Forestar Group Inc. (FOR) Q2 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. And welcome to the Forestar Second Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, today’s conference call is being recorded. I would now like to turn the conference over to Anna Torma. Please go ahead.

Thanks and good morning. I would like to welcome each of you who have joined us by conference call or webcast this morning to discuss Forestar’s second quarter 2015 results. I am Anna Torma, Senior Vice President, Corporate Affairs. Joining me on the call today is Jim DeCosmo, President and CEO; and Chris Nines, Chief Financial Officer. This call is being webcast, and copies of the earnings release and presentation slides are now available on the Investor Relations section of our website at forestargroup.com. Before we get started, let me remind you to please review the warning statements in our press release and our slides as we will make forward-looking statements during the presentation. In addition, this presentation includes non-GAAP financial measures. The required reconciliation to GAAP financial measures can be found at the back of our earnings release and slides or on our website. Now, let me turn the call over to Jim for opening remarks.

Thank you, Anna. And I’d also like to welcome everyone who has joined us on the call this morning. On May 12, we announced that the board management unanimously approved and initiated a focused plan to enhance shareholder value by growing net asset value through investments in real estate, our core business. Execution of the following four principal initiatives is key. First, as a market-driven company we’ll make disciplined investments in acquisitions, design, entitlement and development of highly desirable residential and mixed-use communities. That’s the cornerstone of Forestar’s real estate. Second, we’ll invest our multifamily business with objectives of growing net asset value and increasing recurring cash flow. As a market-driven company, we’ll evaluate each project and determine whether property provides the greatest value as a longer term hold or sale. Third, harvesting cash flow from our non-core oil and gas business by significantly lowering capital and operating cost. Fourth, given the little basis in our quality timberland, we expect to tax efficiently transition certain acreage over time primarily in the multifamily. This is an opportunity to create NAV and increase current cash flow. And last, we’re committed to managing the business so that we maintain a healthy balance sheet and adequate liquidity to fund growth or manage through downturn. Now, let me turn the call over to Chris for review of our financial.

Thank you, Jim. And I would also like to welcome everyone joining us on the conference call or webcast this morning. As we announced last week, second quarter 2015 financial results were negatively impacted by almost $57 million in non-cash charges, related to our non-core oil and gas property. Principally, as a result of these charges, the company reported a net loss of approximately $34.5 million, or $1.01 per share in the second quarter 2015, compared with net income of $14.8 million, or $0.34 per share in the second quarter 2014. On an after-tax basis, second quarter 2015 non-cash charges related to our non-core oil and gas properties were $36.7 million, or $1.07 per share, and include $16.3 million of proved property impairments, $13.5 million of unproved leasehold interest impairments, principally associated with the suspension of exploration and drilling activity in Oklahoma, Nebraska, and Kansas, which is consistent with the execution of our strategic initiatives, the harvest cash flow from our oil and gas business by significantly lowering its capital investments and operating costs, and $6.9 million of dry hole expenses principally related to an exploratory well in Oklahoma. Excluding these special items, second quarter 2015 net income was $2.2 million, or $0.06 per share, as compared with net income of $14.8 million, or $0.34 per share in the second quarter of 2014. Turning to our segment results. This next slide illustrates our second quarter 2015 segment financial results as reported, compared with second quarter 2015 segment results, excluding the previously mentioned special items and second quarter 2014 actual results. Let me begin with our real estate segment. Real estate segment earnings were $15.5 million in the second quarter 2015, compared with $27.3 million in the second quarter of 2014. This decline in year-over-year results is principally due to a $10.5 million gain associated with the exchange of leasehold timber rates for 5,400 acres of undeveloped land from the Ironstob venture in the second quarter 2014. Excluding this gain, real estate segment earnings in the second quarter 2015 were in line with prior year, reflecting relatively stable market demand in our communities and low housing inventories. Oil and gas segment loss in the second quarter 2015 was approximately $56.9 million, compared with earnings of $9.5 million in the second quarter 2014. This year-over-year decline was driven by almost $57 million in non-cash charges related to our non-core oil and gas properties. Excluding these charges, our second quarter 2015 oil and gas segment results were essentially break-even, as the decline in commodity prices was offset by increased oil productions and significantly lower segment operating expenses. Other natural resources reported essentially break-even in the segment results in the second quarter 2015, compared with earnings of $2.1 million in the second quarter 2014. As a reminder, our other natural resources segment results in the second quarter of 2014 included approximately $1.4 million in gains related to a groundwater reservation agreement and the partial termination of a timber lease associated with land sales from our Ironstob venture. Principally, as a result of the $57 million in non-cash charges related to our oil and gas segment, the company reported a total segment loss of $41.4 million in the second quarter 2015. Excluding these non-cash charges, second quarter 2015 total segment earnings were $15.1 million, compared with $38.9 million in the second quarter of 2014. Now, let me turn the call back over to Jim to discuss our segment operating results, market conditions, and the further execution of our strategic initiatives.

