Title

Presentation

Operator: Good afternoon, and welcome to Forestar’s Second Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note, this conference is being recorded. I will now turn the call over to Katie Smith, Director of Finance and Investor Relations for Forestar.

Katie Smith: Thank you, John. Good afternoon, and welcome to the call to discuss Forestar’s second quarter results. Thank you for joining us. Before we get started, today’s call includes forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Although, Forestar believes any such statements are based on reasonable assumptions, there is no assurance that actual outcomes will not be materially different. All forward-looking statements are based upon information available to Forestar on the date of this conference call, and we do not undertake any obligation to update or revise any forward-looking statements publicly. Additional information about factors that could lead to material changes in performance is contained in Forestar’s annual report on Form 10-K and its most recent quarterly report on Form 10-Q, both of which are filed with the Securities and Exchange Commission.

Our earnings release is on our website at investor.forestar.com and we plan to file our 10-Q early next week. After this call, we will post an updated investor presentation to our Investor Relations site under Events and Presentations for your reference. Now, I will turn the call over to Andy Oxley, our President and CEO.

Andy Oxley: Thanks, Katie. Good afternoon, everyone. I’m also joined on the call today by Jim Allen, our Chief Financial Officer, and Mark Walker, our Chief Operating Officer. The Forestar team delivered a solid second quarter with net income increasing 67% to $45 million or $0.89 per diluted share. Our pre-tax income increased 64% to $58.9 million and our pre-tax profit margin improved 570 basis points to 17.6%. Consolidated revenues increased 11% to $333.8 million, while lots sold increased 10% to 3,289 lots. Forestar achieved a 14.9% return on equity for the trailing 12 months ending March 31, 2024. There is strong demand for developed lots and supply is still constrained in most markets. Forestar’s unique blend of financial strength, operating expertise, and geographic reach positions us as a leading supplier of finished lots.

Over the last 90 days, I’ve been on the road visiting with our local teams, walking our active projects, and assessing our pipeline to better understand our strengths and opportunities. We have talented market leaders with a proven track record of producing results. Our current land portfolio offers attractive finished lot positions for builders, and our pipeline is full of opportunities supporting our future growth. We remain focused on investing in compelling land parcels, turning our inventory, maximizing returns, and consolidating market share in the highly-fragmented lot development industry. Jim will now discuss our second quarter financial results in more detail.

Jim Allen: Thank you, Andy. In the second quarter, net income increased 67% to $45 million, or $0.89 per diluted share, compared to $26.9 million, or $0.54 per diluted share in the prior-year quarter. Revenues for the quarter increased 11% to $333.8 million compared to $301.5 million in the prior-year quarter. Lots sold in our second fiscal quarter increased 10% to 3,289 lots with an average sales price of $98,400. Our average sales price was higher this quarter due to the mix of lot deliveries from communities and higher price-point markets. We expect continued quarterly fluctuations in our average sales price based on the geographic and lot size mix of our deliveries. Our pre-tax income increased 64% to $58.9 million compared to $35.9 million in the second quarter of last year.

Our pre-tax profit margin this quarter was 17.6% compared to 11.9% in the prior-year quarter. Pre-tax margin for the prior-year quarter includes $19.4 million of non-cash real estate impairment charges, partially offset by high margin track sales. Our gross profit margin for the quarter was 24.9% compared to 18.5% for the same quarter last year. Gross margin this quarter was positively impacted by non-recurring revenue items with unusually high margins, including selling excess sewer capacity and a land contract assignment fee. Excluding the effects of these items in the prior-year impairment charges and unusually high-margin track sales, our second quarter gross profit margin would have been approximately 22.5% compared to approximately 23% for the prior-year quarter.

In the second quarter, SG&A expense increased 33% to $29.2 million, primarily due to a 25% increase in the number of employees. SG&A expense as a percentage of revenues was 8.7% compared to 7.3% in the prior-year quarter. We’re pleased with the progress we have made building our team and we continue to attract high-quality talent. We remain focused on efficiently managing our SG&A while investing in our teams to support our continued growth. Mark?

