Item 1. Business
Item 1. Business.
Overview
We are a publicly traded residential lot development company listed on the New York Stock Exchange under the ticker symbol "FOR." In October 2017, we became a majority-owned subsidiary of D.R. Horton, Inc. (D.R. Horton) by virtue of a merger with a wholly-owned subsidiary of D.R. Horton. Immediately following the merger, D.R. Horton owned 75% of our outstanding common stock, and as of September 30, 2020 they owned 65% of our outstanding common stock. As our controlling shareholder, D.R. Horton has significant influence in guiding our strategic direction and operations.
In connection with the merger, we entered into certain agreements with D.R. Horton including a Stockholder’s Agreement, a Master Supply Agreement and a Shared Services Agreement. Under the terms of the Master Supply Agreement, we supply finished lots to D.R. Horton at market terms and both companies identify land development opportunities to expand our portfolio of assets. Our alignment with and support from D.R. Horton has allowed us to grow our business into a national, well-capitalized residential lot developer selling lots to D.R. Horton and other homebuilders. Our strategy is focused on making investments in land acquisition and development to expand our residential lot development business across a geographically diversified national platform and consolidating market share in the fragmented U.S. lot development industry. We are primarily investing in short duration, phased development projects that generate returns similar to production-oriented homebuilders. This strategy is a unique, lower-risk business model that we expect will produce more consistent returns than other public and private land developers. We also make short-term investments in finished lots (lot banking) and undeveloped land with the intent to sell these assets within a short time period, primarily to D.R. Horton, utilizing available capital prior to its deployment into longer term lot development projects. At September 30, 2020, we had operations in 49 markets in 21 states, and our lot position consisted of 60,500 residential lots, of which approximately 42,400 were owned and 18,100 were controlled through purchase contracts. Of our total owned residential lots, approximately 14,000 are under contract to sell to D.R. Horton. Additionally, D.R. Horton has the right of first offer on approximately 16,400 of these lots based on executed purchase and sale agreements. At September 30, 2020, lots owned included approximately 5,000 lots that are fully developed, of which approximately 1,400 are related to lot banking. At September 30, 2020, we had approximately 400 lots under contract to sell to builders other than D.R. Horton.
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We manage our operations through our real estate segment. Our results of operations, including information regarding our real estate segment, are discussed in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, and in Item 8, Financial Statements and Supplementary Data. We conduct our operations in the states and markets listed below.
State Market State Market
Alabama Birmingham Maryland Suburban Washington, D.C.
Huntsville
Mobile/Baldwin County Minnesota Minneapolis/St. Paul
Arizona Phoenix Nevada Las Vegas
Tucson
New Jersey Southern New Jersey
California Los Angeles County
Modesto/Merced New Mexico Albuquerque
Riverside County
Sacramento North Carolina Charlotte
San Diego County Greensboro
Raleigh/Durham
Colorado Denver
Fort Collins Pennsylvania Philadelphia
Florida Fort Myers/Naples South Carolina Charleston
Jacksonville Greenville
Lakeland Myrtle Beach
Melbourne
Miami Tennessee Knoxville
Orlando Nashville
Pensacola/Panama City
Port St. Lucie Texas Austin
Tampa/Sarasota Dallas
Volusia County Fort Worth
West Palm Beach Houston
San Antonio
Georgia Atlanta
Augusta Utah Salt Lake City
Illinois Chicago Virginia Southern Virginia
Indiana Indianapolis Washington Seattle/Tacoma/Everett
When evaluating new or existing markets for purposes of capital allocation, we consider local, market-specific factors, including among others:
• Economic conditions;
• Employment levels and job growth;
• Local housing affordability;
• Availability of land and lots in desirable locations on acceptable terms;
• Land entitlement and development processes;
• Availability of qualified subcontractors;
• New and secondary home sales activity; and
• Competition.
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Business Operations
The majority of our real estate projects are single-family residential communities. We develop lots for single-family homes on sites we typically purchase in the open market and sell residential lots primarily to local, regional and national homebuilders. In certain markets where we do not have local development infrastructure in place, D.R. Horton provides development services to us for a fee. Our managers are responsible for the following activities related to our lot and land acquisition and development activities.
• Site selection, which involves:
– A feasibility study;
– Soil and environmental reviews;
– Review of existing zoning and other governmental requirements;
– Review of the need for and extent of offsite work required to obtain project entitlements and to complete necessary infrastructure; and
– Financial analysis of the potential project;
• Negotiating lot purchase, land acquisition and related contracts;
• Obtaining all necessary land development approvals;
• Selecting land development subcontractors and ensuring their work meets our contracted scopes;
• Planning and managing land development schedules;
• Determining the sales pricing for each lot in a given project;
• Developing and implementing marketing and sales plans; and
• Coordinating all interactions with customers throughout the lot sale process.