Thank you, Chris. Although our second quarter financial results were certainly not up to our standard, as a result of non-cash charges and depressed oil prices, I continue to be encouraged with our real estate business. We have very desirable communities and locations, where home buyers or renters want to be. Let me begin the review with our real estate segment. Real Estate segment earnings of $15.5 million in the second quarter were down $11.8 million year-over-year principally due to $10.5 million gain in the second quarter of last year that resulted from the exchange of timber leases and Ironstob venture for fee ownership. In addition, mitigation credit and undeveloped land sales were lower in the second quarter of this year. Most important, market and builder demand for finished lots remains steady, as we sold 519 lots during the quarter. We continue to focus on maximizing value which equates to managing for lot margin first followed by velocity. For the quarter, lot sales priced average $73,400 per lot and an average gross profit of $34,400. In last, we sold 783 acres of non-core residential tracts near Atlanta for approximately $4 million generating $1.3 million in earnings. Shifting gears to an update on our view of the Texas housing market conditions. Given the decline in oil prices, we closely monitor the Texas economy housing market, looking for signs of weakness or slowdown. As the charts on the left indicate, new home inventories remain at low levels and demand measured by job growth is outpacing the national average in all markets except Houston. Even though there has been a slowdown in Houston’s job growth, we get see a widespread impact on new home start sale. Current market intel notes new home price points above the $400,000 range is met some resistance, but below that price point, which is where our communities are priced, demand continues to be stable. At the lower price points, particularly for new home entry level, demand is strengthening. One of the more common questions we could ask is, how is business in Texas, or in particular, what are you seeing in Houston? To address the question we provided year-to-date lot sales by market on the right. As the schedule illustrates, about 45% of Forestar’s first-half lot sales are in Houston. In fact, we closed 158 lots in Harper’s Preserve in the second quarter. That’s a community located just east of The Woodlands. Internally, we believe these take-downs would be a good barometer for the market. As it turned out, builders didn’t hesitate to close, and I think that’s a good sign. I’d sum it up by saying Texas is in good health today. Relative to the balance of the year let’s take a look at the next chart. One way to view or think about the balance of the year is backlog, which is illustrated on the left. We continue to have just done a year’s worth of sales under option contracts. As I noted on the last call and I’ll repeat today, we still expect lot sales to be in 1,800, 1,900 range; heavier in the fourth quarter than the third, which is just a function of construction or development schedule. Developments in Houston are recovering from 40 inches of rain in the first-half of the year, and that’s 18 inches above normal. As noted, we have about 300 lots in development that are scheduled to close late in the year that are dependent on normal weather conditions, contractor performance, and administrative approvals. If there is potential risk to our estimate, it’s development delays. Moving to multifamily, similar to single family, multifamily market conditions continue to offer opportunities. The pros: one, strong job growth for rental cohort of 20- to 34-year-old; two, household formation is accelerating with job growth and improving economy; three, occupancy and rent growth remains strong; four, difficult to qualify for single-family mortgages persist; five, a preferred lifestyle or locations that provide mobility, flexibility and easy access to jobs and recreations; and last, as the chart illustrates, housing is generally undersupplied, particularly multifamily. The cons: one, some concerns regarding affordability, reflective of strong rent growth; two, construction costs are more difficult to control, particularly materials and labor or crafts; and last, sites are becoming more difficult to underwrite. On balance, we continue to be optimistic relative to our multi family business and we’ll stay true to our strategy, invest and operate with discipline. At the end of second quarter, we had about 2,600 units in six markets in our portfolio. Two completed and stabilized projects, and another six projects under construction. In the second quarter, we started construction on two new wholly-owned multifamily projects, expected to be longer-term hold; one in Nashville and one in Charlotte, representing over 600 units. I’ll provide additional color on these two projects in the next series of slides. 