Mark Walker: As for current market conditions, the supply of new and existing homes at affordable price points remains limited, and demographics supporting housing demand are favorable, despite elevated mortgage interest rates and inflationary pressures. Builder incentives continue to bridge the affordability gap for many home buyers, and the low resale supply continues to be a driver of buyers choosing new construction. Availability of contractors and necessary materials has improved over the past several months, but we have not seen overall reductions in the cost of developing land. We utilize best management practices and work with our trade partners to develop lots in the most efficient way possible. Our development cycle times are still impacted by governmental delays.

The supply of vacant developed lots, especially at affordable price points, remains constrained across our footprint. And Forestar is uniquely positioned to take advantage of the shortage of finished lots. Our ongoing focus is to develop lots for homes at affordable price points. Homebuilders are competing to secure land and lot positions, and many are looking to replace current closed-out communities to position for future growth. As a result, we are not seeing any softening in land prices. However, our team remains disciplined, flexible, and opportunistic on pursuing new land acquisition opportunities. Jim?

Jim Allen: D.R. Horton is our largest and most important customer. 15% of the homes D.R. Horton started in the past 12 months were on a Forestar developed lot. With a mutually stated goal of one out of every three homes D.R. Horton sells to be on a lot developed by Forestar, we have significant opportunity to grow our market share within D.R. Horton. We also continue to work on expanding our relationships with other homebuilders. 6% of our second quarter deliveries, or 184 lots, were sold to other homebuilders. Katie?

Katie Smith: Forestar’s underwriting criteria for new development projects remains unchanged at a minimum 15% pre-tax return on average inventory and a return of our initial cash investment within 36 months. We are positioning Forestar to return to strong growth by accelerating our investments in land acquisition and development. During the second quarter, we invested approximately $350 million in land and land development, almost double the investment from the prior-year quarter. Roughly two-thirds of our investment was for land development, and one-third was for land acquisition. We still expect our investments in land acquisition and development to total $1.5 billion to $1.6 billion in fiscal 2024 subject to market conditions.

Our lot position at March 31st increased 26% to 96,100 lots from 76,400 lots a year ago. At quarter-end, our total lot position was comprised of 57,400 owned lots and 38,700 lots that are controlled through purchase contracts. Lots owned at March 31st include 6,300 finished lots. We continue to target owning a three- to four-year supply of land and lots and remain focused on managing our development in phases to deliver finished lots at a pace that matches market demand consistent with our emphasis on capital efficiency. 31% of our owned lots are under contract to sell, representing approximately $1.6 billion of future revenue. These contracts have $145 million of hard-earnest money deposits associated with them. Another 30% of our owned lots are subject to a right of first offer to D.R. Horton based on executed purchase and sale agreements.

Jim?

Jim Allen: We have significant liquidity and are using modest leverage to keep our balance sheet strong and support our growth objectives. We ended the quarter with approximately $800 million of liquidity, including an unrestricted cash balance of $420 million and $380 million of available capacity on our undrawn revolving credit facility. Total debt at March 31st was $706 million, with no senior note maturities until fiscal 2026, and our net debt-to-capital ratio was 16.4%. We ended the quarter with $1.5 billion of stockholders’ equity, and our book value per share increased to $29.09, up 16% from a year ago. During the quarter, we issued approximately 546,000 shares of common stock under our at-the-market equity offering program, raising net proceeds of $19.7 million.

Forestar’s capital structure is one of our biggest competitive advantages, and it sets us apart from other land developers. Project-level land acquisition and development loans are less available and have become more expensive in recent years, impacting most of our competitors. Other developers generally use project level development loans, which are typically more restrictive, have floating rates, and create administrative complexity, especially in a volatile rate environment. Our capital structure provides us with operational flexibility, while our strong liquidity positions us to take advantage of attractive opportunities when they arise. Andy, I’ll hand it back to you for closing remarks.

Andy Oxley: Thanks, Jim. In closing, I’m incredibly excited to be leading Forestar, and I believe there’s tremendous opportunity ahead of us. Forestar is uniquely positioned to gain market share in the highly-fragmented lot development industry. Continued execution of our strategic and operational plans, supported by favorable market tailwinds across our diverse national footprint, positions Forestar for further success. We are expanding our team and accelerating our investments in land and development to position the company for consistent, long-term growth. Elevated mortgage interest rates continue to impact affordability, but the underlying fundamentals of a housing shortage remain in place. We believe the low supply of existing homes will continue to drive buyers to new construction and our strong relationship with D.R. Horton provides a clear path for growth.

