Forestar Group Inc. (FOR) Q4 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Forestar Group Fourth Quarter 2016 Earnings Conference Call. At this time all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to Chuck Jehl, Chief Financial Officer for Forestar. Sir, you may begin.

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 an update on Forestar's key initiatives and fourth quarter and full year 2016 results. I'm Chuck Jehl, Chief Financial Officer of Forestar. Joining me on the call today is Phil Weber, our Chief Executive 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 forestagroup.com. Before we get started let me remind you to please review the warning statements in our press release and on our slides as we will make forward-looking statements during this presentation. Now, let me turn the call over to Phil to provide an update on our key initiatives.

Thank you for joining us this morning. First let me start by thanking David Grimm who after 25 years of loyal service at Forestar and its predecessor Company Temple-Inland will be retiring at the end of March. David has provided outstanding California advice, has unimpeachable integrity and has worked hard for over quarter of a century to always do what is right. David thanks again, we wish you much luck and success on the next chapter in your professional life. To state the obvious 2016 was a transformative year for Forestar. We were successful in making exceptional progress on all of our key initiatives. We substantially reduced costs, we simplify the company through the strategic sale of $482 million in non-core assets, we delivered near record levels on both lots sales and margins in our core community development business and we substantially strengthened our balance sheet by eliminating $278 million of debt in 2016 and $323 million in debt since third quarter 2015 reducing our debt to cap to its lowest level in the Company's history. Let me add some additional details and make a few key points in each of the areas I just mentioned. As reflected on slide 3, our transformative results speak for themselves. First since our peak run-rate in 2015, we've taken actions to eliminate nearly $60 million of SG&A from 87 million to a targeted 2018 full-year run rate of 28 million once all non-core assets are sold. The $60 million decrease represents a reduction of nearly 68%. As part of our ongoing cost elimination at the end of March we will reduce our workforce by an additional 34%. Following this reduction, we will have reduced our headcount by over 70% since our peak in 2014. Second we sold $482 million in non-core assets in 2016. These strategic sales capitalize on strong interest by better owners of these assets that were willing in many cases to pay a market premium or above the Company's internal now for these assets. These non-core asset sales held to reduce debt and SG&A that was supporting them simplify the Company and will enable us to focus our remaining linear resources on our core community development business. Third in 2016 we achieved very positive results in our core community development business with our second highest total lots sold since our spin-off in 2018 at 1940 box and our third highest margin per lot year. We ended 2016 with a very strong fourth quarter and we start 2017 with a strong order book with 2100 lots under contract for sale to builder. Fourth point here we paid down $278 million of debt during the year taking our debt to cap to 16% from 46% at the end of the third quarter 2015. With reductions since Q3 of 2015, annual interest expense has been reduced by $23 million going forward and we exited 2016 with $266 million in consolidated cash on our balance sheet. And as you saw in the 8-K we filed a week ago, we started off 2017 very strong with the successful strategic sale of our remaining mineral assets for $85.6 million. This non-core sale allows us to further reduce SG&A cost. Before I turn it over to Chuck, who will walk through the rest of our presentation, I want to close with one last point. It is quite obvious that Forestar has now generated a significant amount of net cash and significantly decreased leverage, largely through these non-core asset sales. As I stated before, the Board and Management fully appreciate the time value of money and know you're interested or in some cases, anxious about next steps. You can have confidence that the Board and management remains focused on maximizing shareholder value and are actively and constructively working towards that end. With that, I'll turn it over to Chuck.

