Good afternoon. And welcome to Forestar’s Third Quarter 2022 Earnings Conference Call. At this time, all participants have been placed on a listen-only mode and the floor will be open for your question-and-comments after the presentation.

[Operator Instructions] I will now turn the call over to Katie Smith, Director of Finance and Investor Relations for Forestar..

Thank you, John. Good afternoon, everyone. And welcome to the call to discuss Forestar’s third 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 issues that could lead to material changes and 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.

This afternoon’s earnings release is on our website at investor.forestar.com and we plan to file the 10-Q later this week. After this call, we will post an updated investor presentation to our Investor Relations site under Events & Presentations for your reference. Now I will turn the call over to Dan Bartok, our CEO..

Thank you, Katie, and good afternoon, everyone. In addition to Katie, I am pleased to be joined on the call today by Jim Allen, our Chief Financial Officer. The Forestar team delivered a strong third quarter highlighted by net income increasing 151% from the prior year to $39.7 million or $0.80 per diluted share.

Pretax income increased 150% to $52.7 million and our pretax profit margin expanded by over 1000 basis points year-over-year to 17.1%. Revenues decreased 1% to $308.5 million, while lot deliveries decreased by 10% to 3,473. Our lot deliveries for the quarter fell below our expectations, due to increased headwinds in the development process.

This was primarily related to municipality delays, and to a lesser extent, shortages of certain materials. However, demand for finished lots remained strong during the quarter, supported by our seventh consecutive quarter of finished lots on hand accounting for less than 10% the Forestar’s own portfolio.

Customers continue to purchase lots soon after completion. Forestar lots were sold to D.R. Horton continue to grow as a percentage of D.R. Horton’s closings year-over-year. Additionally, our lot sold to customers other than D.R. Horton increased 213% compared to the prior year quarter.

As a result of continued demand and our focus teams, we achieve significant improvement in our pretax profit margin both year-over-year and sequentially. Our increasing profitability and focus on capital efficiency is translating into higher returns for our shareholders.

Forestar achieved a 16.2% return on equity for the trailing 12 months ended June 30, 2022. This was a 620-basis-point improvement from the same period a year ago and our ninth consecutive quarter of ROE improvement. Interest rates rose very quickly in June and the housing market is adjusting accordingly.

Although, we did not see demand deteriorate for finished lots during the third quarter, we expect new home starts will continue to moderate. We will now discuss our third quarter results in more detail and I will end the call with closing remarks and updated guidance.

Jim?.

Thank you, Dan. In the third quarter, Forestar’s net income increased 151% to $39.7 million or $0.80 per diluted share, compared to $15.8 million or $0.32 per diluted share in the prior year quarter. Consolidated third quarter revenues decreased 1% to $308.5 million.

Lots sold decreased 10% year-over-year to 3,473 lots, with an average sales price of $86,500. Our average sales price this quarter was higher than the second quarter due to the geographic and lot size mix of lot deliveries. We expect our average sales price will continue to fluctuate quarter-to-quarter due to those factors.

We are pleased that we continue to make progress delivering more lots from projects source by Forestar, 43% of lots sold in the quarter were Forestar sourced, compared to 16% in the third quarter of 2021. Additionally, this is the first quarter since D.R.

Horton acquired their controlling interest that 100% of lot sold during the quarter were from development projects. 13% of Forestar’s third quarter lot deliveries were sold to customers other than D.R. Horton, up from 4% in the third quarter of fiscal 2021. We sold 435 lots to 12 customers other than D.R.

Horton, which was a 213% increase in lots sold to other customers compared to the prior year quarter. We are excited about the significant progress we have achieved in expanding our customer base and continue to target selling approximately 30% of our lots to other customers over the intermediate term.

Dan?.

Our pretax income for the third quarter increased 150% to $52.7 million with a pretax profit margin of 17.1%. As I said in my opening remarks, this was an improvement of over 1,000 basis points compared to the prior year quarter.

The prior year quarter included an $18.1 million pretax loss on extinguishment of debt related to the redemption of the company’s 8% senior notes. Excluding that $18.1 million charge, our pretax income for third quarter increased 34% and our pretax profit margin improved 460 basis points.