Our guidance for fiscal 2024 remains unchanged. Based on current market conditions, we still expect to deliver between 14,500 and 15,500 lots and generate between $1.4 billion and $1.5 billion worth of revenue. We are closely monitoring each of our markets as we strive to balance sales price and pace to maximize returns for each project. We are a market leader in a highly-fragmented and undercapitalized industry and are uniquely positioned to take advantage of builder demand for finished lots. There is a significant opportunity to expand our presence in the markets we operate in and our goal remains the same, to double our market share to 5% over the intermediate term. We expect to aggregate significant market share over the next few years while maintaining our disciplined approach when investing capital to enhance the long-term value of Forestar.

With a clear strategic direction, a dedicated team, and a strong operational and financial foundation, I’m excited about the future at Forestar.

Katie Smith: Okay, John, this time we’ll open the line for questions.

Operator: Absolutely. Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] And the first question comes from Carl Reichardt from BTIG. Please proceed.

Carl Reichardt: Thanks everybody. First of all, just on the top-line guide, if I’ve got this right, you’ve got 6,300 lots finished. You need about 8,500 more deliveries this year to get to the midpoint of your guide. So, that’s a relatively small number of lots you’d need to finish and move for the rest of the year. Am I assuming correctly that the 6,300 that you’ve got finished now will all come off this year?

Katie Smith: No, some of those will come off in fiscal 2025 if they have a land takedown structure. So, if a builder is buying 25 lots a quarter, that could roll into fiscal ’25.

Carl Reichardt: So, Katie, you finish those up ahead of time but then they’ll do monthly takes to get to that then?

Katie Smith: Right. So, if say, we finish 100 lots or 125 lots in a phase, the builder doesn’t need that many at the time. So, we can structure it on a takedown schedule.

Carl Reichardt: Okay. Got it. Thank you. Okay. And then, on the margin side, you talked about, Jim, the normalized margin excluding some one-time items this quarter is about 22.5%. As you look at what you’ve got in backlog now, and recognize there will be a lot of timing differential as things bounce around, does that 22.5% feel like a fairly sustainable margin in terms of your backlog right now, or is there going to be a big move up or big move down there, do you think?

Jim Allen: No, that looks sustainable, and it’s really in line with what we’ve been tracking as kind of our normalized margin over the last 10 quarters or so.

Carl Reichardt: Okay. Great. And then, if you’ll indulge me, Andy, can you tell me sort of in your travels now that you’ve been there in the seat for a bit, if you look at the markets where you think there’s increased demand but very low supply of lots, where are the markets that you feel that’s most true? And then, counter to that, where do you think there are markets where perhaps land is much more easily available and the market is somewhat more competitive?

Andy Oxley: So, I would say that the more constrained land markets would be Florida, Texas, sort of the southern Smile markets, and going up into the Carolinas. I don’t know that I can really say there’s any place where there’s an abundance of land. There are probably some secondary markets where that is, but mostly where our markets lining up with Horton, it’s a pretty competitive land marketplace.

Carl Reichardt: Great. Thank you, Andy. I’ll get back in queue. Thanks, all.

Operator: [Operator Instructions] Okay. It appears we have a question coming from Anthony Pettinari with Citi. Please proceed.

Anthony Pettinari: Hey, good afternoon. You saw strong lot pricing in the quarter and you talked about some geographic and lot size dynamics that help to drive that. I’m just wondering where you think underlying year-over-year price appreciation might look like on kind of an apples-to-apples basis if you could — if you can kind of generalize?

Jim Allen: Yeah. We did have one relatively large lot sale of expensive lots during the quarter in California, from a project in California, that really helped to impact the ASP for the quarter and for the year-to-date period. So, if you exclude that, if you exclude those lot sales, our average selling price for the quarter was really closer to $90,300, which is about 6.5% or so above the same ASP or above the ASP last year. For the six-month period, I think it brings the average lot price to $93,300, So again, about 7% above last year.

Anthony Pettinari: Got it. And from a big picture perspective, it seems like the quarterly performance is a little bit better than we expected. I don’t know if your results were, if you’d agree with that or if you performed better or in line with expectations, but in terms of raising or adjusting full your guidance, how do you think about that? And from a big picture perspective, what are the factors that could get you maybe to the high end or the low end of the guide?

