Business context and reporting period
Forestar Group Inc.’s unaudited Form 10-Q covers the quarter and nine months ended September 30, 2017. The company develops residential and mixed-use real estate and had been selling non-core assets, including its remaining mineral and oil-and-gas interests. On October 5, 2017, after quarter-end, D.R. Horton acquired 75% of Forestar; Forestar remained publicly listed.
Financial performance and position
Unless noted otherwise, amounts are in millions of dollars.
- Revenue: Third-quarter revenue was $33.1, down from $47.2 a year earlier. Nine-month revenue was $83.5, down from $132.8, reflecting asset divestitures and the absence of prior-year undeveloped-land sales.
- Profit: Third-quarter continuing-operations net income was $8.0 versus $17.4; diluted continuing-operations EPS was $0.19 versus $0.40. Nine-month continuing-operations net income was $29.1 versus $33.7. Total net income attributable to Forestar was $45.2 for the quarter and $67.8 for nine months, substantially boosted by discontinued-operations income of $37.2 and $38.8, respectively. That income included a significant tax benefit related to the final oil-and-gas entity sale.
- Cash flow: Nine-month operating cash flow was $1.0 versus $29.8 in 2016. Investing cash flow was $127.7, principally from asset-sale proceeds; financing cash flow was positive $0.9. Cash increased to $395.4 from $265.8 at year-end 2016.
- Costs and unusual items: Nine-month operating income was $55.6 versus $89.4. General and administrative expense rose to $38.4 from $16.5, including a $20.0 merger termination fee and $5.6 of proposed-merger professional and other costs. Asset-sale gains were $113.4; the company also recorded a $37.9 non-cash goodwill impairment tied to its mineral assets.
- Margins: The filing does not provide a single consolidated operating-margin measure; results include significant asset-sale gains and non-recurring charges.
- Debt and liquidity: Quarter-end debt, net, was $115.5 versus $110.4 at year-end 2016. Cash exceeded reported debt by approximately $279.9. The former $50.0 revolving credit facility had no borrowings but $14.3 of letters of credit outstanding and $14.8 of unused borrowing capacity. Forestar reported compliance with its financial covenants at quarter-end.
Material changes versus the prior comparable period
- Owned and consolidated residential lot sales volume declined: 240 lots in the quarter versus 272, and 682 for nine months versus 975. Average revenue per lot increased 40% for the quarter and 36% for nine months, primarily due to product mix. Equity-method venture lot sales and earnings were higher for the nine-month period.
- Forestar sold its remaining owned mineral assets for approximately $85.7 and approximately 19,000 acres of timberland and undeveloped land for $46.2. It also completed the sale of its remaining oil-and-gas entities in September.
- The prior-year comparison included $121.7 of nine-month asset-sale gains and a $35.9 debt-extinguishment loss; 2017 included $28.7 of gains on timberland and undeveloped-land sales and higher mineral-asset disposal gains.
- Operating cash flow fell materially, in part due to merger-related payments, no retail land sales, and a $3.0 legal-settlement payment.
Outlook, commentary, risks and contingencies
- Management said the D.R. Horton relationship could support growth in community development through a master supply agreement for finished lots at market prices. The agreement does not require D.R. Horton to present development opportunities, and Forestar cautioned that anticipated benefits may not be realized.
- Management expected initially to fund growth from available cash, was evaluating longer-term capital structure and liquidity needs, and planned to pursue a new credit facility while retaining the option to raise debt or equity. The filing provides no numerical earnings or revenue guidance.
- After the merger, D.R. Horton held 75% of Forestar’s shares. The filing highlights risks from controlling-stockholder influence, potential conflicts, effects on other builder relationships, and uncertainty around the strategic relationship.
- After closing, Forestar entered a $30.0 secured letter-of-credit facility backed by $30.0 of cash and terminated its prior credit facility. It offered to repurchase its 3.75% convertible notes following the merger and redeemed the remaining $5.3 principal of its 8.50% notes for approximately $5.9 on October 30.
- Key operating uncertainties include real-estate demand and pricing, development approvals and costs, labor and materials availability, and the timing and collection of utility-district reimbursements. At quarter-end, $10.2 of Cibolo Canyons reimbursements were pending submission/approval processes; the company noted uncertainty in timing and amount of collections. Forestar also had guarantees associated with construction loans of unconsolidated ventures.
- Management stated that ordinary-course litigation and environmental reserves were adequate for probable, estimable losses, while noting that additional charges could be significant in an individual period. Disclosure controls were deemed effective, with no material change in internal control reported.
Important facts for investors to verify
- How much of reported 2017 earnings reflects recurring real-estate operations versus asset-sale gains, discontinued-operations tax benefits, and transaction costs.
- Post-merger debt, liquidity, cash collateral, and the final outcome of the convertible-note repurchase offer and note redemption.
- Whether the D.R. Horton master supply agreement generates development opportunities and lot sales on market terms, and how the relationship affects other builder customers.
- Collection timing and recoverability of utility-district reimbursements, including the Cibolo Canyons balance, and exposure under venture-loan guarantees.
- Whether deferred tax assets are realizable given the disclosed $66.5 valuation allowance and cumulative-loss evidence.