter was $90,400. 53% of lots sold in the quarter were from development projects, with the remainder from lot banking.

For the fiscal year ended September 30, 2019, net income attributable to Forestar was $33 million or $0.79 per diluted share compared to $51.2 million or $1.22 per diluted share in the 12 months ended September 30, 2018. Fiscal 2019 revenues increased 292% to $428.3 million from $109.2 million in the 12 months ended September 30, 2018.

Residential lots sold during fiscal 2019 totaled 4,132 lots, an increase of 223% from the 12 months ended September 30, 2018. The average lot sales price for the year was $84,200 and 63% of lots sold in fiscal 2019 were from development projects. Of Forestar's total lots sold, approximately 1,800 were sold to D.R. Horton during the September quarter and approximately 3,700 were sold during the fiscal year. Dan?

[Daniel Bartok, executive]

It's our goal to build a company that will produce consistent returns. During this early period of rapid growth, we expect our quarter-to-quarter results to have significant variability. However, we are focused on generating consistent returns through our low risk, high turnover, production-oriented lot manufacturing model.

Our pretax income for the quarter was $16 million, with a pretax profit margin of 6.8%. And our pretax income for all of fiscal 2019 was $45.7 million, with a pretax profit margin of 10.7%. Our gross profit margin was 9.8% in the fourth quarter and 15.3% for the year. SG&A expenses as a percentage of revenues for the quarter was 3.9%. And for the year, SG&A expenses were 6.7% of revenues.

We currently expect our pretax profit margin in fiscal 2020 to be in the mid- to high single-digit percentage range. As we mentioned in our last call, we expect significant quarterly fluctuations in our gross and pretax margins during fiscal 2020 due to the mix of our inventory and lot deliveries. We still anticipate approximately 2/3 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 not sourced by Forestar, which will produce margins at the lower end of this range.

Additionally, short-term lot banking projects are expected to be roughly 1/3 of lot deliveries during fiscal 2020. Lot banking is expected to generate 12% to 16% annual returns, with gross margins ranging from 3% to 9% due to the short duration of our current portfolio.

Finally, the continued build-out of our platform infrastructure will require increased SG&A to support our ability to achieve scale. We're focused on managing our SG&A efficiently while building out our infrastructure to support our significant growth. At scale, we believe we will manage our business at an SG&A percentage lower than a typical homebuilder. Jessica?

[Jessica Hansen, executive]

Forestar's underwriting criteria for new development projects includes a minimum 15% annual pretax return on inventory and a return of the initial cash investment within 36 months.

During the fourth quarter, investments in lots, land and development totaled $170 million, of which $80 million was for land acquisition and $90 million was for land development. During fiscal 2019, Forestar invested $850 million in land and land development. In fiscal 2020, Forestar expects to invest approximately $1 billion, subject to market conditions.

Forestar is currently operating in 51 markets and 20 states, which is an increase of 27 markets and 6 states from just a year ago. Forestar is more diversified today and in more markets than most homebuilders. Forestar's recruiting efforts to date have been very successful, and the company now has 12 division offices open. There is a tremendous opportunity for growth through Forestar's existing markets and the relationship with D.R. Horton.

At September 30, Forestar's lot position consisted of 38,300 lots, of which 29,700 are owned and 8,600 are controlled through purchase contracts. 12,800 or 43% of Forestar's owned lots are already under contract to sell to D.R. Horton, representing approximately $1 billion of future revenue. Another 10,600 of Forestar's owned lots are subject to a right of first offer to D.R. Horton under the master supply agreement. And Forestar currently expects to own a 3 to 4-year inventory of land and lots. Dan?

[Daniel Bartok, executive]

While we grow our platform and scale rapidly, we are focused on maintaining sufficient liquidity and modest leverage. At September 30, we had approximately $720 million of liquidity, including $380 million of unrestricted cash and approximately $340 million of available capacity under our revolving credit facility. Subsequent to year-end, we amended our revolving credit facility to extend its maturity date to October 2022. Our net debt-to-capital ratio at year-end was 8.8%.

We continue to be focused on building a strong balance sheet that will utilize modest leverage. During the quarter, we issued approximately 6 million shares of our common stock. Net proceeds from this offering were approximately $100 million. This equity raise provides Forestar growth capital for fiscal 2022 and beyond. And as a result of this issue -- issuance, D.R. Horton's ownership of our outstanding common stock decreased from 75% to approximately 66%. The added equity also creates additional debt capacity within our balance sheet leverage target.