11 wholly-owned projects in Downtown Austin remains 95% occupied and expected to generate about $3 million in net operating income in 2015. Our Midtown Cedar Hill project near Dallas is substantially complete and nearly 84% leased at quarter-end. As, I mentioned last quarter, Midtown is being marketed for sales in the second-half of this year. Given our new strategy, we’ll evaluate offers and determine if the greatest value is due to sale or holding for recurring cash flow and value appreciation. During second quarter, we delivered the first units at our 360 project in Denver which is now over 95% complete and over 65% leased. In addition, we delivered first units at Acklen in Nashville, which is now over 95% complete and about 34% leased and we expect HiLine in Denver to deliver units in the third or the early fourth quarter of this year. And last, we currently have a site for potential development in Austin, and in addition, we’re evaluating other sites in several markets. Now, for additional color on our two multifamily projects recently started. One of our second quarter multifamily starts is in Nashville and located on Music Row which is how the project got its name. A standard with our Class A community, significant planning and design, expertise operate with a common mission to develop a property and lifestyle that perspective renters can’t live without. Equally important is to manage the development process and deliver at a cost that generates the return, cash flow and value to meet our standards. All-in cost for the 230 units in Music Row is expected to be in $47 million to $48 million range. And when stabilized, net operating income is estimated to be above $3.5 million. Another critically important element is location, which is the next slide. Our multifamily team assembled six parcels in a parking lot along Music Square West followed by successful rezoning for multifamily. Since that time, a temporary moratorium has been placed on rezoning in the area. Within walking distance are 20,000 Vanderbilt and Belmont University students and approximate the 20,000 employees associated with four hospital campuses. In addition, the surrounding employment base includes 7.5 million square feet of office in the Central Business District, 1.5 million square feet of retail and easy access to night life at The Gulch and Midtown. We expect construction to be completed at midyear 2017 and re-stabilization within the following six months. Once again, this 100%-owned property is expected to be held longer-term. Moving to Dillon located in Charlotte. Our second start in the quarter is called Dillon and located in Charlotte. This 379 unit Class A project is located less than 2 miles from Downtown, Charlotte. The structure will have five-stories of apartments, including high-end studio, one and two bedroom units, on top of three stories of parking. In addition, the project will include 12,000 square feet of ground floor retail. Development cost for Dillon, including land is expected to be in the range of $81 million to $83 million. Construction should be completed in next 24 to 30 months and stabilize late in 2018. At that time, the project is expected to generate net operating income in the $6 million range. Like Music Row, location if key for Dillon. Charlotte has emerged as a financial distribution and transportation nexus for the Southeast, and it’s one of the nation’s fastest growing regions. Dillon is a short 1.9-mile commute to Charlotte Central Business District, comprised of 21 million square feet of office and 83,000 jobs. As you can see on the map, the project is located across the street from Carolinas Medical Center with current staffing at 2,400 employees. Also in close proximity are parks, retail and entertainment. Like Music Row, Dillon is 100% owned and expected to be held longer term. I’m going to leave you with two thoughts on our real estate business. First, housing is undersupplied in the underlying fundamentals: demographics, household formations, inventories and job growth are healthy. I believe this to be equally true across our target markets for both single and multifamily communities, evidenced by the chart on the left. We’re generating some of the highest gross profits from lots since 2006. Second, we’re focused on increasing net asset value by investing with discipline in real estate, our core business. Year-to-date, we’ve acquired five future community development sites in five markets, which yield our 640 highly desirable lots. We started two multifamily projects on balance sheet and in the quarter with eight multifamily projects stabilized or under construction, representing almost 2,600 units in solid locations. Shifting to other natural resources, during the second quarter this year other natural resources segment results were essentially breakeven, down from $2.1 million