Forestar Group Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included in this quarterly report and with our annual report on Form 10-K for the fiscal year ended September 30, 2023. Some of the information contained in this discussion and analysis constitutes forward-looking statements that involve risks and uncertainties. Actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those described in the “Forward-Looking Statements” section following this discussion. Our Operations Forestar Group Inc. is a national, well-capitalized residential lot development company with operations in 57 markets in 23 states as of December 31, 2023. We are focused primarily on making investments in land acquisition and development to sell finished single-family residential lots to homebuilders. Our common stock is listed on the New York Stock Exchange (NYSE) under the ticker symbol “FOR.” The terms “Forestar,” the “Company,” “we” and “our” used herein refer to Forestar Group Inc., a Delaware corporation, and its predecessors and subsidiaries. In October 2017, Forestar 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 the Company's outstanding common stock. As of December 31, 2023, D.R. Horton owned approximately 63% of the Company's outstanding common stock. As our controlling shareholder, D.R. Horton has significant influence in guiding our strategic direction and operations. We manage our operations through our real estate segment, which is our core business and generates substantially all of our revenues. The real estate segment primarily acquires land and installs infrastructure for single-family residential communities, and its revenues generally come from sales of residential single-family finished lots to local, regional and national homebuilders. We have other business activities for which the related assets and operating results are immaterial and therefore are included within our real estate segment. Our real estate segment conducts a wide range of project planning and management activities related to the entitlement, acquisition, community development and sale of residential lots. We generally secure entitlements while the land is under contract by creating plans that meet the needs of the markets where we operate, and we aim to have all entitlements secured before closing on the investment. Moving land through the entitlement and development process creates significant value. We primarily invest in entitled short-duration projects that can be developed in phases, enabling us to complete and sell lots at a pace that matches market demand, consistent with our focus on maximizing capital efficiency and returns. We occasionally make short-term strategic investments in finished lots (lot banking) and undeveloped land (land banking) with the intent to sell these assets within a short time period to utilize available capital prior to its deployment into longer-term lot development projects. Our customers are primarily local, regional and national homebuilders. The lots we deliver in our communities are primarily for entry-level, first-time move-up and active adult homes. Entry-level and first-time move-up homebuyers are the largest segments of the new home market. We also market some of our communities towards build-to-rent operators. Demand for residential lots, particularly at affordable price points, remained strong in the three months ended December 31, 2023, and our lot sales increased 39% from the prior year period. The supply of new and existing homes at affordable price points remains limited, and low resale supply continues to support the demand for new construction. Demographics supporting housing demand remain favorable despite higher mortgage rates and inflationary pressures, and homebuilders have continued to adjust to current market conditions by using incentives and price adjustments accordingly. While the disruptions in the supply chain for certain construction materials and tightness in the labor market have improved, municipality delays are still extending development cycle times, and development costs remain elevated. We increase our land and lot sales prices when market conditions permit, and we attempt to offset cost increases in one component with savings in another. However, if market conditions are challenging, we may have to reduce selling prices or may not be able to offset cost increases with higher selling prices. We believe we are well-positioned to operate effectively through changing economic conditions because of our low net leverage and strong liquidity position, our low overhead model, our geographically diverse lot portfolio that is focused on affordable price points and our strategic relationship with D.R. Horton. We plan to remain disciplined when investing in land opportunities and to remain focused on managing our lot sales pace and lot pricing at each community to optimize the return on our investments. 16 Table of Contents Results of Operations The following tables and related discussion set forth key operating and financial data as of and for the three months ended December 31, 2023 and 2022. Operating Results Components of income before income taxes were as follows: Three Months Ended December 31, 2023 2022 (In millions) Revenues $ 305.9 $ 216.7 Cost of sales 233.0 169.2 Selling, general and administrative expense 28.0 22.9 Gain on sale of assets — (1.6) Interest and other income (6.3) (1.7) Income before income taxes $ 51.2 $ 27.9 Lot Sales Residential lots sold consisted of: Three Months Ended December 31, 2023 2022 Development projects 3,150 2,263 Average sales price per lot (a) $ 96,400 $ 90,100 _______________ (a) Excludes lots sold from deferred development projects and any impact from change in contract liabilities. 