Subject to market conditions, we expect to opportunistically access the capital markets to provide additional capital for long-term growth while managing to a net leverage ratio of 40% or less. At September 30, our stockholders' equity was $808 million and book value per share was $16.84, up 5% from a year ago.

Forestar is uniquely positioned to consolidate market share in the highly fragmented lot development industry through housing market and economic cycles. We expect to deliver 10,000 lots and generate $750 million to $850 million of revenue in fiscal 2020 and to deliver approximately 12,000 lots and generate $900 million to $1 billion of revenue in fiscal 2021.

At scale, we expect our operating model to produce financial results and returns that are similar to or better than most mid-cap homebuilders, with long-term pretax profit margins of approximately 10%. As I indicated earlier, we currently expect our pretax profit margin to be in a mid- to high single-digit percentage range for fiscal 2020 and 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 than a typical land developer. We have a strategic relationship with D.R. Horton, the nation's largest builder. We are on a significant growth trajectory. We are geographically diversified. We are focused on developing lots for affordably priced housing, the heart of the market. We have an experienced management team that is excited about our opportunities, and we have a strong balance sheet and liquidity position. To put it simply, we are executing on our plans, and we are positioned for success.

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

[Operator]

[Operator Instructions] Our first question comes from the line of John Lovallo from Bank of America.

[Spencer Kaufman, analyst]

This is actually Spencer Kaufman on for John. Congrats on another good quarter. I wanted to start with the ASPs of about $90,400 in the quarter. It's pretty high relative to the past few quarters. So I was just curious, was this driven primarily by lot banking sales? And should we be thinking about modeling a higher ASP in the first half of 2020, just given the remaining lot banking sales?

[Daniel Bartok, executive]

Yes, I think that we've always kind of guided to a lot of change and volatility from a quarter-to-quarter basis. And I would say that the $90,000 in the fourth quarter was due to a higher mix of lot banking and some of that was kind of West Coast oriented. So I don't think I would look at $90,000 as a good run rate.

[Spencer Kaufman, analyst]

Okay. That makes sense. And then if we could go back to just the role of CFO for a second. I know the timing was pretty unfortunate, and I'm sure that just given the shared service agreement, Bill and Aron weren't probably too far away from the process anyways. But can you just give us a -- some thoughts as to how you guys are thinking about the role of CFO? Because if I remember correctly, I don't think you guys should need one, but just any thoughts into how you guys are thinking about that whether that be filling that internally, externally and maybe some type of time line for that, that would be helpful?

[Daniel Bartok, executive]

Yes. We were just made aware of Chuck's departure recently. So we don't really have any near-term expectations of how we're going to fill that role. I think we're going to take a little time. We're going to really evaluate the role. Obviously, it's great to have the shared services flexibility behind us in order to really -- we really have no concern of dropping any balls or not being able to get the information that we need. So I feel really good about that. I think for right now, we're going to take a little bit of time to really evaluate the right person for that role.

[Operator]

Our next question comes from the line of Truman Patterson from Wells Fargo.

[Truman Patterson, analyst]

Dan, congratulations on a sub-4% SG&A ratio. And Jessica, I imagine this is giving D.R. Horton something to shoot for, right?

[Jessica Hansen, executive]

I know you were going to go there the minute you started, Truman.

[Truman Patterson, analyst]

No. I just wanted to dig into SG&A a little bit in the leverage that's inherent in this model. Could you just discuss, did the $59 million residential track sale impact this at all? I'm really just trying to figure out how we should think about this ratio going forward over the next few quarters or so? I believe, Dan, you said that you guys might be adding some costs as well in near-term to build out your infrastructure?

[Daniel Bartok, executive]

Yes, we are continuing to build out our infrastructure. I'd say, we've made a lot of progress now having 12 division offices open, but we need to continue staffing those up. But I think as I've said all along, we're a wholesale business. We really expect to operate at a lower SG&A percentage than a typical homebuilder. And yes, in this quarter, I would look at the 3.9% having a definite influence by the track sales that we had in the fourth quarter. I wouldn't expect 3.9% on a quarterly basis, that's for sure.

[Truman Patterson, analyst]

Okay. Okay. And then going forward, I believe you said long term, you want to be about 2/3 of your lot sales as development sales. I'm trying to understand more near-term land banking has increased as a portion of your sales, again, over the next few quarters, how that should look? And could you maybe just walk us through why you rotated more towards land or lot banking near term?

