Business context and reporting period
Forestar Group Inc.’s unaudited Form 10-Q covers the quarter and six months ended June 30, 2016, compared with the same periods in 2015. Its continuing businesses comprise real estate development and land sales, owned mineral interests, and timber, recreational leases and water resources. During the quarter, Forestar completed its exit from substantially all oil and gas working-interest properties; those operations are presented as discontinued operations.
Financial performance and liquidity
| Metric | Q2 2016 | Q2 2015 | First six months 2016 | First six months 2015 |
|---|---|---|---|---|
| Revenue | $48.0 million | $43.6 million | $85.6 million | $81.0 million |
| Income from continuing operations | $12.3 million | $2.7 million | $16.2 million | Loss of $2.8 million |
| Net income (loss) attributable to Forestar | $9.6 million | Loss of $34.5 million | $5.2 million | Loss of $42.7 million |
| Basic EPS | $0.23 | Loss of $1.01 | $0.13 | Loss of $1.25 |
| Operating cash flow | Not separately stated for the quarter | $12.5 million | Use of $17.5 million |
- Quarterly revenue grew about 10%; first-half revenue grew about 6%. First-half residential lot sales volume increased, while average revenue per lot declined 8% due to product mix. Real estate segment revenue benefited from higher undeveloped-land sales.
- Reported earnings include substantial asset-sale gains: $107.7 million in Q2 and $121.2 million for the first half. These were partly offset by $48.8 million of non-cash real estate impairments in Q2. Excluding these unusual items, reported profit is not a clear measure of recurring operating performance; the filing does not provide an adjusted earnings figure.
- Q2 included a $35.8 million loss on debt extinguishment; the first-half loss was $35.9 million. The Q2 tax rate on continuing operations was 55%, and the first-half rate was 51%, including the effect of an increased valuation allowance. The company reported a $97.0 million valuation allowance against deferred tax assets.
- Cash and cash equivalents were $107.4 million at quarter-end, versus $96.4 million at December 31, 2015. Total assets were $681.8 million, down from $972.2 million. Debt, net, fell to $114.2 million from $381.5 million.
- First-half investing cash flow was $309.5 million, principally reflecting $318.5 million of asset-sale proceeds. Financing cash flow used $311.1 million, chiefly for debt repayments. Cash increased $11.0 million over the first half.
- The $300 million revolving credit facility had no borrowings and $15.3 million of letters of credit outstanding; net unused capacity was $216.2 million. Together with cash, available liquidity was reported at $318.7 million. Forestar was in covenant compliance; its reported interest coverage ratio was 6.12x and total leverage ratio 22.6%.
Material changes versus prior period
- Forestar sold the Radisson hotel for $130.0 million, multifamily property Eleven for $60.2 million, and properties Dillon and Music Row, as well as its interests in ventures and oil and gas assets. These transactions drove much of the year-over-year improvement in reported earnings and cash flows.
- The company repurchased approximately 97.6% of its 8.5% senior secured notes in a cash tender offer, paying a premium, and also repurchased convertible notes. It eliminated or modified certain note covenants and released related subsidiary guarantees and collateral.
- Real estate impairments reflected a portfolio review and revised plans to market selected non-core projects and a multifamily site for sale. First-half undeveloped land sales were 7,397 acres, versus 1,634 acres in 2015.
- Discontinued operations generated a first-half after-tax loss of $10.3 million, compared with a $39.7 million loss in 2015. The 2016 result included losses on disposals of oil and gas properties.
Outlook, risks and contingencies
The filing provides no quantified earnings or revenue guidance. Management described initiatives to reduce costs, review the asset portfolio and capital structure, and sell non-core assets. It cited supportive housing indicators in key markets, including job growth and demand for developed lots, but cautioned that restrictive mortgage lending and global economic uncertainty could constrain housing recovery. Lower oil and gas prices and production reduced mineral royalty revenue and could hinder future leasing activity.
- Future results depend on real estate demand, sale timing and pricing, development approvals, construction costs, and reimbursement timing from utility and improvement districts. At quarter-end, $19.7 million of Cibolo Canyons reimbursements had been approved but remained unpaid; amounts and timing depend on available district funds.
- Approximately 40,000 Louisiana mineral acres may revert to surface owners in 2017 unless qualifying drilling operations commence before the relevant deadline.
- A former executive’s royalty-interest litigation is being contested; Forestar said it cannot estimate a possible loss or range. Environmental remediation costs are estimated at $651,000, though additional work may be required.
- Forestar guaranteed certain obligations on construction loans of equity-method ventures. Its maximum stated exposure to loss on one variable-interest-entity venture was $3.7 million.
- Management identified risks including economic and housing-market changes, entitlement and reimbursement approvals, commodity prices, partner performance, debt covenant compliance and the outcome of contingencies. It reported disclosure controls as effective and no material changes in internal control over financial reporting.
Key facts investors should verify
- How much of reported earnings and cash generation is repeatable after separating asset-sale gains, impairments and debt-extinguishment charges.
- The pace and economics of future lot and land sales, including average lot pricing and remaining development and entitlement requirements.
- Available liquidity and borrowing-base capacity as additional non-core assets are sold, along with covenant headroom and the revolving facility’s maturity and extension options.
- Collection timing for Cibolo Canyons reimbursements and any developments regarding the Louisiana mineral acreage deadline.
- The effects of elevated tax rates and the deferred-tax-asset valuation allowance, and any material change in legal, environmental or venture-guarantee exposures.