Forestar Group Inc. — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013. Unaudited results; amounts are in millions unless otherwise noted.
Business context
Forestar operates in real estate, oil and gas, and other natural resources. Its real estate activity is concentrated in Texas and Georgia. In 2013, the company began reporting fiber and water activities together as other natural resources; prior periods were reclassified.
Financial performance and liquidity
| Metric | Q3 2013 | Q3 2012 | First 9 months 2013 | First 9 months 2012 |
|---|---|---|---|---|
| Revenue | $75.1 | $40.6 | $232.7 | $104.0 |
| Operating income | $10.6 | $4.8 | $23.7 | $17.0 |
| Income (loss) before taxes | $10.0 | $(1.5) | $19.1 | $5.9 |
| Net income attributable to Forestar | $11.8 | $(0.7) | $16.3 | $2.9 |
| Diluted earnings (loss) per share | $0.33 | $(0.02) | $0.45 | $0.08 |
- Revenue mix: Q3 real estate revenue was $50.4, oil and gas $22.1, and other natural resources $2.7. Nine-month segment earnings were $40.7 for real estate, $17.9 for oil and gas, and $2.8 for other natural resources.
- Margins: The filing does not provide a clear consolidated gross-margin measure. Cost of sales and operating costs are reported by activity.
- Cash flow: Nine-month operating cash flow was $45.1, versus cash used of $19.4 in 2012; investing used $62.3, and financing provided $61.6. Cash rose to $54.8 from $10.4 at year-end 2012.
- Debt and liquidity: Debt was $335.2 at quarter-end, up from $294.1 at year-end 2012. The balance included a $200.0 term loan and $99.1 carrying value for the 3.75% convertible notes. The $200.0 revolving facility had $196.3 of unused capacity after letters of credit. Reported available liquidity, including cash, was $245.8.
- Balance sheet: Total assets were $1,003.5 and total equity $580.2. Real estate was carried at $509.5; oil and gas properties at $207.8.
Material changes versus prior periods
- Q3 revenue increased about 85% year over year; nine-month revenue more than doubled. The Credo acquisition, completed in September 2012, contributed $15.3 of Q3 and $36.4 of nine-month 2013 oil and gas revenue.
- Real estate results benefited from higher residential lot volume and prices and undeveloped land sales. The nine-month period also included the $41.0 sale of the Promesa multifamily property, generating $10.9 of segment earnings.
- Oil and gas segment earnings rose in Q3 but declined for the nine-month period. Acquired production and higher prices supported results, while lower production and reduced lease bonus and delay rental income from owned mineral interests were offsets.
- Q3 2012 included a $10.2 gain on sale of assets; nine-month 2012 included $25.5 of such gains. The 2012 comparison also included Credo acquisition transaction costs and a $4.4 debt-extinguishment loss.
- Nine-month 2013 net income included a $6.3 tax benefit from expiration of the statute of limitations on a previously reserved tax position. Management said the effective tax rate would have been 33% without this benefit.
Outlook, commentary, and risks
- Management described improving U.S. single-family housing conditions and strong multifamily markets, but cited unemployment, economic uncertainty, and restrictive mortgage lending as risks to housing recovery.
- The company planned to drill or participate in approximately 140 gross (50 net) wells in 2013 and projected $73.9 of annual drilling and completion expenditures. Management said spending could change with commodity prices, drilling results, service availability, acquisition opportunities, and liquidity.
- Management noted stronger oil and natural gas prices versus the prior year, while emphasizing commodity-price volatility. No commodity hedging positions were outstanding at quarter-end.
- Debt agreements include leverage and coverage covenants; Forestar was in compliance at quarter-end. Its leverage ratio exceeded the threshold for distributions, so distributions were restricted until conditions are met.
- Key uncertainties include real estate approvals and sales timing, oil and gas production and reserve estimates, commodity prices, and collection timing for improvement-district reimbursements. The company had $41.8 of pending Cibolo Canyons infrastructure reimbursements, excluding interest, and said collection depends on approvals and district funding.
- Contingencies include $26.6 of performance bonds and letters of credit for ventures, construction completion and repayment guarantees on venture projects, and estimated remaining remediation costs of $1.2 for a California site. Maximum estimated exposure for certain unconsolidated VIEs was $3.7.
- Management stated that ordinary-course litigation reserves were adequate and it did not expect proceedings to materially affect financial position or long-term results, while acknowledging charges could be significant in an individual period. No material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- How much of reported earnings and cash generation is repeatable after the Promesa sale and the $6.3 tax benefit?
- Whether projected 2013 drilling activity and $73.9 capital spending were completed, and the resulting production, costs, and returns.
- Progress and timing of Cibolo Canyons reimbursements, including the $41.8 pending amount and district funding capacity.
- Debt covenant headroom, restrictions on distributions, and the cash-versus-share settlement implications of the convertible notes.
- Exposure from venture guarantees, performance obligations, and the stated maximum loss on unconsolidated VIEs.