Forestar Group Inc. — Q1 2014 Form 10-Q
Business context and reporting period. The filing covers the quarter ended March 31, 2014. Forestar operates in real estate, oil and gas, and other natural resources, with significant real estate holdings in Texas and Georgia. Results are interim and may not indicate full-year performance.
Financial results and position
| Metric | Q1 2014 | Q1 2013 / comparison |
|---|---|---|
| Revenue | $84.6 million | $97.5 million; down 13% |
| Operating income | $15.9 million | $9.5 million |
| Operating margin | 18.8% | 9.8% |
| Income before taxes | $13.7 million | $7.0 million |
| Net income attributable to Forestar | $8.3 million; $0.20 basic and $0.19 diluted per share | $4.0 million; $0.11 per share |
| Operating cash flow | $5.5 million | $33.3 million |
| Cash and cash equivalents | $148.0 million | $192.3 million at year-end 2013 |
| Total debt | $345.4 million | $357.4 million at year-end 2013 |
| Total assets / total equity | $1,143.2 million / $722.1 million | $1,172.2 million / $715.4 million at year-end 2013 |
Net cash used in investing activities was $28.2 million, primarily reflecting $19.4 million of oil and gas property and equipment investment. Financing used $21.7 million, including $15.7 million of debt repayments and $8.0 million to purchase noncontrolling interests. Cash declined by $44.3 million during the quarter. The reported operating margin is operating income divided by total revenue.
Material changes versus the prior comparable period
- Real estate revenue fell to $65.5 million from $78.7 million, but segment earnings rose to $23.6 million from $19.4 million. Q1 2014 benefited from 9,329 acres of undeveloped land sales generating $19.7 million in revenue and approximately $16.2 million in segment earnings, as well as higher residential lot sales. Q1 2013 included the $41.0 million sale of the Promesa multifamily property, which generated $10.9 million in segment earnings.
- Oil and gas revenue increased to $17.6 million from $15.5 million, while segment earnings declined to $0.8 million from $5.1 million. Higher production and exploration costs more than offset higher production volumes and gas prices.
- Other natural resources revenue declined to $1.6 million from $3.3 million; the segment shifted to a $0.5 million loss from $1.3 million of earnings, principally because of lower timber harvest volumes.
- Net income increased despite lower total revenue. Management attributed the improvement principally to much lower share-based compensation expense: $0.3 million versus $10.4 million in Q1 2013. Q1 2014 included a $2.7 million credit for cash-settled awards, associated with a 16% share-price decline since year-end 2013; the prior-year comparison reflected a share-price increase.
- Basic weighted-average shares were 35.6 million; diluted shares were 43.9 million, up from 35.7 million in Q1 2013, principally reflecting the tangible equity units issued in November 2013.
Liquidity, debt, and outlook
- At quarter-end, the $200 million term loan was outstanding, and the company had a $200 million revolving credit facility with $140.0 million of net unused borrowing capacity. Including cash, available liquidity was $285.8 million. The company reported compliance with debt covenants.
- Quarter-end covenant measures included a 5.87:1.0 interest coverage ratio, 36.2% total leverage ratio, and 1.64:1.0 collateral-value-to-loan-commitment ratio. Because leverage exceeded 30%, the company was prohibited from making distributions under the stated distribution conditions.
- Subsequent event: on May 7, 2014, Forestar agreed to issue $250 million of 8.50% senior secured notes due 2022, with closing expected May 12. Proceeds were intended to retire the $200 million term loan, pay transaction costs, and fund general corporate purposes, potentially including strategic growth opportunities.
- For 2014, management planned to drill or participate as a non-operator in approximately 235 gross wells and projected $100.8 million of drilling and completion expenditures. These are plans, not earnings guidance, and are subject to commodity prices, operator plans, service availability, and drilling results.
- Management described single-family housing conditions as improving and multifamily conditions as strong, while noting restrictive mortgage lending, economic uncertainty, and market cyclicality. Oil and gas results remain exposed to commodity-price and operating-cost changes.
Risks, contingencies, and unusual items
- Real estate development, sales timing and pricing, entitlements, construction costs, and potential impairment of project assets are material uncertainties. One real estate customer generated $15.6 million of Q1 revenue, more than 10% of total revenue.
- Forestar had $41.8 million in pending Cibolo Canyons infrastructure reimbursements at quarter-end, excluding interest; reimbursement timing depends on approvals and the district’s ability to pay. No SID reimbursements were received in Q1 2014. The company also held a $28.1 million investment in the third-party resort development, with uncertain timing and amount of future receipts.
- The company provided construction-completion and repayment guarantees for certain venture loans, and had $26.6 million of performance bonds and letters of credit outstanding on behalf of ventures. Four unconsolidated VIEs had $59.0 million of liabilities; Forestar estimated maximum loss exposure of $3.7 million for one of them.
- Forestar estimated remaining remediation costs of approximately $1.0 million at a former paper manufacturing site, recorded in accrued expenses. It cautioned that additional remediation or monitoring could be required, with scope and timing unclear. Ordinary-course litigation was not expected to have a material adverse effect, though charges in an individual period could be significant.
- Interest-rate sensitivity: a sustained 1 percentage-point increase was estimated to reduce pretax income by $2.2 million over the next 12 months. A 10% decline in realized oil and gas prices, based on Q1 production, would have reduced production revenue by $1.7 million. No commodity derivatives were outstanding at quarter-end.
Important facts for investors to verify
- Whether the $250 million note offering closed as planned, how proceeds were applied, and the resulting interest burden, debt mix, and covenant headroom.
- Whether land and lot sales, particularly the large undeveloped-land sale and customer concentration, are repeatable; monitor lot pricing and real estate cash flow.
- Whether oil and gas production growth can offset higher exploration, production, and operating costs, and whether the planned drilling program remains economically justified.
- Timing and collectability of Cibolo Canyons reimbursements, venture guarantees, and other contingent exposures.
- The sustainability of reported earnings given the large year-over-year effect of cash-settled share-based compensation and the increase in diluted shares.