Our gross profit margin expanded 620 basis points this quarter to 24%, compared to 17.8% a year ago. The improvement was primarily due to increased margins on lot sales from development projects sourced by Forestar. SG&A expense as a percentage of revenues in the third quarter was 7.8%, compared to 5.4% in the prior year quarter.

While this was higher than expected due to fewer lot deliveries this quarter, we believe we will continue to manage our business at a mid single-digit SG&A percentage for the full fiscal year. We remain focused on efficiently managing our SG&A while investing in our teams.

Katie?.

Forestar’s underwriting criteria for new development projects includes a minimum 15% annual pretax return on inventory and the return of the initial cash investment within 36 months. During the third quarter investments in land and land development totaled $368 million, of which $79 million was for land and $289 million was for land development.

Fiscal year-to-date, our investments in land and land development totaled approximately $1.1 billion. We continue to be very selective when investing in new projects and remain focused on developing projects within our owned land portfolio at a discipline pace.

We now plan to invest approximately $1.425 billion in land and land development during fiscal 2022 subject to market conditions and we are continuing to target a three-year to four-year owned inventory of land and lots.

Forestar’s lot position at June 30th was 97,000 lots, of which 65,300 lots were owned and 31,700 lots were controlled through purchase contracts. The majority of our owned lots were put under contract prior to 2021. At quarter end, we had 5,300 finished lots on hand.

Finished lots have accounted for less than 10% of Forestar’s owned portfolio for seven consecutive quarters. We are intensely focused on managing our development in phases to ensure we’re delivering finished lots at a pace that matches market demand consistent with our focus on capital efficiency and returns.

At June 30th, 53% of our owned lots were sourced by Forestar, up from 51% a year ago. As Jim said, 43% of lots sold in the quarter were from projects sourced by Forestar, up from 16% a year ago. That percentage will continue to trend higher as more Forestar’s sourced projects start to deliver lots. We also have good visibility into future revenues.

Of our 65,300 owned lots, 30% are under contract to sell to D.R. Horton, representing approximately $1.5 billion of future revenue. Additionally, 29% of our owned lots are subject to a right of first offer to D.R. Horton based on executed Purchase and Sale agreements.

Jim?.

Forestar remains focused on maintaining a strong balance sheet with ample liquidity and modest leverage. At quarter end, we had approximately $500 million of liquidity, including $150 million of unrestricted cash and $350 million of available capacity on our revolving credit facility.

Total debt at June 30th was $706 million with no senior note maturities until 2026 and our net debt-to-capital ratio at quarter end was 32.8%. Forestar’s capital structure is one of our key competitive advantages.

Most traditional land developers are encumbered by project level financing, which makes it more difficult to react to changing market conditions, while adding complexity and administrative costs.

Our strong liquidity and corporate level financing enable us to effectively operate through changing economic conditions and positions us to be opportunistic when attractive opportunities present themselves. At quarter end, stockholders equity was $1.15 billion and our book value per share increased to $23.05, up 18% from a year ago.

Dan?.

We expect the environment will remain challenging due to rising interest rates, persistent inflation, continued municipality delays and shortages of certain materials. However, our teams are relentless problem solvers and they continue to navigate this environment exceptionally well. We will continue to be proactive in the areas we can control.

As I said in my opening remarks, we expect new home starts will continue to moderate. We also expect to experience a brief period of reduced lot deliveries. As outlined in our press release, we are updating our guidance for fiscal 2022.

We now expect our pretax profit margin to be approximately 14.25% for the year, consistent with the midpoint of our prior range of 14% to 14.5%.

We expect to deliver approximately 17,000 lots this year, generating roughly $1.425 billion of revenue, compared to our prior guidance of between 19,500 to 20,000 lot deliveries, generating $1.7 billion of revenue. Finally, we still expect our effective tax rate in fiscal 2020 to be approximately 24.5%.

Although, the uncertainty of this market transition may persist for some time, we remain positive on the long-term demand outlook for finished lots and our ability to gain market share in the fragmented lot development industry.

