Forestar Group Inc. — FY2017 Form 10-K
Reporting period: Year ended December 31, 2017. This annual filing includes fourth-quarter results; Forestar also disclosed that it changed its fiscal year-end to September 30 effective January 1, 2018.
Business context
Forestar is a residential and mixed-use land developer with interests in 49 projects across 11 states and 16 markets at year-end. D.R. Horton acquired 75% of Forestar on October 5, 2017, making Forestar a controlled subsidiary. Forestar’s strategy is to expand community development, sell non-core assets, and supply finished lots to builders, including D.R. Horton under a Master Supply Agreement.
Financial results and liquidity
| Metric | FY2017 | FY2016 |
|---|---|---|
| Revenue | $114.3 million | $197.3 million |
| Net income attributable to Forestar | $50.3 million | $58.6 million |
| Diluted earnings per share | $1.19 | $1.38 |
| Net income from continuing operations attributable to Forestar | $4.2 million | $75.5 million |
| Operating cash flow | $(16.2) million | $66.9 million |
| Cash and cash equivalents at year-end | $321.8 million | $265.8 million |
| Debt, net, at year-end | $108.4 million | $110.4 million |
| Shareholders’ equity | $604.2 million | $560.7 million |
FY2017 investing cash flow was $134.5 million, principally reflecting proceeds from non-core asset sales; financing cash flow was $(62.3) million. Restricted cash was $40.0 million at year-end. After the February 2018 Starwood asset sale, Forestar reported over $530 million of consolidated cash as of February 23, 2018. The filing does not provide a clear consolidated operating margin measure.
Changes versus the prior year
- Revenue fell approximately 42%, chiefly reflecting lower real estate sales and no retail undeveloped-land sales in 2017. Forestar sold 937 lots from owned and consolidated projects, compared with 1,662 in 2016; average revenue per lot rose to about $89,300 from $66,700.
- Continuing-operations income attributable to Forestar declined to $4.2 million from $75.5 million. Real estate segment earnings fell to $47.3 million from $121.4 million, as 2016 included substantial gains on asset disposals and undeveloped-land sales.
- Reported FY2017 net income included $46.0 million of after-tax income from discontinued operations, primarily a tax benefit associated with the final sale of oil and gas working-interest assets. Mineral asset sales generated an $82.4 million gain, partly offset by a $37.9 million goodwill impairment.
- Operating cash flow turned negative, reflecting merger costs, higher real estate acquisition and development expenditures, no retail land sales, and lower residential sales activity. Cash from investing was lower than in 2016 because asset-sale proceeds declined.
Outlook, material events, and risks
- Growth and asset sale: Management plans significant investment in land acquisition and development to build a diversified national platform. On February 8, 2018, Forestar closed a $232 million sale of 24 legacy projects to Starwood; estimated net proceeds were approximately $216 million. Management expects to invest capital principally in new land-development projects. The sale is not expected to materially affect FY2018 pretax earnings; management anticipated tax losses would substantially reduce FY2018 income tax expense.
- D.R. Horton relationship: As of February 23, 2018, Forestar had acquired 13 projects since the merger, representing nearly 5,300 planned lots. About 35% were under contract to D.R. Horton, and management expected a majority of the remaining lots also to be sold to D.R. Horton under the agreement. The agreement provides D.R. Horton specified purchase rights, generally at mutually agreed market terms.
- Ownership and governance: D.R. Horton owns approximately 75% of Forestar and has significant influence over board composition and specified corporate actions. Forestar said it had not elected to use NYSE controlled-company governance exemptions at the time of filing.
- Debt and funding: Forestar redeemed its remaining 8.50% senior secured notes in October 2017. The principal remaining debt was $120 million of 3.75% convertible notes due 2020; the reported carrying value was $108.1 million, net of discount. Management expected to use cash reserves initially for growth, was evaluating longer-term capital needs, and expected to pursue a new credit facility.
- One-offs and tax: Merger-related costs totaled $43.8 million, including a $20 million termination fee to Starwood, advisory and professional costs, severance, and accelerated equity awards. The 2017 continuing-operations effective tax rate was 88%, affected by nondeductible merger costs and goodwill impairment, tax-law remeasurement, and valuation-allowance items. The Tax Cuts and Jobs Act lowered the federal corporate rate to 21% beginning in 2018.
- Key risks: Housing-market cyclicality, competition, lengthy entitlement approvals, and concentration in Texas could affect sales and returns. Other risks include reliance on homebuilders and venture partners, potential conflicts or customer concerns arising from D.R. Horton’s control, district reimbursement timing, asset-sale indemnities, environmental obligations, and impairment risk. Unconsolidated ventures had approximately $85.2 million of debt, of which $80.6 million was non-recourse to Forestar.
- Contingencies and controls: Forestar said ordinary-course legal matters were reserved for and were not expected to materially affect its financial position, though charges could be significant in an individual period. Management and the auditor concluded internal control over financial reporting was effective; the auditor issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- How much of FY2017 net income and cash generation was attributable to asset disposals, impairments, discontinued operations, and merger-related items, versus recurring development activity.
- Whether the reported post-sale cash balance and Starwood net proceeds are available for growth after restrictions, closing adjustments, and other obligations.
- The pace, returns, and funding requirements of the new project pipeline, including actual lot purchases by D.R. Horton and other builders under the Master Supply Agreement.
- The timing and terms for repayment or conversion of the $120 million principal amount of 2020 convertible notes, and Forestar’s planned replacement credit facility.
- The recoverability of deferred tax assets and use of tax attributes following the D.R. Horton ownership change and Section 382 limitations.
- Potential venture, environmental, development-bond, and post-sale indemnity exposures, and whether district reimbursements are collected on schedule.