Thank you, Phil. If we move to Slide 4, in addition to the accomplishments that Bill discussed on Slide 3, let's turn to Slide 4 and a review of our assets. We're very focused on delivering value from our core community development business and continue to make good progress marketing and selling our remaining nine non-core assets. Our core community development business is producing much needed finished lots in several of the top home building markets in the country. It represents 50 real estate developments in 10 states and 14 markets in which we've developed lots for national, regional and local homebuilders in 2016. Builder demand for our residential lots in our key communities remain steady. Now let me turn to our nine remaining non-core assets. Timberland and undeveloped land; with the completion of the bulk sale in the fourth quarter 2016 of 58,300 acres for nearly $1800 an acre, we have approximately 19,000 acres of remaining Timberland in undeveloped land of sale, 11,000 acres in Georgia, 8,000 acres in Texas. These remaining acres represent three transaction of which two are under contract and we are finalizing negotiations on the third one. Now let me turn to multifamily. We have four remaining assets in multifamily. The Westlake site in Austin is under contract and expected to close in the third quarter 2017. The remaining three communities are in lease-up mode and we're discussing potential exit strategies with our partners as we get closer to stabilization. Acklen and Nashville, which is nearly 86% occupied and nearly 90% leased was listed for sale on February 21, 2017. HiLine near Denver is 82% occupied and 84% leased and finally Elan in Houston is 65% occupied and 72% leased. Last example on the non-core assets you'll note on Slide 4 is we're also under contract for the sale of our permitted Central Texas water assets are in the due diligence period with the buyer. As you can see, we're very focused on completing our key initiatives to sell non-core asset. We made good progress in 2016 and with the sale of our mineral interest assets, we certainly have carried that focus and the momentum forward into 2017. Now let's turn to Q4 '16 and full year '16 results. Forestar reported net income from continuing operations of $43.2 million or $1.02 per share in fourth quarter 2016, compared with $33.3 million or $0.79 per share in fourth quarter 2015. Net income from discontinued operations, net of taxes was $0.6 million in fourth quarter 2016 or $0.01 per share and a net loss of $39.5 million in fourth quarter 2015 or a loss of $0.93 per share. So after discontinued operation, Forestar reported net income of $43.7 million or $1.03 per share in fourth quarter '16 compared with a net loss of approximately $6.2 million or $0.14 per share in fourth quarter '15. Now let's turn to full year '16 results. Forestar reported net income from continuing operations of $75.5 million or $1.78 per share compared with a loss of $26.9 million or 79% loss per share in 2015. Loss from discontinued operations net of taxes was $16.9 million in 2016 or a loss of $0.40 compared with a net loss of $186.1 million in 2015 or a loss of $5.43 per share. So all in after discussed, full year 2016 net income was $58.6 million, a $1.38 per share compared with a net loss of approximately $213 million or loss of $62.2 per share in 2015. Now lets' look at an overview and turn to the next slide of our segment results. Real estate segment earnings were $12.9 million in fourth quarter 2016 compared with $37.9 million in fourth quarter 2015. Full year 2016 real estate segment earnings were $121.4 million compared to $67.7 million in full year 2015. I will provide additional details on our real estate segment results in a moment. Let me turn to mineral resources. Mineral resources segment earnings were $0.7 million in fourth quarter 2016 compared to $1 million in fourth quarter 2015. Mineral resources earnings in full year 2016 were $3.3 million compared to $4.2 million in full year 2015. Earnings were down year-over-year in mineral resources primarily due to lower oil and gas production volumes and prices and lower drilling activity on our acreage. As mentioned earlier, we sold our mineral assets in February of this year for $85.6 million. With this sale we have now the divested substantially all of our remaining oil and gas assets. Now let me turn to our other segment results which were a loss of $3.7 million in fourth quarter 2016 compared with a loss of $0.1 million in fourth quarter 2015. Full year 2016 other segment results were a loss of $4.6 million compared with a loss of $0.6 million in full year 2015. Earnings were negatively impacted year-over-year due to a $3.9 million goodwill non-cash impairment charge related to our water interests in Central Texas which we have under contract to be sold, as well as the deferral of timber harvest activity as a result of our initiative to sell our Timberland in undeveloped land. Let's turn to the next slide, Slide 7 and do a deeper dive into our real estate segment, our core business. Q4 2016 segment results again I'm in short $12.9 million compared to $37.9 million in fourth quarter 2015. We would like to point out fourth quarter 2015 results benefited from a $9.3 million in earnings from selling Midtown Cedar Hill multifamily property and higher levels of undeveloped land sales from our retail sales program. Significant items for Q4 of 2016 are as follows; we sold 835 residential lots on an average price of 67,600 per lots with average gross profit of 21,500 per lots which included 235 bulk lots sales from non-core community development projects. Excluding these non-core sales, our average price per lot was 78,900 with an average gross profit of 29,300 per lots. We also sold 1481 residential track acres for approximately 4300 per acre and 178 commercial track acres for approximately 7400 per acre from these non-core projects. Our Q4 2016 non-core projects sales generated significant tax losses to offset tax gains in 2016. Now let me turn to full year 2016 segment results and give you a recap. Again full year 2016 segment earnings were $121.4 million compared with $67.7 million in 2015. 2016 earnings benefited from combined gains of 117.9 million as a result of executing our key initiatives to opportunistically divest non-core assets. These gains were partially offset by non-cash impairment charges of $56.5 million related to six non-core community development project and two multifamily sites. These impairments were result of our key initiative to review our entire portfolio of assets which resulted in business plan changes inclusive of cash tax savings considerations. Non-core asset sales both community development and multifamily provided approximately 117 million in tax losses that were utilized to offset tax gains in 2016. Minimized income taxes paid and reduced our annual carry cost by over $3 million as we transformed our Company. Other significant items for full year 2016 as Phil mentioned we sold 1940 residential lots at an average price of 68,200 per lot with an average gross profit of 23,400. Again excluding the 235 bulk lots sales from non-core projects sold in the fourth quarter, our average price for full year 2016 would be $72,200 with an average profit of $26,500. We sold 14,000 over 14,900 acres of undeveloped land in Timberland in our retail sales program at an average price of $2,450 per acre. In total, we sold approximately 73,000 acres of undeveloped land in Timberland from both the Timberland transaction as well as from our retail land program at a combined average price for 2016 of $1,925 per acre. Now let me turn to the final slide before we take your question and give a brief update and a little more color on community development our lot sales and lots under contract on Slide 9. As Phil mentioned, we ended 2016 and began 2017 with over 2,100 lots under option contract of which 1,600 of these lots are either developed or under development. We have over 6,000 additional future lots to be developed located in our key markets where we already selling to current homebuilders and many of the lots are located in some of the strongest housing markets. As Phil mentioned earlier, we started 2017 with a strong order book of lots under contract for sale to builders. Our key states and markets continue to have inventory levels that reflect markets with a balance between supply and demand. Those are our prepared comments for the presentation and would now like to open the call up for a few questions.

