Forestar Group Inc. 10-K

Item 1. Business. Overview We are a national, well-capitalized residential lot development company focused primarily on selling finished single-family residential lots to 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 while consolidating market share in the fragmented U.S. lot development industry. We are primarily investing in short-duration, phased development projects. 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 strategic short-term investments in finished lots (lot banking) and undeveloped land with the intent to sell these assets within a short time period utilizing available capital prior to its deployment into longer-term lot development projects. At September 30, 2021, we had operations in 56 markets in 23 states, and our lot position consisted of 97,000 residential lots, of which approximately 64,400 were owned and 32,600 were controlled through purchase contracts. At September 30, 2021, our lots owned included approximately 5,300 lots that are fully developed, of which approximately 300 are related to lot banking. 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, 2021 they owned 63% 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. Of our total owned residential lots, approximately 21,000 are under contract to sell to D.R. Horton. Additionally, D.R. Horton has the right of first offer on approximately 18,200 of our owned residential lots based on executed purchase and sale agreements. 3 Table of Contents 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 Washington/Arlington/Alexandria Huntsville Mobile/Baldwin County Minnesota Minneapolis/St. Paul Arizona Phoenix Nevada Las Vegas Tucson New Jersey Southern New Jersey California San Diego County Riverside County New Mexico Albuquerque/Santa Fe Sacramento Modesto North Carolina Charlotte Raleigh-Durham Colorado Denver Asheville Fort Collins Greensboro Wilmington Florida Fort Myers/Naples Volusia County Ohio Columbus Jacksonville Lakeland Oregon Portland/Salem Miami/Ft. Lauderdale West Palm Beach Pennsylvania Allentown/Bethlehem/Easton Orlando Melbourne South Carolina Charleston Pensacola/Panama City Myrtle Beach Port St. Lucie Greenville Tampa/Sarasota Ocala Tennessee Nashville Gainesville Knoxville Georgia Atlanta Texas Austin Augusta Dallas Savannah Ft. Worth Houston Illinois Chicago San Antonio Indiana Indianapolis Utah Salt Lake City Iowa Des Moines Washington Seattle/Tacoma/Everett Spokane 4 Table of Contents 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; • Competition; and • Performance capabilities of our local management teams. 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 finished lots primarily to local, regional and national homebuilders. In select situations, we contract with D.R. Horton for land development services, generally in geographic markets where we do not have established development teams and capabilities. Our managers are responsible for the following activities related to our land and lot 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 land acquisition, lot purchase 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 land and lot 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; 5 Table of Contents • Oversight of land and lot 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: • Finance and treasury; • Risk and litigation management; • Information technology; • 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, 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 development rights (known as entitlements). 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. 6 Table of Contents We attempt to mitigate our exposure to real estate inventory risks by: • Managing our supply of land and lots owned and controlled through 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. 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 have been readily available from numerous sources. More recently, the effects of the COVID-19 pandemic, combined with the improvement in economic conditions and strong demand in the real estate industry, have caused disruptions in our supply chain and resulted in shortages in certain construction materials and tightness in the labor market, which has caused our development cycle to lengthen in some markets. In select situations, we contract with D.R. Horton for land development services, generally 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 strategic 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 numerous national, regional and local developers, including homebuilders. In addition, we 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 land and lots at prices that meet our return criteria. 7 Table of Contents The land and lot 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 People and Culture For the past two fiscal years, despite the COVID-19 pandemic, we increased our number of employees and made no reductions to our employee compensation plans or employee benefit plans. We have increased our number of employees from 143 at September 30, 2020 to 250 at September 30, 2021 to support the growth of our residential lot development business across a geographically diversified platform. At September 30, 2021, 201 of our employees worked in our regional and divisional offices and 49 worked at our corporate office. In fiscal 2021, our total cost for employee compensation and benefits was $41.6 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. We believe the people who work for our company are our most important resources and are critical to our continued success. We focus significant attention toward attracting and retaining talented and experienced individuals to manage and support our operations. Our people 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. Recruitment, Development and Retention We are committed to hiring, developing and supporting a diverse workforce and maintaining an inclusive workplace. We believe diversity in the workplace produces unique perspectives and fresh ideas and helps us better serve our customers. Management is committed to supporting the development of our employees in many ways including onboarding programs, training and providing employees exposure to senior management. Our management team also supports a culture of developing future leaders from our existing workforce, enabling us to promote from within for many leadership positions. We believe this provides long-term focus and continuity to our operations while also providing opportunities for the growth and advancement of our employees. Compensation and Benefits We believe our compensation package and benefits are competitive with others in our industry. In addition to base pay, all eligible employees participate in our short-term incentive bonus program and certain employees participate in our long-term stock incentive program. We also offer our employees a broad range of benefits, including medical, dental and vision healthcare benefits and paid parental leave. Additional information about our employee benefit plans is included in Note 11 to the accompanying financial statements. Workplace Safety and Wellness The safety and well-being of our employees is our first priority. We take workplace safety seriously at our construction sites and in our offices. We provide certification training to our field personnel through an Occupational Safety and Health Administration (OSHA) authorized third-party vendor, and we communicate with all of our employees through a monthly safety newsletter to inform and reinforce our commitment to and concern for their well being. We also require certain personal protective equipment, such as hard hats, high visibility safety wear and hearing and eye protection to be worn in certain circumstances at our active development sites. 8 Table of Contents During the COVID-19 pandemic, we implemented safety protocols to protect our employees and our contractors. These protocols include complying with 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. Our land development activities are also subject to an extensive array of local, state and federal statutes, ordinances, rules and regulations concerning protection of health, safety and the environment. The particular compliance requirements for each site vary greatly according to location, environmental condition and the present and former uses of the site and adjoining properties. We believe that we are in compliance in all material respects with existing environmental regulations applicable to our business. Additionally, our compliance with such regulations has not had, nor is expected to have a material adverse effect on our consolidated financial position, results of operations or cash flows. However, changes in regulations could increase our costs to comply with such regulations, as discussed in “Item 1A. Risk Factors.” Available Information Our principal executive offices are located at 2221 E. Lamar Blvd., Suite 790, Arlington, Texas 76006. Our telephone number is (817) 769-1860. On the Investor Relations section of our website, 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 a website ( www.sec.gov ) that contains reports, proxy and information statements and other information that is filed electronically with the SEC. 9 Table of Contents