Forestar Group Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2014. Forestar develops and sells land and real estate, explores for and produces oil and gas, and manages timber and other natural resources.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $58.8 million | $75.1 million | $226.5 million | $232.7 million |
| Operating income | $12.7 million | $10.6 million | $55.5 million | $23.7 million |
| Net income attributable to Forestar | $5.2 million | $11.8 million | $28.4 million | $16.3 million |
| Diluted EPS | $0.12 | $0.33 | $0.65 | $0.45 |
| Operating margin | 21.6% | 14.1% | 24.5% | 10.2% |
Revenue declined 21.7% in Q3 and 2.7% for the first nine months. Operating margins include significant asset-related gains. Q3 net income fell despite higher operating income, reflecting lower pretax income and a $2.8 million tax expense, versus a $2.9 million tax benefit in Q3 2013. Nine-month earnings improved, aided by gains and stronger real estate results; the 2013 comparison included a $6.3 million tax benefit from the lapse of a statute of limitations.
- Cash flow: Nine-month operating cash flow was $36.4 million, down from $45.1 million. Investing used $82.9 million; financing provided $24.8 million. Cash fell $21.7 million to $170.6 million.
- Balance sheet and debt: Assets were $1.268 billion and equity $745.4 million at quarter-end. Debt was $429.3 million, up from $357.4 million at 2013 year-end. This included $250 million of 8.5% senior secured notes due 2022 and $102.4 million of convertible notes, net of discount.
- Liquidity: The $300 million revolver had $289.9 million of unused capacity after outstanding letters of credit. Cash plus unused capacity was reported as $458.7 million of available liquidity. Forestar reported compliance with debt covenants; interest coverage was 6.02x, leverage 37.0%, against a 50% maximum.
- Segments: Nine-month real estate earnings rose to $66.9 million from $40.7 million, while oil and gas earnings declined to $16.3 million from $17.9 million. Other natural resources earnings fell to $2.2 million from $2.8 million.
Material changes and unusual items
- Q3 real estate earnings benefited from a $7.6 million gain on acquiring the remaining interest in the Eleven Austin multifamily venture. Nine-month real estate results also included a $10.5 million gain from a non-monetary timber-rights exchange. The company recorded a $9.0 million gain on oil and gas property sales for the nine months.
- Oil and gas costs rose substantially, including exploration costs of $14.1 million versus $5.1 million in the prior-year period; dry-hole costs were $9.5 million versus $2.2 million. Higher production volumes lifted revenue, but lower oil prices, exploration costs, and operating expenses weighed on segment earnings.
- Forestar issued $250 million of 8.5% secured notes and used proceeds principally to repay its $200 million term loan. Interest expense increased to $21.5 million for the nine months from $14.9 million.
- In Q3, Forestar acquired its partner’s interest in the 257-unit Eleven multifamily property for $21.5 million and took full ownership. Nine-month real estate development and acquisition expenditures were $82.9 million.
Outlook, risks, and contingencies
- Management described the housing recovery as tentative, while multifamily conditions remained strong. It cited lower oil prices and weakening global demand as potential constraints on future oil exploration and development economics.
- No earnings guidance was provided. The company planned to drill or participate in approximately 155 gross wells in 2014, with projected drilling and completion expenditures of $76.8 million; management said spending could change with commodity prices, drilling results, costs, and opportunities.
- On October 24, 2014, after quarter-end, Forestar received $46.5 million from the Cibolo Canyons Special Improvement District. It expects to apply proceeds against its $24.1 million resort investment and recover that investment in Q4. In connection with the bond financing, Forestar provided a $10 million surety bond and a $6.846 million letter of credit; the letter of credit may remain outstanding through 2034.
- Forestar had $40.0 million of pending Cibolo Canyons infrastructure reimbursements at quarter-end, excluding interest; collection timing depends on district approvals and available funds. It also provided construction and repayment guarantees for certain multifamily venture loans.
- The company reported no material change in risk factors, no outstanding commodity hedges, and no expected material effect from ordinary-course litigation. It estimated $810,000 of remaining remediation costs at a California site, while noting additional remediation could be required.
Investor verification priorities
- Reconcile reported earnings and margins to the $7.6 million acquisition gain, $10.5 million exchange gain, and oil and gas asset-sale gains; assess how repeatable underlying segment results are.
- Review oil and gas exploration spending, dry-hole costs, production trends, realized prices, and exposure to further oil-price declines.
- Verify receipt and use of the $46.5 million post-quarter Cibolo Canyons payment, and track outstanding surety, letter-of-credit, and infrastructure reimbursement exposures.
- Monitor debt-service costs, covenant headroom, revolver availability, and guarantees tied to multifamily venture borrowings.
- Assess real estate sales pace, project-level costs and approvals, and the risks inherent in management’s development and reimbursement estimates.