in the prior-year. This is principally due to reduced short-term mill quotas. For comparative purposes, 2014 included earnings of $1.4 million associated with a gain on a timber lease termination and execution of a groundwater reservation agreement. We sold over 55,000 tons of fiber, that’s down 49% compared with the same quarter of last year. For 2015, we continue to anticipate that fiber sales are going to be in the range of 275,000 to 300,000 tons. Average fiber pricing was down 19% compared with same quarter last year and that’s due to higher mix of pulpwood volume and lower pulpwood prices. Moving to oil and gas, second quarter 2015 oil and gas segment results were a loss of approximately $56.9 million compared with earnings of $9.5 million in the same quarter of last year. This decline is principally due to the previously mentioned impairment. Excluding these non-cash charges, second quarter 2015 oil and gas results are essentially breakeven. Contributions from production volumes are up $4.6 million, that’s reflective of a 24% increase in working interest production, mostly attributable to production growth in the Bakken/Three Forks. Nine new wells came online in second quarter, most of which were committed to in 2014. We ended the quarter with 10 wells waiting on completion with about 6% working interest on average. Despite the decline in costs and increased production, average realized oil price were down almost 46% from the same quarter last year, offsetting these improvements. Four new AFEs were signed during the second quarter for wells located in the core of the Bakken/Three Forks. In most cases, these are wells proposed in units with existing production, which increases the accuracy of our EUR estimates. We also elected not to participate in other wells due to lower turns, once again due primarily to a combination of higher cost and lower EURs. Our focus is on harvesting cash flow and preserving value. In the second quarter, the oil and gas segment generated about $8.8 million in cash flow prior to capital investment. Excluding restructuring costs, we reduced oil and gas segment operating cost about 44% compared to 2014. And furthermore, we’re pursuing additional reduction. I’ve shared with you on last call our plan for 2015 new capital commitment is expected to be in the $10 million to $15 million range as compared to approximately $110 million last year. So far the majority of capital spending this year is associated with the carryover of 2014 commitment. As one of our key initiatives, we’re targeting oil and gas segment to generate cash flow on an after CapEx basis by year end. The initiative is based on quarter-end NYMEX strip prices. Relative to initiatives, I’ll close the call with an update on our progress today. We believe executing the initiatives will drive net asset value and shareholder value. We officially started the fourth quarter of 2014, we’ve made good progress to-date, and we’re 110% committed to the plan. In community development, we’ve acquired five new tracks for $24 million, representing over 640 future lots that I believe we could put under contract tomorrow. In multifamily, we started construction on two new projects, while balance sheet expect to add over 600 units to the portfolio, growing net asset value and expected to generate an estimated net operating income of almost $10 million. As I just stated, we’re intently focused on generating cash flow from oil and gas. Excluding restructuring costs, segment operating costs were down almost 45% from 2014, and new capital has been limited to a small number of Bakken/Three Forks wells versus the $110 million in 2014. Companywide, we’re focused on lowering operating costs and expenses across the board, as second quarter G&A costs were 7% lower than the same quarter in 2014. The bottom line, I believe we’ve got the right strategy focused on growing net asset value and our employees, management, and board are committed to executing initiatives designed to maximize long-term shareholder value. And equally important, we’re looking forward to telling you more about it. I’m excited to announce that we’ll be holding an Investor Conference this year in Nashville. The conference will begin with dinner on November the 18, with a presentation on housing market conditions. The following day we’ll have presentations from our senior management team followed by a tour of multifamily and community development projects. It would be a great opportunity for you to spend time with our broader senior leadership team, visit some new projects, and gain additional insight into Forestar. We have a block of rooms that are set aside at the Omni for limited time, so I encourage you to RSVP to Anna, if you plan to join us. Once again, I want to thank you for joining us on the call this morning, as well as your interest in Forestar. I’ll open up the call for questions.