17 Table of Contents Revenues Revenues consisted of: Three Months Ended December 31, 2023 2022 (In millions) Residential lot sales: Development projects $ 303.5 $ 204.0 Decrease in contract liabilities 0.7 2.7 304.2 206.7 Deferred development projects 1.3 6.7 305.5 213.4 Tract sales and other 0.4 3.3 Total revenues $ 305.9 $ 216.7 Residential lots sold and residential lot sales revenues in the three months ended December 31, 2023 increased compared to the prior year primarily as a result of improved demand for finished lots as homebuilders have increased their pace of new home starts to better match the stronger demand for new homes, particularly at affordable price points. Residential lot sales to D.R. Horton and customers other than D.R. Horton, excluding deferred development projects, consisted of: Three Months Ended December 31, 2023 2022 Residential lots sold to D.R. Horton 2,834 2,094 Residential lots sold to customers other than D.R. Horton 316 169 3,150 2,263 Residential lot revenues from lot sales to D.R. Horton and customers other than D.R. Horton, before deferred development projects and changes in contract liabilities, consisted of: Three Months Ended December 31, 2023 2022 (In millions) Revenues from lot sales to D.R. Horton $ 272.8 $ 187.1 Revenues from lot sales to customers other than D.R. Horton 30.7 16.9 $ 303.5 $ 204.0 Lots sold to customers other than D.R. Horton in the three months ended December 31, 2023 included 124 lots that were sold for $15.1 million to a lot banker who expects to sell those lots to D.R. Horton at a future date. Cost of Sales, Real Estate Impairment and Land Option Charges and Interest Incurred Cost of sales in the three months ended December 31, 2023 increased compared to the prior year period primarily due to the increase in the number of lots sold. Each quarter, we review the performance and outlook for all of our real estate for indicators of potential impairment and perform detailed impairment evaluations and analyses when necessary. As a result of this process, there were no impairment charges recorded for the three months ended December 31, 2023 and 2022. In the three months ended December 31, 2023, land purchase contract deposit and pre-acquisition cost write-offs related to land purchase contracts that the we have terminated or expect to terminate were $0.2 million compared to $2.4 million in the prior year period. 18 Table of Contents We capitalize interest costs throughout the development period (active real estate). Capitalized interest is charged to cost of sales as the related real estate is sold. Interest incurred was $8.1 million in the three months ended December 31, 2023 compared to $8.2 million in the prior year period. Interest charged to cost of sales was 2.6% of total cost of sales (excluding impairments and land option charges) in the three months ended December 31, 2023 compared to 3.0% in the prior year period. Selling, General and Administrative (SG&A) Expense and Other Income Statement Items SG&A expense in the three months ended December 31, 2023 was $28.0 million compared to $22.9 million in the prior year period and as a percentage of revenues was 9.2% compared to 10.6%. Our SG&A expense primarily consisted of employee compensation and related costs. Our business operations employed 329 and 277 employees at December 31, 2023 and 2022, respectively. We attempt to control our SG&A costs while ensuring that our infrastructure supports our operations; however, we cannot make assurances that we will be able to maintain or improve upon the current SG&A expense as a percentage of revenues. Income Taxes Our income tax expense for the three months ended December 31, 2023 was $13.0 million compared to $7.1 million in the prior year period. Our effective tax rate for both periods was 25.4% and included an expense for state income taxes and nondeductible expenses. At December 31, 2023, we had deferred tax liabilities, net of deferred tax assets , of $49.3 million. The deferred tax assets were partially offset by a valuation allowance of $0.9 million, resulting in a net deferred tax liability of $50.2 million. At September 30, 2023, deferred tax liabilities, net of deferred tax assets , were $49.8 million. The deferred tax assets were partially offset by a valuation allowance of $0.9 million, resulting in a net deferred tax liability of $50.7 million. The valuation allowance for both periods was recorded because it is more likely than not that a portion of our state deferred tax assets, primarily NOL carryforwards, will not be realized because we are no longer operating in some states or the NOL carryforward periods are too brief to realize the related deferred tax asset. We will continue to evaluate both the positive and negative evidence in determining the need for a valuation allowance on our deferred tax assets. Any reversal of the valuation allowance in future periods will impact our effective tax rate. Land and Lot Position Our land and lot position at December 31, 2023 and September 30, 2023 is summarized as follows: December 31, 2023 September 30, 2023 Lots owned 55,400 52,400 Lots controlled through land and lot purchase contracts 27,000 26,800 Total lots owned and controlled 82,400 79,200 Owned lots under contract to sell to D.R. Horton 16,200 14,400 Owned lots under contract to customers other than D.R. Horton 500 600 Total owned lots under contract 16,700 15,000 Owned lots subject to right of first offer with D.R. Horton based on executed purchase and sale agreements 17,500 17,000 Owned lots fully developed 7,300 6,400 19 Table of Contents Liquidity and Capital Resources Liquidity At December 31, 2023, we had $458.9 million of cash and cash equivalents and $385.7 million of available borrowing capacity on our revolving credit facility. We have no senior note maturities until fiscal 2026. We believe we are well-positioned to operate effectively during changing economic conditions because of our low net leverage and strong liquidity position, our low overhead model and our strategic relationship with D.R. Horton. At December 31, 2023, our ratio of debt to total capital (debt divided by stockholders’ equity plus debt) was 33.4% compared to 33.7% at September 30, 2023 and 36.7% at December 31, 2022. Our ratio of net debt to total capital (debt net of unrestricted cash divided by stockholders’ equity plus debt net of unrestricted cash) was 14.9% compared to 5.5% at September 30, 2023 and 28.7% at December 31, 2022. Over the long