We believe that homebuilders will continue to shift their focus towards buying finished lots of third-party developers instead of self developing, with our national footprint, strong balance sheet and seasoned management team that has experienced in navigating to market cycles.

Forestar is extremely well-positioned to deliver further value to our shareholders. John, at this time, we will now open the line for questions..

Thank you. [Operator Instructions] And the first question is coming from Deepa Raghavan with Wells Fargo. Your line is live..

Hi. Good evening, everyone. Thanks for taking my question.

Dan, would you be able to talk about some of the markets where you expect to see housing slowdown impact the most? Also, are you looking to change your future land mix, as you know, fall off, perhaps, can bring about some of those changes?.

Well, I think, at this point, I don’t know that we’ve really seen the fall off in demand, much of it is somewhat anticipated. Obviously from the release this morning on housing starts, housing starts are paying the single-family permits or starts are down about 16% year-over-year. And -- so at this point, I can’t pick -- pinpoint any one market.

We’re just being cautious and attempting to adapt as market conditions continue to change. As far as our land strategy, I -- there’s nothing at this point that is changing our strategy, about -- almost two-thirds of the lots that we own today were put under contract before 2021. So we feel very good about the basis in our land and our positions.

And I think that we’re diversified appropriately and as it relates to current permits market-by-markets. I actually feel really good about our current land and lot position..

Okay. You brought up the housing starts, just curious, would you have a forecast for housing starts next year.

I do appreciate you didn’t have the opportunity to take share down cycle, but at a high level, what level of housing starts would you be planning your business for in [inaudible]?.

Well, actually, I was looking at the Wells Fargo report earlier today. So I think I got -- we got some of our information from your group. But right now, I think, at least from your data, your estimate for next year is down about 2.5% to 3% in single-family’s starts.

But again, that -- I don’t know how old that report was and I think the market is changing pretty rapidly. Just over the last several weeks we’ve seen builders start to moderate starts kind of across the Board..

All right. That’s fair. My last question, if I can squeeze one in. Anyway to think, your released and also your prepared commentary mentioned, moderating housing demand, you’ve also mentioned municipal delays.

Just curious out of that, close to 2K pull back in volume wise, how much would you attribute to municipal delays and how much would you attribute to pull back in the housing market and that’s the last question? Thanks..

Okay. For this prior quarter, basically our -- as we were finishing lots, they were still being purchased, we did not really see the impact of what may be the future is going to bring in demand for those lots.

So as we finished lots, they were still sold our finished lot on our inventory really didn’t change much quarter-over-quarter or year-over-year, we are staying pretty steady at that number. It’s funny and all the prior calls, last several calls and discussions I’ve had, a lot of the other builders have been talking about municipality delays.

And we really had not experienced it until this past quarter. So it was -- came as somewhat of a surprise to us.

But just really the delays in getting the paperwork finished, plats recorded, getting those final certifications from the municipalities, the lots run the ground that we just didn’t have that the right ability to transact and sell that platted lot..

Okay. Thanks very much. Good luck..

Yeah. Thank you..

Okay. The next question is coming from Truman Patterson with Wolfe Research. Your line is live..

Hey. Good afternoon, everyone. Thanks for taking my questions and I do apologize, I was having a hard time hearing Deepa. So if I double up on questions, I apologize.

But -- so it looks like you all pulled back a bit on land activity during the quarter based on your lot count, I’m just hoping you can give us kind of the lay of the land from a competition standpoint, whether builders have generally pause bidding on certain parcels in the market.

Are you hearing many are attempting to renegotiate kind of option land terms and whether there are any metros, you’re actually starting to see land prices soften a bit sequentially..

Okay. First, actually, if you really look back at our lot inventory over the past year, we really kind of started slowing our land acquisition about a year ago and we stayed pretty steady year-over-year in our owned and controlled lots. As far as markets and what other builders doing, we’re clearly hearing about builders dropping contracts.

We’re seeing that firsthand in some instances where the land that was tied up by builders, they’re just -- they’re letting those contracts go and are coming back into the market. I don’t know that that has translated into reduced land prices yet.

I think it’ll probably take a little longer for the landowners to realize that maybe the value they encountered track to that before is -- was overstated.