Mark Walker: Yeah, we’re confident we can deliver between 14,500 to 15,500 lots based on current market conditions or lot delivery timing. And it sets us up well for a solid year, anywhere from 3% to 10% growth. Since really 4Q ’23, we’ve ramped up our development acquisition activity to be in line with market demand, and it sets us well — sets us up well for future rev in 2025. So, right now, we’re sticking with our guidance and confidence we can hit those numbers.

Andy Oxley: And we feel good about the quarter. It’s a strong quarter. Demand is there. The degree of engagement between our teams and the builders’ teams is very high. And there’s a lot of enthusiasm out in the field.

Anthony Pettinari: Right. Maybe one last one if I could. In terms of increasing exposure to third-party builders, understanding that will be pretty choppy quarter to quarter, is there anything you can say about that effort and — or maybe some of those smaller mid-sized builders are you seeing more appetite, less appetite in terms of what acquisition versus your large customer?

Andy Oxley: I think that there’s a large appetite across the board. We want to have complementary builders when we have a multiple builder scenario. And particularly in our larger projects where another builder or several builders building different product and different price points help us monetize the asset and produce a return, that’s a positive. We’ll always focus on Horton, but I think last year we did business with 25 other builders. And on a quarter by quarter, you’re exactly right, it’ll be a little choppy, but we expect to continue to grow that business as well.

Mark Walker: The interest is still strong from all builders across the board.

Katie Smith: Yeah. So, it’s going to be lumpy just depending on which lots deliver in any given quarter, but we sold to six other builders this past quarter.

Anthony Pettinari: Okay. That’s very helpful. I’ll turn it over.

Operator: The next question comes from [Michael Emhoff] (ph) with JPMorgan. Please proceed.

Mike Rehaut: Hi, good afternoon. It’s Mike Rehaut. Thanks for taking my question. So, I wanted to discuss — maybe it’s a little kind of more difficult question to answer, but with the stock pullback today, just curious what type of feedback you’ve gotten for investors, if there’s been any kind of elements of surprise. I mean, relative to our estimates, your closings came in below what we were looking for, for the quarter deliveries, which would kind of make the back half — shift some of the delivery timing a little bit more to the back half. But similar to your own comments around confidence on the full year, it doesn’t seem like making those numbers is too much of a stretch per se. So, just kind of curious on the market reaction and if there’s any kind of elements of disappointment that you’ve been able to detect from the investor base.

Katie Smith: We were disappointed too by the reaction to the stock today. We thought it was a really good quarter. Net income was up 67%. Pre-tax income was at 64%. And revenues were at 11%. So, we were surprised to see the reaction. Our deliveries might have been a little light from what you had estimated, but we beat on EPS across the board. So, we don’t have any specific feedback that we’ve received from the investor community today, but we’d be very interested to hear what they’re thinking and why the stock traded the way that it did today.

Mark Walker: And based off a lot of deliveries in the first half of the year, if you look back at fiscal year ’22 and ’23 and now for fiscal year ’24, they’re all approximately lined up about 40% where we end the year. So, we’ve been stacked up against 60% of lot closings at the back half of the year. The positive is we closed 1,200 more units, approximately 1,200 more units this first half of the year versus the last half. So, we feel good.

Mike Rehaut: Right. No, understood. And I’m happy to share any feedback I get over the next couple days as well. But just a couple of smaller questions, if I could. I think in answer to one of the prior questions, you had kind of broken out that, excluding some items, this current quarter, the average sales price per lot was closer to $90,000 for the second quarter. Is that kind of a good number to use going forward for the back half?

Katie Smith: It’s kind of — I mean, it really just depends on which projects deliver in any given quarter, but our guidance implies ASP for the year of about $96,000.

Mike Rehaut: Right. Okay. And I guess just lastly, maybe more of a bigger picture question around the ability to sell lots to other builders outside of D.R. Horton. I mean, noticing that the percent of total owned lots connected to Horton remain around 60%, a little bit higher than perhaps a couple of quarters in 2023. We still have a fairly high percentage of lots sold to Horton. Appreciate any type of update around how you’re thinking about the next two or three years in terms of building out other builder relationships and how that might unfold.