Thank you. [Operator Instructions] And our first question comes from Steve Chercover of D.A. Davidson. Your line is now open.

Thank you. Good morning, everyone.

Good morning, Steve.

So I just want to make sure I understand the nuance, maybe it’s not even nuance, maybe it’s just blunt. You’re definitely shifting your strategy towards holding the income-generating properties as opposed to developing, selling, and using the funds to fund growth. Is that correct?

Yes. Steve, I think that’s materially correct. We’ll look at each project and make the decision, is it of greatest value to Forestar in its value to hold it longer-term, or to sell it. You’re correct that prior to the announced initiatives and strategy that we put out, it was principally a merchant build model, and now we’re shifting to holding these properties longer-term.

I mean, even Midtown in Dallas, which is for sale might ultimately turn out to be something that’s held. I mean, does that – I mean you will change the amount of leverage you will run the business with?

I’m sorry, Steve, can you repeat that?

Would the amount of leverage required to run the business change, as you hold more assets?

Steve, what I would say and I’ll encourage Chris to jump in here too is that the more stable and the deeper the cash flow, recurring cash flow underpinning is of the business, the more leverage the balance sheet can stand. Chris, do you want to chime in, or do you want to tell us what that leverage ratio might be?

I would say relative to the construction of these assets, our intent would be to use 60% to 65% attractive project level financing for the development of those multifamily assets, which today is very attractively priced at, call at all in the 2% to 2.5% range. Long-term if we decide to hold these assets, we would probably look for a more permanent type financing on those 7 to 10-year range. So the answer is, yes, I think, certainly, to the extent we begin to generate a portfolio of multifamily assets that generate more recurring cash flow. The business can certainly have a little bit more leverage, but I would tell you, we’re still committed to maintaining balance sheet strength and financial flexibility. So we’re going to make sure that even as we grow that portfolio, we’re going to want to maintain an appropriate leverage positions going forward, so we can continue to grow the business.

Okay. Just couple of more questions. What kind of return on capital do you expect on projects like Music Row in Dillon, I mean, we saw what the NOIs would be, so what kind of returns?

Yes. In terms of targets, on a return on capital, if you look at the entire asset, it’s probably in the 6% to 7% range today for development. From a return on equity perspective, it’s probably in the 10% to 12% range, on an ongoing basis. Based on our equity investment in a project assuming we have 60% to 65% financial leverage, and about 30% to 35% equity in those communities. Based on the cost of development, we probably be looking at a return on that equity investment in the low double digits of 10% to 12%. And that would be a stabilization then obviously, the hope would be with continued rent growth those returns would go up from there.

Okay. And last two questions. Can you – so the swaps of timberland into urban residential land, is that a like kind exchange?

Yes. That’s the intent, Steve. I think, as you know, that there is minimal opportunity to create value with timberland for Forestar. So to the extent that we can tax efficiently exchange into multifamily sites and develop. There’s an opportunity to create value to maintain the – some tax efficiency plus there is also a step up in the cash flow this asset that we generate comparing apple-to-apples.

Okay. And finally, switching gears, in your prerelease last week you said that non-core oil and gas assets are likely to be sold, what about core assets in the Bakken, Texas, and Louisiana?

Yes. The releases has been pretty consistent, Steve. We said that oil and gas operating assets are non-core period. So I would tell you that the Bakken/Three Forks, Kansas, Nebraska, Oklahoma everything, but the minerals is seemed to be a long-term noncore. I will say that there is certainly, a difference in the assets between the Bakken/Three Forks, which is a resource play, where we’ve got really good position in the core versus Kansas and Nebraska, which is a very nice platform for our conventional play and probably attractive to some of the private operators.

Thank you very much.

Thank you, Steve.

Thank you. And our next question comes from the line of Mark Weintraub of Buckingham Research. Your line is now open.

Thank you. Just first, obviously, you had the impairment charge at the end of last year on the oil and gas, and now you have the additional write-down. Have you – at this point, have you sort of gone through and made all the adjustments that you would anticipate, as you go to the process of looking to exit, or is this a step-by-step process and there may be more additional actions that would be reflected in the P&L and balance sheet yet to come in your opinion at this point?

Mark, what I would say is that, we don’t forecast or anticipate impairments. It’s – there’s a process where we look at it on a quarterly basis. And it’s a – lot of these impairments are price-driven. And so it’s very difficult for us to sit here this morning and say either there’s more or there’s not, because we just – I think as you will know, it’s extremely difficult to predict what’s going on with oil prices.

Sure, well, I guess, in this particular situation why then would have there been no impairments, say, in the Bakken? Obviously, the price changes are affecting all of your various oil and gas assets.

Yes, Mark, big picture, as we look at impairment for oil and gas, as well as real estate in a quarterly basis, the first step in that analysis is basically taking the strip price at quarter-end, and looking at those future cash flows that are expected to be generated from those assets to the extent those future undiscounted cash flows exceed your basis, you essentially don’t have an indication of an impairment. So every quarter-end we’ll get to look at what our basis is in each of the oil and gas basins that we have investments, take the strip price as of quarter-end to the extent those undiscounted cash flows exceed our basis. It is unlikely that we would have impairment to the extent that those future undiscounted cash flows come up short of our basis. We would then have an impairment at which point we would discount it back at our weighted average cost of capital, similar to the way we do impairments for real estates. So as of – I mean, at the end of the second quarter, based on strip prices, the expected cash flow is based on the proved reserves that we had on Bakken exceeded our basis in those properties.

Okay. So you effectively, you had more cushion in the Bakken/Three Forks is that a way to…?