Our corporate executives and corporate office personnel provide control and oversight functions to many important risk elements in our operations, including:
• Allocation of capital;
• Cash management;
• Review and approval of business plans and budgets;
• Review, approval and funding of lot and land acquisitions (Board of Directors must approve acquisitions greater than $20 million in accordance with the Stockholder's Agreement);
• Environmental assessments of land and lot acquisitions;
• Review of all business and financial analysis for potential land and lot inventory investments;
• Oversight of lot and land inventory levels;
• Monitoring and analysis of profitability, returns and costs; and
• Review of major personnel decisions and incentive compensation plans.
Our corporate executives and corporate office personnel are responsible for establishing our operational policies and internal control standards and for monitoring compliance with established policies and controls throughout our operations. We have a Shared Services Agreement with D.R. Horton whereby D.R. Horton provides us with certain administrative, compliance, operational and procurement services. Our corporate executives and corporate office departments are responsible for, and provide oversight and review for, the following shared services performed by D.R. Horton:
• Accounting, finance and treasury;
• Risk and litigation management;
• Corporate governance;
• Information technology;
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• Income tax;
• Internal audit;
• Investor and media relations; and
• Human resources, payroll and employee benefits.
We have a Master Supply Agreement with D.R. Horton which establishes our business relationship with D.R. Horton as both companies identify residential real estate opportunities. The agreement provides D.R. Horton the right of first offer to purchase, at market prices and terms, up to 100% of the lots from D.R. Horton sourced projects and up to 50% of the lots in the first phase of a Forestar sourced project and up to 50% of the lots in any subsequent phase in which D.R. Horton purchases at least 25% of the lots in the previous phase. D.R. Horton has no such rights on third-party sourced development opportunities. The Master Supply Agreement continues until the earlier of (i) the date at which D.R. Horton owns less than 15% of our voting shares or (ii) June 29, 2037; however, we may terminate the agreement at any time when D.R. Horton owns less than 25% of our voting shares.
We have a Stockholder's Agreement with D.R. Horton which defines D.R. Horton’s right to nominate members to our board, requires D.R. Horton’s consent for certain transactions and established an investment committee. D.R. Horton has the right to nominate our board members commensurate with its equity ownership. As long as D.R. Horton owns at least 20% of our voting securities, it retains the right to nominate individuals to our board based on its equity ownership as well as designate the Executive Chairman.
As long as D.R. Horton owns at least 35% of our voting securities, we must obtain D.R. Horton’s consent to (i) issue any new class of equity or shares of our common stock in excess of certain amounts; (ii) incur, assume, refinance or guarantee debt that would increase our total leverage to greater than 40%; (iii) select, terminate, remove or change compensation arrangements for the Executive Chairman, Chief Executive Officer, Chief Financial Officer and other key senior management; and (iv) make an acquisition or investment greater than $20 million. The Stockholder’s Agreement also established an investment committee to approve new investments up to $20 million.
Land/Lot Acquisition and Inventory Management
We acquire land for use in our development operations after we have completed due diligence and after we have obtained the rights (known as entitlements) to begin development work resulting in an acceptable number of residential lots. Before we acquire lots or tracts of land, we complete a feasibility study, which includes soil tests, independent environmental studies, other engineering work and financial analysis. We also evaluate the status of necessary zoning and other governmental entitlements required to develop the property for home construction. Although we purchase and develop land primarily to sell finished lots to homebuilders, we may sell land where we have excess land positions or for other strategic reasons.
We also enter into land purchase contracts, in which we obtain the right, but generally not the obligation, to buy land at predetermined prices on a defined schedule commensurate with planned development. These contracts generally are non-recourse, which limits our financial exposure to our earnest money deposited into escrow under the terms of the contract and any pre-acquisition due diligence costs we incur. This enables us to control land with limited capital investment.
We attempt to mitigate our exposure to real estate inventory risks by:
• Managing our supply of lots and land owned and controlled under purchase contracts in each market based on anticipated future demand;
• Monitoring local market and demographic trends that affect housing demand;
• Limiting the size of our land development projects and focusing on short duration projects;
• Acquiring fully-entitled land and developing the land in phases;
• Focusing on developing lots for entry level housing, the segment where housing demand has been the highest;
• Developing the majority of our lots for a known buyer; and
• Geographically diversifying our land portfolio.
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Land Development
Substantially all of our land development work is performed by subcontractors. Subcontractors typically are selected after a competitive bidding process pursuant to a contract that obligates the subcontractor to complete the scope of work at an agreed-upon price and within a specified time frame. We monitor land development activities, participate in major decisions, coordinate the activities of subcontractors and suppliers, review the work of subcontractors for quality and cost controls and monitor compliance with building codes or other regulations.
We typically do not maintain inventories of land development materials, except for work in progress materials for active development projects. Generally, the materials used in our operations are readily available from numerous sources.
We contract with D.R. Horton for land development services in projects owned by us in geographic markets where we do not have established development teams and capabilities.
Lot/Land Banking
In addition to our residential lot development activities, we also make short-term investments in finished lots (lot banking) and undeveloped land with the intent to sell these assets within a short time period, primarily to D.R. Horton, utilizing available capital prior to its deployment into longer term lot development projects. We manage our level of lot/land banking relative to short-term liquidity and expected future cash requirements for lot development projects.