Although, we do anticipate seeing that sometime later this year that we expect landowners to maybe get a little more realistic about some of the pricing and the terms, I mean, some of the -- some of it wasn’t prices as much as it was terms that really tightened up and as far as short through diligence periods in closing on entitled land was kind of became the norm there for a while for other land buyers.

So I expect that that will soften, but again, I don’t know that we have seen that in the marketplace yet..

Okay. Okay. Thanks for that. And then, with rates moving higher and homebuyer demand has clearly cooled a bit here.

You all who mentioned the financial -- refinancing competitive advantage over your peers, but I’m just trying to understand what the strategy is over the coming, we’ll call it, 12 months, I think, you were talking about single-family starts being down a little bit earlier.

But do you take advantage of the slowdown really go out and capture incremental market share, perhaps, even grow the land bank or do you shore up a bit of cash, and maybe even just develop and liquidate a portion of your current owned land bank?.

Well, we’re going to be constantly looking for those opportunities. If we see attractive opportunities to buy land in good locations, at good prices, that’s one of the reasons we want to keep a strong balance sheet with a lot of liquidity is to be able to take advantage of those opportunities.

But we don’t feel the same need that maybe we did a couple of years ago to go out and build up our land portfolio. Again, I -- we expect that pricing will become more reasonable in terms of come more reasonable as the year progresses.

So, but from a day-to-day, we are looking at starts in the each of the subdivisions that we have, we’re looking at the underlying sales, and trying to make sure we’re monitoring and adjusting our lot deliveries as best as we can.

Maybe potentially staging lots in a partially completed fashion so that we can quickly react when demand changes and turns around, I think everybody’s out there experimenting a little bit with some reduced starts, it’s not necessarily every subdivision, but in many places where maybe spec inventory had grown or the builders loaded up on some finished lots, we expect some moderation for time being.

But again, it’s really just kind of watching as closely as we can and adapting as quickly as we can..

Okay. And then one final for me, clearly a third of your land bank is optioned or controlled deals, which have a pretty attractive basis, given the land appreciation the past couple of years.

But I’m just hoping you can help us think through, like, what would market conditions really need to look like before you might, just step aside from some of that optioned land?.

Again, I think, it’s really on a project-by-project basis and we’ll be looking at, one, what other land do we own in that area? What are lot positions are? What the sales activity looks like and trying to make sure that we aren’t too long on land in those markets.

It’s -- again, if you think about how we’re focused on our returns, just making sure that the cash that we’re deploying, we can return relatively quickly. So I don’t know that there’s any widespread answer for your question, but it’s -- because it really is going to be done on a deal-by-deal basis and a submarket-by-submarket basis..

Okay. Got you. So when you’re thinking through it, it’s a bit more about the amount of land that you have in the market, rather than any level of price declines or anything like that in the land market..

Yeah. Again, we hope to be able to take advantage of opportunities as they come up. But right now, it’s pretty darn granular.

I mean, we literally spend lots of our days, parts of every day going through project-by-project and understanding the local inventory and a project inventory as we make decisions on, putting lots into development or slowing development or -- and/or looking at future land purchases..

Okay. Perfect. Thanks for taking my questions and good luck in the upcoming quarter..

Great. Thanks, Truman..

Okay. Up next we have Max Downey with BTIG. Max, your line is live..

Hey, guys. Thanks for taking my questions.

So on the material side, are there any particular materials that are causing delays right now?.

There’s two that are probably the most prominent, one of them is getting transformers from the power companies to get subdivisions hot with electricity. It seems to be kind of widespread. It’s not just one location versus another.

But I’d say that’s probably the most common problem we’re having is actually, lots can be done, but we just can’t get electricity to them, waiting on that utility company. The second is actually reinforced concrete pipe and there’s a lot of that pipe is made in locations close to our projects, it is shipped at long distance.

It isn’t necessarily the pipe itself, but it’s the reinforcing wire that goes in that pipe and there seems to be a shortage of that. And again, the best we can determine is it’s, there’s a shortage that’s pretty national and scope is, as I think most of us made in China and send over here, then the pipe is made locally.