That’s correct.

Okay.

There were more expected cash flows than our existing basis at the end of the second quarter, based on current strip prices at the end of June.

And I apologize, but we’re – so where strip prices though higher or lower than when you took – because you did take impairment on the Bakken and Three Forks at the end of last year, correct?

Yes, most of the impairments, Mark, in Q4 were not related to the Bakken/Three Forks. They were located at the unproved leasehold interest in Texas and Georgia and Alabama as well as projects in the Texas Panhandle, principally in the Cleveland and Tonkawa formations, that came with the acquisition of Credo. There was not a significant amount of impairments associated with the Bakken.

Okay. And just help me out on the $11 million on the dry hole costs was with that also somehow related – why would that be taken now as opposed to have been taken previously?

Yes, Mark, in the second quarter based on the drilling activity in Oklahoma, and roughly 90 days of production activity two things occurred. One, our operations and engineering team determined that one of the wells obviously stopped producing oil and gas. So at that point, it was deemed by the operations and engineering team as a dry hole. And when that occurs, you effectively expense those costs, because the well obviously isn’t producing oil and gas. And the second case, relative to proved properties, we had a well, and after 90 days of production the oil and gas engineering group basically determined what the ultimate economic recoveries for the well were going to be. And then based on those recoveries compared to our current basis we took an impairment against that that investment as well. So it’s really a function of that oil and gas engineering team looking at each individual well, determining whether it’s a producer or not, and then, ultimately, what the economic recovery of that well is going to be relative to our current basis in those wells.

Mark, it’s not too dissimilar from the dry hole cost that we’ve taken over last couple years in Kansas and Nebraska.

Okay.

Our accounting is based on successful efforts, so when there’s either a dry hole or low production, it’s taken in which the quarter is determined.

Shifting gears, just on the timberland potential sales, redeployment into multifamily, at this point is there any bank so to speak from the multifamily activities of potential sheltered income for the timberlands and roughly if so, what would that number be at this stage?

Mark, can you ask that question again, please?

Well, as I understand it, essentially as you – for the 1031 exchanges you sell timberlands and then those proceeds can be used for acquiring multifamily properties on a tax effective basis, so there’s no leakage on the timberland sale. But I believe you can also buy the multifamily first and then essentially do the timberland sales after. And so the question is, do you have any – effectively any bank of sheltering from having already made moves on the multifamily side?

Yes, I understand now, Mark. There’s – as I said in my comments, there is a number of sites that are being evaluated. But there’s not a bank of acquired sites that are in place to execute the exchange.

Okay. And then lastly, just wanted to clarify, so when you are talking about 10% to 12% ROE on the multifamily, I assume that’s in – is that after-tax or pre-tax?

Pre-tax NOI.

Pre-tax.

And again that would be start. Certainly, you would expect rent growth above and beyond that going forward, longer-term the returns would hopefully be better than that.

Okay. Thank you.

You’re welcome, Mark.

Thank you, Mark.

Thank you. And our next question comes from the line of Steve O’Hara of Sidoti & Company. Your line is now open. Stephen O’Hara: Hi. Good morning.

Good morning, Steve. Stephen O’Hara: Could you just talk a little bit about the maybe the lots that you bought and maybe the cost per lot there, how that could potentially – or what the outlook is on, let’s say, lot margin due to cost per lot, revenue per lot? And then also just in the quarter, the ventures lot sales was – seemed high, I think, relative to what it’s been recently. Could you just talk about why that was, and if there is any financial impact there? Thank you.

Yes, relative to the lots that were acquired in the five acquisitions, Steve, we’re consistent in the underwriting. We underwrite for 35% return on costs, which I’ve explained several times, that that equates to a mid-to low 20s IRR. So, it’s still a very healthy margin. These are typically smaller communities anywhere from 200 to 400 lots to manage duration risk. So from a margin standpoint, we obviously have got some community selling at some very high margins and others a little bit tighter. But that I think the key message here and answer, Steve, is that, we remain disciplined in the way that we underwrite, and we’ll continue to expect attractive margins going forward. But what was your second part of your question, Steve? Stephen O’Hara: Just on the venture in the quarter?