Cost Controls
We control development costs by obtaining competitive bids for materials and labor. We monitor our land development expenditures versus budgets for each project, and we review our inventory levels, margins, expenses, profitability and returns for each project compared to both its business plan and our performance expectations.
Competition
We face significant competition for the acquisition, development and sale of real estate in our markets. Our major competitors include landowners who market and sell undeveloped land and numerous national, regional and local developers, including homebuilders. In addition, our projects compete with other development projects offering similar amenities, products and/or locations. Competition also exists for investment opportunities, financing, available land, raw materials and labor. Some of our real estate competitors are well established and financially strong, may have greater financial, marketing and other resources than we do, or may be larger than us and/or have lower cost of capital and operating costs than we have and expect to have. The presence of competition may increase the bargaining power of property owners seeking to sell. These competitive market pressures can sometimes make it difficult to acquire, develop or sell lots and land at prices that meet our return criteria.
The lot and land acquisition and development business is highly fragmented, and we are unaware of any meaningful concentration of national market share by any one competitor. Enterprises of varying sizes, from individuals or small companies to large corporations, actively engage in the real estate development business. Many competitors are local, privately-owned companies. We have a few regional and national land developer competitors in addition to national homebuilders that may develop lots on which they construct and sell homes. During periods when access to capital is restricted, participants in a weaker financial condition tend to be less active.
Human Capital Resources
We believe the people who work for our company are our most important resources and are critical to our continued success. We increased our number of employees from 78 at September 30, 2019 to 143 at September 30, 2020 to support the growth of our residential lot development business across a geographically diversified platform. At September 30, 2020, 106 of our employees worked in our regional and divisional offices and 37 worked at our corporate office. In fiscal 2020, our total cost for employee compensation and benefits was $25.0 million. In addition to our employees, we also have a Shared Services Agreement with D.R. Horton whereby D.R. Horton employees provide us with certain administrative, compliance, operational and procurement services.
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We focus significant attention toward attracting and retaining talented and experienced individuals to manage and support our operations. Management is committed to supporting the development of our employees in many ways including onboarding programs, training, and providing employees exposure to senior management. We are committed to hiring, developing and supporting a diverse and inclusive workplace. Our management teams are expected to exhibit and promote honest, ethical and respectful conduct in the workplace. All of our employees must adhere to a code of conduct that sets standards for appropriate behavior and includes required internal training on preventing, identifying, reporting and stopping any type of discrimination. We offer our employees a broad range of company-paid benefits, and we believe our compensation package and benefits are competitive with others in our industry. In addition to base pay, all our employees participate in our short-term incentive bonus program and certain employees participate in our long-term stock incentive program. Additional information about our employee benefit plans is included in Note 13.
As a result of the COVID-19 pandemic (C-19), we have implemented safety protocols to protect our employees and our contractors. These protocols include complying with social distancing and other health and safety standards as required by federal, state and local government agencies, taking into consideration guidelines of the Centers for Disease Control and Prevention and other public health authorities. Many of our administrative and operational functions during this time have required modification, including some of our workforce working remotely. Our experienced teams of people adapted to the changes in our work environment and have managed our business successfully during this challenging time.
Governmental Regulation and Environmental Matters
Our operations are subject to extensive and complex regulations. We and the subcontractors we use must comply with many federal, state and local laws and regulations. These include zoning, density and development requirements and building, environmental, advertising, labor and real estate sales rules and regulations. These regulations and requirements affect substantially all aspects of our land development and sales processes in varying degrees across our markets. Our properties are subject to inspection and approval by local authorities where required and may be subject to various assessments for schools, parks, streets, utilities and other public improvements. We may experience delays in receiving the proper approvals from local authorities that could delay our anticipated development activities in certain projects.
Available Information
Forestar Group Inc. is a Delaware corporation formed in 2007. Our principal executive offices are located at 2221 E. Lamar Blvd., Suite 790, Arlington, Texas 76006. Our telephone number is (817) 769-1860.
From our Internet website, https://www.forestar.com , you may obtain additional information about us including:
• our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and other documents as soon as reasonably practicable after we file them with the SEC;
• copies of certain agreements with D.R. Horton, including the Stockholder’s Agreement and Master Supply Agreement;
• beneficial ownership reports filed by officers, directors, and principal security holders under Section 16(a) of the Securities Exchange Act of 1934, as amended (or the “Exchange Act”); and
• corporate governance information that includes our:
– corporate governance guidelines,
– audit committee charter,
– compensation committee charter,
– nominating and governance committee charter,
– standards of business conduct and ethics,
– code of ethics for senior financial officers, and
– information on how to communicate directly with our Board of Directors.
We will also provide printed copies of any of these documents to any stockholder free of charge upon request. The SEC also maintains an Internet website ( http://www.sec.gov ) that contains reports, proxy and information statements, and other information that is filed electronically with the SEC.
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