That’s probably the two biggest areas that we’re experiencing material delays..

Got it. Thank you. That’s really helpful. And then my second question is, last quarter you guys discussed an interest from the build-for-rent operators for some of your assets.

Have you seen a change demand or interest either up or down this quarter and do you have any updated thoughts on the space in general?.

At this point, we’re still seeing the demand to be strong. We expect maybe pricing might be -- as we look to sell additional parcels, we think pricing might be a little softer, because I think, the interest rates have gone up and at least the appearance of cap rates has gone up a little bit and as they back into what they can pay for develop land.

We are continually looking at the space. We have sold some parcels to that space that was happening. It’d be a unique transaction in the way that it was structured, which probably brought a little more visibility to that particular transaction.

And but, yeah, we will continue to look at the build-for-rent market as a viable demand for lots in our subdivisions..

Awesome. Thanks so much, guys..

Thanks..

[Operator Instructions] Up next we have Anthony Pettinari with Citigroup. Anthony, your line is live..

Hi. This is Asher Sohnen on for Anthony. Thanks for taking my questions.

I just want to know, what kind of home price or home sales volumes, the client scenario, would you have to see materialized before you could start thinking about potential impairments to your book if any?.

That’s always a hard question. When I think about home prices, there’s a couple of factors that I think have driven home prices up. One is, I think, builders have been able to increase their margins over what may have been a historical run rate and a lot of their material costs have run up.

So I think there’s going to be a -- if there’s going to be some price adjusting downward, I think there’s room before it gets to the two lot prices themselves. So far, we haven’t seen any pushback on our lot pricing. And I think we’ve -- again, a lot of our portfolio was tied up and put under contract before 2021.

So we feel really good about our land bases. And it will just -- it will really be looked at on a -- again on a project-by-project basis, if we see that prices have fallen substantially. I think there’s room for builders to give incentives and adjust pricing for quite a bit before it would impact lot prices..

Thanks. That’s helpful.

Another question I had was, your full year guide seems to imply pretty strong a year-over-year decline in volumes in the fourth quarter, and obviously, you’re not going to 2023 yet, but you’re just directionally, so we think about 4Q is being maybe a good run rate for the next the following year or it could have been some reacceleration in fiscal 1Q 2023 as maybe some of the delays you’re seeing in 4Q kind of get delivered in 1Q.

Is that how should we think about it?.

Yeah. I don’t -- again, I’m not really -- we’re not given guidance for good reason. That’s -- the future is a little bit unclear. We don’t really know what it’s going to look like. We’re going to be positioned to really retain the growth rate that which we could have achieved if the market hadn’t changed on us.

I think every week we get smarter as we see sales results come in and so what -- how this is all going to unfold. Obviously, the fed are still talking about further interest rate rises.

So we just don’t really know what to expect, but we’re positioned to be able to retain the run rates that which we have been operating at and I wouldn’t really do anything for Q4 look forward at this point..

Okay. Thanks. That’s really helpful. I’ll turn it over..

Okay. Up next we have Mike Rehaut with JPMorgan. Your line is live..

Thanks. Good afternoon, everyone.

Just curious on the reduced lot delivery guidance for fiscal 2022, nearly about 3,000 lots, how should we think of that in terms of the two different reasons that you cited, being municipal delays versus builders walking away from the option contracts?.

Yeah. I think rather I fill the [ph] second one first. I don’t really see builders walking away from option contracts, at least at this stage of the game for us. What we have is contracts to sell those lots there, every one of them is still in compliance with the terms of those contracts. We don’t have any contracts that are in default.

If anything, builders got ahead of the required takes in those contracts and have a little bit of room to adjust before we would have to change those contracts and prices. So, some of it is just kind of a finger in the wind, to be honest with you.

So what we’re expecting to see in changing demand and some of it is those continued delays in the -- again municipalities really sign off. I mean, what we’re -- the delays, to say, it went from the less, not really seeing anything to pretty significant delays and getting plats approved.

I don’t know if it’s understaffing or just happen to be the summer months and there are lot of people were on vacation or but clearly it was -- for us, it was a widespread change in the ability to get those plats recorded and get final lot certifications through the municipality. I don’t know how I would handicap one versus the other.