[Daniel Bartok, executive]

Yes. Number one, I don't think that 2/3, 1/3 is a long-term goal. I think that's really our expectations maybe over the next year, maybe 2 years. It really has to do with our available capital as we continue to grow our land development opportunities. And we've obviously had some lumps of cash coming. We did a bond issuance this year and an equity issuance this year, and we want to get that money to work as best as we can. Then we're very returns focused. So having those investments in lot banking gives us some solid return on those dollars. And at the same time, is allowing us to learn some new markets and build relationships with the various local divisions of Horton. So we think it's a great use of our cash, and it will mix from quarter-to-quarter based on when those lots are in demand by the homebuilder. So we think of it -- again, we just think of it as a great use of our money. But really don't see it as a long-term goal, right now, that's just really because right now, we have cash during this rapid growth period.

[Jessica Hansen, executive]

And specific to Q4, it really was just, as Dan indicated, timing based on when D.R. Horton divisions wanted those lots. So some of those got pulled into Q4, and it was a heavier mix than we would have originally anticipated for the fourth quarter.

[Truman Patterson, analyst]

Okay. Okay. And then just one final follow-up. Dan, you mentioned the equity issuance, you guys have a large amount of capital to deploy, only 9% net debt to total capital. Could you just walk us through how long do you think it will take you to actually deploy that capital into more of development lots and just run through the cadence?

[Daniel Bartok, executive]

If you think back, I think we're guiding to spending $1 billion between land acquisition and lot development. Obviously, some of that is coming from inventory turn and others of it is growth capital. So I don't know that I have an exact time frame in my head, but I would expect that over the next 1 to 2 quarters, that available cash as being deployed. And then, obviously, we'll have to decide how things are looking in the capital markets versus beginning to utilize our debt facility.

[Operator]

[Operator Instructions] Our next question comes from the line of Ryan Gilbert of BTIG.

[Ryan Gilbert, analyst]

So first question, we've heard from a number of homebuilders this quarter who -- I guess one has expressed interest in ramping land spend and community count in the second half of 2019 and then into 2020 and also increasing their entry-level mix. And I guess, on the one hand, this is good for Forestar because you own a lot of the lots that these builders would need to open entry-level communities. On the other hand, it could make the -- I guess the environment a little more difficult to source new lots. So I guess, one, are you seeing more interest from homebuilders? I guess just generally for entry-level lots with the types of communities that you're developing. And two, is that impacting your ability to source new lots at all?

[Daniel Bartok, executive]

Yes, I don't know that I've seen more interest from homebuilders. It's pretty much from day 1, it's been a constant interest in how we can help deliver lots to other homebuilders, and my phone has always been ringing. Now that we're building out our teams in local markets, I think our capabilities to deliver those lots to other builders is expanding. And in some markets, those discussions are pretty progressed in some of the Forestar-sourced transactions. So I feel really good about how that's playing out. As far as the availability to find transactions, I'm not really seeing it be that difficult. Some markets are tighter than others, but that's one of the beauties of being a -- having the footprint that we do in different markets. And right now, what -- some markets are producing a lot of opportunities and others might be a little tighter. So I think it really plays to the geographic diversity that we're -- we've planned for. So overall, I feel really good about it.

[Ryan Gilbert, analyst]

Okay. Do you think it would be fair to say then that, on balance, there hasn't been too much of a change in the competitive landscape, just as you're outsourcing new lots?

[Daniel Bartok, executive]

Yes, I would say, on balance, I have not seen much of a competitive change right now. So we're -- I think we just continue to cope for plan and in the rearview mirror, we've done pretty good at that. And I expect to continue hitting our plan.

[Ryan Gilbert, analyst]

Got it. And then just the land bank overall, great growth on a year-over-year basis in the fourth quarter. It looks like we're -- we've kind of flattened out at around 38,000 lots, which is more than enough to meet the 2020 and 2021 targets that you put out there. I guess, is a high 30s, low 40,000 controlled lot land bank kind of in the -- is that how we should think about the land bank for 2020? Or do you think you need to move it higher to fund or to...

[Daniel Bartok, executive]

I would -- yes, I would continue to guide towards that 3 to 4 years of owned inventory based on our future deliveries. It might be -- we kind of maybe -- I won't say thin right now, but we had some really strong sales in that last quarter. But I think that's where really, what I would, from a modeling standpoint, kind of stick that 3 to 4 years of future deliveries.

[Jessica Hansen, executive]

So we would expect our total owned and controlled position to continue to increase over time.

[Operator]

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

[Daniel Bartok, executive]

Thank you, Darryl, and thank you to everyone on the Forestar team for your focus and hard work. I think it was a tremendous quarter and a tremendous year. 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 January to share our first quarter results. Thank you.

[Operator]

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful evening.