Forestar Group Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Unaudited results; comparisons are with the corresponding 2016 periods. Forestar was shifting toward residential and mixed-use real estate after selling substantially all of its oil and gas interests.
Key financial results
| Metric | Q2 2017 | Q2 2016 | First six months 2017 | First six months 2016 |
|---|---|---|---|---|
| Revenue | $28.0 million | $48.0 million | $50.3 million | $85.6 million |
| Operating income | $7.0 million | $69.5 million | $43.2 million | $83.1 million |
| Net income (loss) attributable to Forestar | $(2.6) million | $9.6 million | $22.6 million | $5.2 million |
| Diluted EPS | $(0.06) | $0.23 | $0.53 | $0.13 |
| Operating cash flow | Not presented for quarter | $(11.4) million | $12.5 million |
Q2 revenue declined about 42% year over year; first-half revenue declined about 41%. Prior-year operating income included substantial asset-sale gains. The first-half 2017 result included $74.2 million of gains on mineral asset sales, a $37.9 million noncash goodwill impairment, and $28.0 million of gains on timberland and undeveloped-land sales. Q2 continuing-operations results were also affected by $20.0 million paid to terminate the Starwood merger agreement and $4.1 million of transaction-related professional fees and costs.
- Cash and balance sheet: Cash and equivalents were $381.4 million at quarter-end, versus $265.8 million at year-end 2016. Total assets were $768.1 million and total equity was $585.8 million.
- Debt and liquidity: Debt, net, was $113.4 million, versus $110.4 million at year-end. The amended revolving facility was reduced from $125 million to $50 million; no borrowings were outstanding, but letters of credit of $15.7 million left $14.2 million in net unused borrowing capacity. The filing reports $390.4 million of available liquidity when cash is combined with unused capacity. The company was in compliance with debt covenants at quarter-end.
- Cash flows: Investing activities provided $126.9 million, principally from $130.0 million of asset-sale proceeds. Financing activities provided $0.1 million. Operating cash use reflected, among other items, the merger termination fee, no retail land sales, and a $3.0 million legal-settlement payment.
- Real estate activity: Owned and consolidated residential lot sales were 252 in Q2 versus 455 a year earlier; average revenue per lot rose to $89,499 from $65,448, reflecting product mix. No retail undeveloped land was sold in the first half, unlike 2016.
Material changes and management commentary
- Forestar sold its remaining owned mineral assets in Q1 for approximately $85.7 million and reported $74.2 million of related gains in the first half. It expects to recognize a further $8.2 million deferred gain in Q3, subject to expiration of the title-review period.
- In Q2, it sold approximately 19,000 acres of timberland and undeveloped land in Georgia and Texas for $46.2 million, generating $28.0 million of gains; $0.6 million was deferred pending approvals and escrow release.
- Lower real estate revenue and segment earnings reflected fewer owned-project lot sales, no retail land sales, and the prior-year sale of income-producing properties. Higher earnings from unconsolidated ventures partly offset these factors.
- Management’s stated initiatives were to reduce costs, complete non-core asset sales, and review capital allocation to maximize shareholder value. It cited generally improving U.S. home sales and housing starts, while noting builder concerns about rising materials prices and land cost and availability.
- No earnings guidance was provided. Management noted that interim results are not necessarily indicative of full-year performance.
Merger, risks and contingencies
- On June 29, 2017, Forestar terminated its agreement with Starwood and signed a merger agreement with D.R. Horton. D.R. Horton was to acquire approximately 75% of Forestar; shareholders may elect $17.75 per share in cash or one share of the continuing Forestar company, subject to proration. The cash consideration was estimated at approximately $558.3 million. Closing was expected in Q4 2017, subject to shareholder approval and other conditions; Forestar would remain publicly traded.
- The merger’s completion was uncertain. Failure to close could result in costs, disruption, and a decline in the stock price; termination-fee and expense obligations may apply under specified circumstances.
- The merger is expected to trigger a “fundamental change” provision in Forestar’s convertible notes, potentially allowing noteholders to convert or require repurchase at par, subject to conditions. Without lender consent, the merger would constitute an event of default under the revolving credit facility; Forestar was discussing a waiver or alternatives with lenders.
- Other notable uncertainties include timing and approval of infrastructure reimbursements from the Cibolo Canyons district ($13.7 million approved but unpaid at quarter-end, excluding interest), real estate development and impairment estimates, and the recoverability of deferred tax assets. The deferred-tax valuation allowance was $73.9 million; the effective tax rate on continuing operations was 146% for Q2 and 57% for the first half.
- Forestar reported ordinary-course litigation and environmental matters, with reserves for probable losses; it said outcomes were not expected to materially affect its financial position, long-term results, or cash flows, but charges in an individual period could be significant. Disclosure controls were reported effective, with no material change in internal control over financial reporting.
Important facts for investors to verify
- Merger status, shareholder approval, election/proration mechanics, and final cash-versus-stock consideration.
- Whether lenders granted a waiver or other accommodation for the merger, and potential convertible-note holder actions.
- Cash use, the revolving facility’s limited net unused capacity, and the reconciliation of reported available liquidity to facility availability.
- Collection timing for Cibolo Canyons reimbursements and any further deferred gains from asset sales.
- Future tax-asset realizability, including the valuation allowance and unusually high effective tax rates.