Okay, venture, I got it. The mix of venture sales, Steve, that’s going to happen from time to time. As I mentioned in my comments, there were 158 lots that closed late in the second quarter in n Harper’s Preserve in Houston and that’s in a venture. Typically, what we see in some of these projects, especially master plans, you’ll get some sizable takedowns in quarters. So I would tell you it’s – I don’t think it’s an indication of a trend. It’s more – it’s reflective of the mix in the quarter. Stephen O’Hara: Okay. So and when you get to that 1,800 to 1,900 lots, we’re including the ventures in that, correct?

Yes, that’s true. Stephen O’Hara: Okay. But you think that, I guess, it sounds like the mix should be different in the second-half?

Yes, it will – it’s going to vary by quarter a little bit, Steve. But if I look – if we look at the balance sheet and looking at investment in wholly-owned projects versus joint ventures, there’s not a material change. So there can be some variability in change from quarter to quarter… Stephen O’Hara: Okay. Okay. And then just on the multifamily strategy, and is there a desire to, maybe add sort of, let’s say, commercial leasing or anything like that, retail or anything like that to that portfolio potentially at some point? And then, is there maybe the ability to, when do you start breaking that the results out? I know you gave the NOI on Eleven for the quarter, I think it was for the quarter, for the year, but I’m just wondering, at what point obviously you got to get more projects in there. But I mean, when do you start breaking that out and kind of reporting on that directly?

Yes, I think you kind of answered your questions. When you get more projects in there, it lend itself to provide more detail metrics for the portfolio and also at the project level. Relative to the other – the first part of that question Steve is that, we’ll certainly be opportunistic, given the land positions that we have. But I’ll also tell you that we’re going to continue to be focused on multifamily, as well as the community development, which is a principally single-family. Stephen O’Hara: Okay. And I’m sorry, just one more. I know you – there had been a renovation of the Radisson in Austin. I’m just wondering what type of improvement there has been possibly in NOI, or maybe rate per room or whatever. If you could talk about that briefly, that would be great. Thanks.

Okay, Steve. The answer is, yes. There has been a step-up in RevPAR. We’re in the process of finishing up that renovation on the rooms. And I think that the best way to address that is we’ll provide some additional color in detail on the Radisson at the investor conference and provide some additional light, as well as insight on that property. Stephen O’Hara: Okay. Thank you very much.

Thank you. And our next question comes from David Spier of Nitor Capital. Your line is now open.

Hey, guys, how are you?

Good, David. How are you?

I’m great. Thank you. Can you give a little detail on possible future plans for the 3,700 acres that are in entitlement at Lake Houston? I Know it’s on your books for about under $2 million. But, at least, from a distance it seems, especially based on the location in Houston and the size of the acreage, that it could represent a significant amount of value.

Yes. David, that parcel is referred to as the Lake Houston tract. It’s one of the relic and legacy parcels that were associated with Temple-Inland when we spun out. So, it’s in good location. Location is improving, as the infrastructure is being developed. There’s currently plans for the extension of some of the major road networks to provide access –better access to that property. So we’re principally focused on the entitlements. There is activity around it, so we’re encouraged. But I won’t speak to value on that individual parcel today though. But you’re right. It’s a nice piece of property that looks better today than it did two or three years ago.

Got it, got it. Understood, thanks. And then in terms of the – just on the strategic initiatives front, I’d say for the past several years there were a couple of different strategic initiatives, and most of which were not really met with much success. And even in the past quarter, where real estate numbers were pretty solid and the oil and gas is break-even, the company still barely made a slight profit. And especially because of the fact the G&A expense and interest expense is still running at about $14 million on a quarterly basis. So I’m just curious to hear your take on the fixed expense side, and if there are any future – if there are any plans to materially reduce that number?

Yes, David. As I mentioned in my comments, there was some reduction in those expenses quarter-over-quarter. There is an initiative, where we are evaluating and targeting, and we’re going to get additional costs out of the system. And as I mentioned to Steve, relative to Radisson, we’ll talk more about that at the investor conference.

Got it, because, I mean, because bigger picture here. I mean, it just seems as if you are running at over a $25 million annual G&A, and then combined with debt, you’re basically looking at about over $50 million annual fixed overhead expenses that has to be – that you have to overcome essentially if you want to make profit. That’s a pretty big hurdle. I mean, I think you still have around 150 employees, which seems like a significant number compared to some of your peers. I mean, I think a company like CTO, which is almost approaching your market size has 14 employees and pays out $6 million in G&A. So I just think if that’s something that can be targeted, I mean, that just seems to be one of the big items here. And if focus was placed in reducing that number, there would be a lot more room for profitability. And I think until that number is reduced, we’re going to have trouble here. So I would really appreciate the efforts you guys are putting in. But I think more as we placed on that number in order to make significant improvements. But I appreciate the time guys.