I think it is probably a pretty even blend between the two..

Okay. So in other words, maybe it’s roughly 50-50, but aside from the municipal delays, the other main reason not necessarily walking away from the option contract, but more just delays, a slower market and reduced takedowns or pushed out takedowns.

Is that fair to say?.

Yeah. That’s right. I think the builders are in the process of adjusting their starts and I expect that they won’t be accelerating those lot takedowns, like they had been in the past..

Right. Okay. Next, just on the gross margins, trying to, maybe the SG&A as well and this might be more of a question for Jim.

But when you kind of triangulate the 14.25% pretax margin, it seems like, you did on the SG&A side, $24 million this quarter and last, if you kind of extrapolate and keep that at $24 million, you’re looking at 6.5% SG&A and then that would require a 20 percentage type of gross margin for the fourth quarter for it to flow through.

Is that the right way to think about it or should we expect any type of significant dollar cut run rates off of the $24 million SG&A that, that you posted each of the last couple quarters?.

No. I think the way you’re thinking about it is right. I mean, our gross margin was a little higher in the third quarter. We just really did a mix. We had some communities with just higher margins in the mix this quarter and we expect that to kind of revert back to more what the margin was in Q2.

But again, we’re having -- we had -- also had a strong delivery of Forestar sourced lots, which helped and no lot banking.

So I think fourth quarter margins probably look more similar to Q2 and our SG&A run rate in terms of dollars, probably, very similar, but -- on lower volume, so we probably won’t have the operating leverage that we originally expected to have..

Right. I guess just extrapolating and understanding and not giving guidance yet for next year. But to the extent that you continue to put out like plus or minus $300 million a quarter run rate, as it looks like you’re kind of more or less going to hit in the back half.

Would that -- if that were to persist, should we be expecting any type of cuts off of the SG&A on a $1 basis or just in order to maintain the infrastructure that you’ve built and what you want to try and create over the next several years, you’re okay with a little bit of deleveraging?.

Yeah. I think for right now, we -- what we don’t want to do is overreact. We have built a great platform. You will notice, if you look at our headcount, we were pretty flat quarter-over-quarter for the first time and in many -- actually since the time of the transaction with Horton four and a half years ago, we expect to probably hold that flat.

At least for now, obviously, we can adjust later down the road, but what we don’t want to do is overreact and start dismantling the fabulous team that we have. So we intend to keep that team intact..

Right. One last one, if I could, and I know it’s a little repetitive, might be a little difficult to answer. But you’re kind of now forecasting with the fourth quarter, a lot delivery rate of plus or minus 3,500 a quarter.

I know you said earlier in the call that you expect the reduced deliveries to be a brief period, outside of further market slowing or deterioration, is this a number that everything else equal, if the market stabilizes here should be a little higher in the next few quarters or depending on municipal delays and further conservatism, it could be at this level or lower?.

Again, I think, we’re going to adapt as need be. But we are positioned to accelerate our lot deliveries in the future back to that run rate. We don’t expect that these municipal delays will continue.

We think that it is something that’s real today, but I wouldn’t think that, six months or nine months from now that they will still be as severe as they been recently. So we expect that that will come to fruition. And again, at this stage, we’re still seeing the demand for the lots. Our anticipation is that it will soften.

But, again, right now, I don’t really think it’s going to be that long. I think the builders are going to try to right size their inventory on a project-by-project basis. And as their building costs come down, we expect starts to kind of reaccelerate.

So -- but we’re still be to -- continue to monitoring on a week-to-week and month-to-month basis and adjusting as we can..

Right. Thanks so much. Appreciate it..

Thank you..

Okay. We have no further questions in queue. I’d like to turn the floor back to Dan Bartok for closing remarks..

Thank you, John. And thank you to everyone on the Forestar team for your focus and hard work. We appreciate everyone’s time on the call today. I look forward to speaking with you again in November to share our fourth quarter results. Thank you..

Thank you, ladies and gentlemen. This does conclude today’s event. You may disconnect at this time and have a wonderful day. Thank you for your participation..