[Operator instructions] And our first question comes from Mark Weintraub with Buckingham Research. You may begin.

Thank you. Good morning. First question was you had noted in your opening remarks that, in many cases, in the sale of the non-core assets, you had gotten above what the internal NAV had been. Can you tell us, in total, would that have been true - would have you been roughly in line, above or below, if you looked at all the sales you did in 2016 relative to where your internal NAVs would have been?

I'll have to do the quick math, but let me give you three specific examples where I believe we sold our internal math, the hotel, the mineral and then certainly our retail land sales where we average $2450 per acre. So I think, let us get back to you on your specific question. If you add them all up, did a total, three examples of where of what I was sighting to.

Okay. And second, on the real estate lots that you have remaining, it looked like you changed the presentation - the format a little bit differently. I think you used tell us the number of lots that were entitled and/or underdevelopment, et cetera. Now you shifted it to acreage; unless I missed something. It's very possible. I haven't seen it. But do you have kind of the old way you used to report it? What number of lots, as opposed to acreage, would be classifiable as developed or under development versus entitled?

Yes. So Mark as we've talked about in the past, we have two projects that are in the entitlement process in California, Terraces at Hidden Hills and then Hidden Creek state. Those were the only two we're currently working on in the entitlement process. Lake Houston was previously in that category, a legacy track that we were working on in Houston that is now part of the Timberland and undeveloped land between the remaining 8,000 acres in Texas. So in the 10K that will be filed tomorrow, you're obviously familiar with it. We've a statistical table of all of our future lots and unit and we have approximately 10,200 future lots either in various stages underdevelopment, developed and in future plan that are in the portfolio.

And I guess the question - and I'm sorry if it wasn't clear - but of that 10,200, historically you used to tell us what percentage was developed and under development versus what would've been classified as entitled.

Yes. So the 1600 that I mentioned earlier, that's developed and under development and those entitled either ready to be sold in a finished state or were in the process of finishing them. So 1600 lots of the - roughly 10,000 in the total inventory.

Got it, okay. And just curiosity - I think you had reclassified some land in Houston from - in the entitlement process just to timberlands. Maybe just a little color on that.

Yes that is the Lake Houston project that was I talking about Mark. That's the 3700 roughly acres that was the third project that's historically been in Lake Houston and our analysis and around the Houston market as well as finished lots there and demand we basically decided that it was better used to not entitle that and develop it over time and sell that is land today.

Okay and then lastly…

It's in markets, it is actually under that is one of the ones that is actually under contract to be sold that will actually come out with more information and color in the coming months.