term, we intend to maintain our ratio of net debt to total capital at approximately 40% or less. We believe that the ratio of net debt to total capital is useful in understanding the leverage employed in our operations. We believe that our existing cash resources and revolving credit facility will provide sufficient liquidity to fund our near-term working capital needs. Our ability to achieve our long-term growth objectives will depend on our ability to obtain financing in sufficient amounts. We regularly evaluate alternatives for managing our capital structure and liquidity profile in consideration of expected cash flows, growth and operating capital requirements and capital market conditions. We may, at any time, be considering or preparing for the purchase or sale of our debt securities, the sale of our common stock or a combination thereof. Bank Credit Facility We have a $410 million senior unsecured revolving credit facility with an uncommitted accordion feature that could increase the size of the facility to $600 million, subject to certain conditions and availability of additional bank commitments. The facility also provides for the issuance of letters of credit with a sublimit equal to the greater of $100 million and 50% of the total revolving credit commitments. Borrowings under the revolving credit facility are subject to a borrowing base calculation based on the book value of our real estate assets and unrestricted cash. Letters of credit issued under the facility reduce the available borrowing capacity. The maturity date of the facility is October 28, 2026. At December 31, 2023, there were no borrowings outstanding and $24.3 million of letters of credit issued under the revolving credit facility, resulting in available capacity of $385.7 million. The revolving credit facility is guaranteed by our wholly-owned subsidiaries that are not immaterial subsidiaries or have not been designated as unrestricted subsidiaries. The revolving credit facility includes customary affirmative and negative covenants, events of default and financial covenants. The financial covenants require a minimum level of tangible net worth, a minimum level of liquidity and a maximum allowable leverage ratio. These covenants are measured as defined in the credit agreement governing the facility and are reported to the lenders quarterly. A failure to comply with these financial covenants could allow the lending banks to terminate the availability of funds under the revolving credit facility or cause any outstanding borrowings to become due and payable prior to maturity. At December 31, 2023, we were in compliance with all of the covenants, limitations and restrictions of our revolving credit facility. Senior Notes We have outstanding senior notes as described below that were issued pursuant to Rule 144A and Regulation S under the Securities Act of 1933, as amended. The notes represent senior unsecured obligations that rank equally in right of payment to all existing and future senior unsecured indebtedness and may be redeemed prior to maturity, subject to certain limitations and premiums defined in the respective indenture. The notes are guaranteed by each of our subsidiaries to the extent such subsidiaries guarantee our revolving credit facility. Our $400 million principal amount of 3.85% senior notes (the "2026 notes") mature May 15, 2026 with interest payable semi-annually. On or after May 15, 2023, the 2026 notes may be redeemed at 101.925% of their principal amount plus any accrued and unpaid interest. In accordance with the indenture, the redemption price decreases annually thereafter, and the 2026 notes can be redeemed at par on or after May 15, 2025 through maturity. The annual effective interest rate of the 2026 notes after giving effect to the amortization of financing costs is 4.1%. 20 Table of Contents We also have $300 million principal amount of 5.0% senior notes (the "2028 notes") outstanding, which mature March 1, 2028 with interest payable semi-annually. On or after March 1, 2023, the 2028 notes may be redeemed at 102.5% of their principal amount plus any accrued and unpaid interest. In accordance with the indenture, the redemption price decreases annually thereafter and the 2028 notes can be redeemed at par on or after March 1, 2026 through maturity. The annual effective interest rate of the 2028 notes after giving effect to the amortization of financing costs is 5.2%. The indentures governing our senior notes require that, upon the occurrence of both a change of control and a rating decline (as defined in each indenture), we offer to purchase the applicable series of notes at 101% of their principal amount. If we or our restricted subsidiaries dispose of assets, under certain circumstances, we will be required to either invest the net cash proceeds from such asset sales in our business within a specified period of time, repay certain senior secured debt or debt of our non-guarantor subsidiaries, or make an offer to purchase a principal amount of such notes equal to the excess net cash proceeds at a purchase price of 100% of their principal amount. The indentures contain covenants that, among other things, restrict the ability of us and our restricted subsidiaries to pay dividends or distributions, repurchase equity, prepay subordinated debt and make certain investments; incur additional debt or issue mandatorily redeemable equity; incur liens on assets; merge or consolidate with another company or sell or otherwise dispose of all or substantially all of our assets; enter into transactions with affiliates; and allow to exist certain restrictions on the ability of subsidiaries to pay dividends or make other payments. At December 31, 2023, we were in compliance with all of the limitations and restrictions associated with our senior note obligations. Effective April 30, 2020, our Board of Directors authorized the repurchase of up to $30 million of our debt securities. The authorization has no expiration date. All of the $30 million authorization was remaining at December 31, 2023. Other Note Payable In December 2023, we issued a