Yes. David. What I would say is, we’re down about 40 employees from the 150.

So you got 110 currently?

Yes. So we’re in the 110 range. Then this strategy that – and the initiatives that we shared streamlining and focusing Forestar enables us to further streamline, support as well as G&A cost. So it’s all part of the plan.

And is there any way to possibly tackle the 8.5% debt that was I think is taking on in 2014, because I mean, that’s running at about over $20 million a year. So is there any way to, I guess, refinance or somehow approach that debt, because that just seems to be a major overhang on the expense side?

David, there is some opportunity there. I’ll tell you today. Based on what we see, it’s probably somewhat limited. But here again as I just mentioned, when we look at whether it’s interest expense or G&A or any other cost in the businesses, it’s all on the table.

All right. I do appreciate it. Thanks.

All right. Thank you, David.

Thank you. And our next question comes from Rob Longnecker of Jovetree. Your line is now open.

Hey, good morning, guys. I just want to clarify. So you’re totally done drilling in Kansas, Nebraska, Oklahoma; there’s no new capital going on there?

Yes. I think, I heard your question. We suspended all exploration in drilling in Kansas and Nebraska.

Is that like you’re fully pulling out, eventually you’re just going to monetize or is that just pending oil prices or I’m not sure what suspended means?

Suspended means that we’re not investing any capital in Kansas and Nebraska. Obviously, at today’s prices it would be very difficult to generate any returns. And with improved oil prices, as we said, these assets are non-core. And also as we mentioned in the recent press release, that there is a likelihood of sale. So, one of the big drivers here is oil price.

So you said Kansas and Nebraska. What about Oklahoma?

True for Oklahoma as well.

Okay. And the $40 million in carryover that you said you have from 2014, is that predominantly in the Bakken?

Yes, yes.

And is that something that you could dial back as well or is that something you’re fully committed on?

Yes. Well, the 2014 commitments, you can’t dial back on those, but I’d say that we probably have funded the majority of those at this time. And as far as going forward, Rob, we make individual well election. So as I said in my comments, there are some that we’ve elected into and many others we have not.

And the ones where you have elected into, given kind of strips and the EURs expected, what do you think the returns are now?

Well, we don’t elect in until we can generate a 20% return. One of the things that’s happened, Rob, within the last six to nine months is the drilling completion cost has come down considerably, which is the big impact to return, because that’s all upfront cost as you know. In addition, the elections are only – or typically made in units where there is existing production. And there’s a high level of confidence in what the EURs or the total recoveries are going to be.

Great. That makes sense. And then, given that there’s obviously been a lot of impairments, and you guys have done a lot of well assessments and whatnot, is there any way that that you guys can provide, I don’t even know, like an updated PV-10 or something along those lines at current strip prices?

Can we provide an updated PV-10 at the current strip prices?

Yes, given that there has been so many impairments and so much movement around in your portfolio that would be kind of useful from a valuation perspective?

Yes, Rob. We typically don’t provide updates on PV-10 and reserves except at year-end. And I don’t think the impairment of impact to PV-10, that’s the function of the future production, right?

Well, I guess, it is also a function of price. I mean, I think you guys have in presentations in the past, I believe. I’d have to go back. But I think you had it in the footnotes, you had some commentary about what the PV-10 would look like at the current strip prices I think a couple presentations ago.

Yes. That would have been year-end 2014, Rob, when we reported reserves.

Got you.

Rob, this is Chris. The only thing I would say is that obviously if you kind of look at our basis in oil and gas, ignoring – at the end of the second-quarter, it’s probably in the range of about $225 million. If you look at strip prices at the end of the second quarter, expected cash flows out of those proved properties in those units would support $225 million of basis.

Got you.

That’s – but that would be kind of an undiscounted cash flow value.

Got you. Okay. Thank you.

Thank you, Rob.

Thank you. And I’m showing no further questions at this time. I’d like to turn the conference back over to Mr. Jim DeCosmo for closing remarks.

Thank you very much. Once again, I want to recognize and thank everyone who joined us on the call this morning, as well as your interest in Forestar and I hope that you have a wonderful day. Thank you.