Okay, great. And then lastly, maybe a bit more color. I know you had indicated that supply and demand in your real estate markets was relatively balanced in terms of lots, et cetera. How have things been changing? I guess it certainly felt, at least in the conversations I had with builders, that the market has been weakening. But it sounds like most areas in Texas have actually started to improve. And I just was hoping to get a little bit more color on developments as you see them more recently, and where you are thinking things may be going.

Mark this is Phil, I will start with just comment on Texas, so the real estate Center at Texas A&M recently came out with statistics showing that the state inventory level remain consistent with the prior year ending at 3.3 months of inventory at the end of December 2016 and according to them market balance between supply and demand has between six and six and half months in inventory. So West Texas overall…

Yes one thing I would point out Mark is if our 1940 lots that we sold this year when I did the math over 80% of those were sold from Texas markets. So we've not seen Houston went through obviously that was energy impact but you know Houston still got positive job growth, I think there is slide in the back of the deck where we support the stable demand in our key markets and all the Texas markets and even some of the Southeast markets have hired job growth in the national average and with Houston even being impacted, there is still positive growth. So we've not seen any we have not had any builders walk contracts or even we've got we got good earnest money deposits and the demands there and had nobody pushing back on not taking lots down.

Okay. I guess what I was trying to ferret out was my sense from having spoken with builders was that previously, there had been increasing concern, particularly in Houston, but in many of the Texas markets. And then in more recent conversations, I thought I had been picking up more optimism again. Obviously oil and energy was doing a bit better. I guess when I'm hearing you, it just sounds like nothing really changed all that much, and it's not that different today than it was yesterday. But it wasn't that bad yesterday. So that's why I was just trying to get that nuance with them.

Now what we agree with that look absolutely.

Okay. Thank you.

Thank you. Our next question comes from Albert Sebastian with Prospect Advisors. You may begin.

Good morning gentlemen. A few questions, and I'm really going to focus on Slide 4, overview of assets. Can you just give a little bit more granularity in terms of the two communities in entitled in California in terms of where they are located, where we stand in the process of getting them entitled, and how many lots potentially that are there?

Yes I will start out this is Chuck, so the two communities near LA are little - I guess Calabasas in one and the other is near San Simeon Valley, 730 acres in total. We continue – we've owned these assets for several years and entitlements in California as you know are challenging. Our team is working very hard and focused on getting these and obtaining these entitlements and we feel like we made good progress. The Hidden Creeks asset which is the larger of the two at 700 acres, yes it's planned for about 188 lots if we - once we receive and move forward and have obtained the entitlement. The other - the Terrace at the Hidden Hills is a little under 30 acres and it's actually being planned for a more assisted-living type product, not a residential mixed-use, but with the teams very focused on those assets in obtained those the opportunity there with the entitlement and moving forward with our business plan, but it's work in progress.

Okay. And in terms of under timberland and undeveloped land, the 11,000 acres in Georgia and the 8,000 acres in Texas, I assume those are really - those acres are kind of HBU type land that is - they are not going to be sold to an institutional buyer. Or is it being marketed to an institutional buyer? Or is it being marketed more towards a retail buyer that wants to have some sort of recreational use, or what?

There is a Lake Houston property which is one of the Texas, that's more speculative I think for longer term goal for development down the road for somebody, the remaining Georgia Timberland I would say that that would be more institutional burst retail being at 11,000 acre package, which still is a sizable package in the Southeast. So that would be my comments on that.

And finally, on the water assets: the 20,000 surface acres, the groundwater lease on the 20,000 surface acres in Central Texas, are there any precedent transactions that might give us an indication of value for those?

That's one of the challenges we face. It is certainly an emerging market as we've talked about and there's not really any good comps, mean the biggest private groundwater transaction with several years ago that you're familiar with the second sold his water rise to 211,000 surface acres to the municipal water supply company in the Panhandle Texas. But otherwise there's not a lot of transaction and comp for private groundwater transaction.

Is there a book value associated with those assets?

Yes, there is Al. What we saw with my opening comments, there are comments that we impaired the goodwill that was on the books for that Central Texas water assets in the fourth quarter and we'll file the K tomorrow likely. So there’ll be some more color on the remaining book value associated with the Central Texas water asset.

And when did you - you purchased those assets, if I remember correctly.

No, you're remembering right, I believe it was in 2010, we acquired sustainable water resources which is the acquisition in 2010, that's correct.