Andy Oxley: So, we look at it, number one, to grow our footprint within Horton, and then number two, to grow our overall footprint. So, with the stated goal of trying to achieve one out of every three lots that is a Horton start requires phenomenal growth by Forestar. But then, as I mentioned earlier, where we look particularly in larger communities, where we can position a complementary builder in there to help absorb and monetize the asset, we have a lot of those conversations. But those bigger projects take a long time to bring to market. It takes a long time taking them through entitlement and then delivery of them. So that leads to some of the lumpiness on a quarter-by-quarter basis. But we do expect to grow our third-party builder business.

Katie Smith: Yeah. Mike, as we get closer to that 30% fulfillment of Horton’s needs that we’ve all talked about multiple times, once we get closer to that, I think that the third-party business will start to grow faster. We just want to make sure that our largest and best customer is well taken care of. But we do believe that ultimately up to 30% of our lots can be sold to other customers.

Mike Rehaut: Great. One last one if I could sneak one in or I can get back in queue. I don’t know if there’s others behind me.

Katie Smith: That’s okay. Go ahead.

Mike Rehaut: Just on the 26% growth in controlled lots in the quarter, it was a nice step up this quarter and predominantly through the option lot bucket. Just trying to think about the timing of how that might flow through. And in particular, I kind of have an eye on this question around lot growth — lot delivery growth for fiscal ’25. If that would help support, I think, a continued goal, correct me if I’m wrong, of at least double-digit volume growth going forward?

Mark Walker: Yeah. We’re continuing to manage our business market by market, project by project. So, we’re trying to deliver finished lots that price and pace that meets demand. I mean, back to land acquisition, that can vary just based off the project in terms of entitlement and timing. And so, across our landscape, the specific, it gets down to the division and that project and what their goals are to expand their business model, as Andy said earlier, just penetrating the markets that we’re currently within. I don’t know that we can actually put a timeframe on that, but a lot of it’s got to do after we acquire the lots or cycle times and getting those deliveries to market. So, we do put some cushion in there, but at the end of the day there’s no specific way based off market to market project by project of how we can put those in the queue to map those out.

Katie Smith: Yeah. And so, of the $1.5 billion to $1.6 billion that we’re going to spend this year, about a third of that will be on land acquisition. And those projects can take anywhere from 12 to 15 months to deliver that first phase. And so, we’re really investing to grow in 2025 and beyond. We do want to get back to high growth at that 20% range or maybe even a little bit higher. And we are putting stuff under contract and doing the due diligence process before we bring it onto our balance sheet. We’ve also added to our team to help us to be able to do that faster.

Mike Rehaut: Great. Appreciate it, Thank you.

Katie Smith: Sure.

Operator: We have a follow-up question coming from Carl Reichardt with BTIG. Please proceed, Carl.

Carl Reichardt: Thanks. And, Katie, on that point, I wanted to ask about SG&A. I recognize the leverage bounces around with the top-line. But is a good run rate to you still sort of $30 million a quarter? When do we get to a point where the staff up is going to have some revenue leverage on it, or should we expect you to continue to add staff over — into through ’25 to support the growth you’re talking about?

Katie Smith: So, the leverage is going to change quarter to quarter just based on volume. We always see really good SG&A leverage in that fourth quarter. It’s not going to stay at stagnant $30 million a quarter. We’re continually adding to our team. And so, I would expect a step-up quarter to quarter, but we do think that the business can be managed at that mid-single-digit SG&A percent on an annual basis. And so, we’re adding team members in line with that, but we do need to add members that are focused on land acquisition and development so that, that way we can double in size.

Carl Reichardt: Okay, great. Thank you very much.

Operator: Okay. We’ve reached the end of the question-and-answer session. I will now turn the call over to Andy Oxley for closing remarks.

Andy Oxley: Thank you, John, and thank you to everyone on the Forestar team for your focus and hard work. Stay disciplined, flexible, and opportunistic as we continue to consolidate market share. We appreciate everyone’s time on the call today and look forward to speaking with you again in July to share our third quarter results.

Operator: This concludes today’s conference, and you may disconnect your lines at this time. Thank you for your participation.