note payable of $9.9 million as part of a transaction to acquire real estate for development. The note is non-recourse and is secured by the underlying real estate, accrues interest at 4.0% per annum and matures in December 2025. Issuance of Common Stock We have an effective shelf registration statement filed with the Securities and Exchange Commission in October 2021, registering $750 million of equity securities, of which $300 million was reserved for sales under our at-the-market equity offering program that became effective November 2021. In the three months ended December 31, 2023, there were no shares of common stock issued under our at-the-market equity offering program. At December 31, 2023, $748.2 million remained available for issuance under the shelf registration statement, of which $298.2 million was reserved for sales under our at-the-market equity offering program. Operating Cash Flow Activities In the three months ended December 31, 2023, net cash used in operating activities was $156.7 million, which was primarily the result of the increase in real estate, partially offset by net income generated in the period and the increase in earnest money on sales contracts. In the three months ended December 31, 2022, net cash used in operating activities was $49.8 million, which was primarily the result of the increase in real estate, partially offset by net income generated in the period. Investing Cash Flow Activities In the three months ended December 31, 2023, net cash used in investing activities was $0.2 million compared to $1.5 million of cash provided by investing activities in the prior year period. Financing Cash Flow Activities In the three months ended December 31, 2023, net cash used in financing activities was $0.2 million compared to $0.1 million in the prior year period. 21 Table of Contents Critical Accounting Policies and Estimates There have been no material changes in our critical accounting policies or estimates from those disclosed in our 2023 Annual Report on Form 10-K. New and Pending Accounting Pronouncements Please read Note 1—Basis of Presentation to the consolidated financial statements included in this Quarterly Report on Form 10-Q. 22 Table of Contents Forward-Looking Statements This Quarterly Report on Form 10-Q and other materials we have filed or may file with the Securities and Exchange Commission contain “forward-looking statements” within the meaning of the federal securities laws. These forward-looking statements are identified by their use of terms and phrases such as “believe,” “anticipate,” “could,” “estimate,” “likely,” “intend,” “may,” “plan,” “expect,” and similar expressions, including references to assumptions. These statements reflect our current views with respect to future events and are subject to risks and uncertainties. We note that a variety of factors and uncertainties could cause our actual results to differ significantly from the results discussed in the forward-looking statements. Factors and uncertainties that might cause such differences include, but are not limited to: • the effect of D.R. Horton’s controlling level of ownership on us and the holders of our securities; • our ability to realize the potential benefits of the strategic relationship with D.R. Horton; • the effect of our strategic relationship with D.R. Horton on our ability to maintain relationships with our customers; • the cyclical nature of the homebuilding and lot development industries and changes in economic, real estate and other conditions; • the impact of significant inflation, higher interest rates or deflation; • supply shortages and other risks of acquiring land, construction materials and skilled labor; • the effects of public health issues such as a major epidemic or pandemic on the economy and our business; • the impacts of weather conditions and natural disasters; • health and safety incidents relating to our operations; • our ability to obtain or the availability of surety bonds to secure our performance related to construction and development activities and the pricing of bonds; • the strength of our information technology systems and the risk of cybersecurity breaches and our ability to satisfy privacy and data protection laws and regulations; • the impact of governmental policies, laws or regulations and actions or restrictions of regulatory agencies; • our ability to achieve our strategic initiatives; • continuing liabilities related to assets that have been sold; • the cost and availability of property suitable for residential lot development; • general economic, market or business conditions where our real estate activities are concentrated; • our dependence on relationships with national, regional and local homebuilders; • competitive conditions in our industry; • obtaining reimbursements and other payments from governmental districts and other agencies and timing of such payments; • our ability to succeed in new markets; • the conditions of the capital markets and our ability to raise capital to fund expected growth; • our ability to manage and service our debt and comply with our debt covenants, restrictions and limitations; • the volatility of the market price and trading volume of our common stock; and • our ability to hire and retain key personnel. Other factors, including the risk factors described in Item 1A of our 2023 Annual Report on Form 10-K, may also cause actual results to differ materially from those projected by our forward-looking statements. New factors emerge from time to time and it is not possible for us to predict all such factors, nor can we assess the impact of any such factor on our business or the extent to which any factor, or combination of factors, may cause results to differ materially from those contained in any forward-looking statement. 23 Table of Contents Any forward-looking statement speaks only as of the date on which such statement is made, and, except as required by law, we expressly disclaim any obligation or undertaking to disseminate any updates or revisions to any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. 24 Table of Contents