Okay. And you are saying that you have subsequently written down the goodwill associated with that acquisition?

That's correct.

Thank you.

[Operator instructions] Our next question comes from Lee Matheson with Broadview Capital Management. You may begin.

Good morning, gentlemen. So I appreciate, in your opening comments, the remark about being cognizant of time value of money, and use of proceeds, and what have you. Can you give us some color in - just in terms of what the Board is thinking from a timing perspective? I mean presumably the Board would've met yesterday or the day before to approve the quarter; the cash would come in at that point, the $75 million of proceeds from the oil and gas transaction, which would've left you in a very flush position at - and presumably the ability to make a decision on use of proceeds at the Board meeting the other day. What is the timing - or what are the issues that are going through the Board's head in terms of not necessarily what to do with the proceeds, but when?

Yes. Thank you for your question. I will reinforce what I said in my remarks. They are actively and constructively working. Just to give you some color in the come out proxy that will be filed shortly. Our Board 14 times last year and so we are - the Board is very engaged. The Board is and management are actively and constructively working very closely and when we have and are ready to report something we will but we were not ready to do that right now.

Okay. And in terms of just to be clear on the range of outcomes that the Board is considering, would include a meaningful share repurchase, a meaningful dividend. Are acquisitions on the table? Or are you simply looking at how to most effectively and accretively return capital to shareholders at this point?

Yes, I think, I’ve said on previous calls that everything is on the table but again the key focus is we're focused on maximizing shareholder value and the Board is actively and constructively working with management towards that end.

Okay. And what I meant from a timing perspective, what is the pretty soon you are going to run out of assets to sell. And I think at that point, one presumes you will act on the excess capital. What's your, I mean if you given the four out of nine non-core assets are already on the market or under contract, would it be safe to assume that we could see something on sort of a next step of this corporation in the next three months?

Well, Lee I can take a couple points. From day one we said we are focused on reducing cost which we're continuing to do. We focused mostly on SG&A in that area. We've now - with the sale of a lot of non-core assets, we are able to focus more time on our core business where there is some value engineering and some cost savings that we think we can generate and increase margin in our core business. So we're focused on cutting cost. We still have as we've identified nine non-core assets that we are trying to sell and there is work that goes with those but we have our core business that we are focused on maximizing the value of our core business on an ongoing basis. So that remains our three priorities and when we have some additional color to give you on the larger question that you're asking we will - will share that with as soon as we can.

Okay. And then just in terms of, let's just say, hypothetically you get everything sold that you want to get sold, and you get the SG&A down to the $28 million run rate, what would be when you guys model it, what does the core business look like on kind of a normalized basis from a cash generation standpoint? Is it we would we assume sort of a couple thousand, 1,500 lots a year at a $30,000 gross margin, per, and then back out the SG&A from that? And then when do you start putting money back into this business, in terms of building back up the land bank to stretch out the, call it, the longer end of the DCF tail here?

Yes, Lee this is Chuck. So I think as you think about the business with the non-core sales in 2016 and you can rolling into 2017 even in our disclosures there is lot of non-core that's in the results. So if you think about the 1800 to 2000 lots range getting SG&A down to $28 million. I think we've got good disclosures around average price around historical margins and then you can actually put into your model some of that information that’s in the public disclosures and run that and as Phil said we're very focused on cost in both SG&A support cost, as well as what it takes to develop and manufacture lots. So I think there is adequate disclosures in the market and in our filings that you can take that and model that.

Yes, got it, okay. And then I mean just based on the existing core community land assets, I mean how sort of what's add an 1,800 to 2,000 lot annual velocity, how many years of inventory would you - do you feel you have?

Well, as I said to Mark's response and Mark's question earlier, we file our K later this or soon. We got 10,000 lots in units in the portfolio and you can make your assumptions on an annual lot sales, velocity and do the math.

Yes okay. Okay. We look forward to hearing some clarity on what you guys are going to do with a monstrous amount of cash. Thanks, guys.

Well thanks for your questions Lee.

Thank you. I am showing no further questions at this time. I would like to turn the call back over to Chuck Jehl for closing remarks.

Okay. Thank you for joining us this morning and for your interest in Forestar and hope everyone has a great day. Thank you.

Ladies and gentlemen, this concludes today's conference. Thanks for your participation and have a wonderful day.