Forestar Group Inc.

Good afternoon and welcome to a four-star third quarter 2020 earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note this conference is being recorded. I will now turn the call over to Jessica Hansen, Vice President of Investor Relations for D.R. Horton, the majority shareholder of Four Star.

Thank you, Sherry. We welcome each of you to the call to discuss Four Star's financial results along with current market conditions. Before we get started, today's call may include comments that constitute forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Although Four Star 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 Forrester on the date of this conference call, and Forrester does not undertake any obligation to publicly update or revise any forward-looking statements. Additional information about issues that could lead to material changes in performance is contained in Forrester's annual report on Form 10-K and subsequent quarterly reports on Form 10-Q, all of which are filed with the Securities and Exchange Commission. This afternoon's earnings release is on Four Star's website at investor.fourstar.com, and the 10-Q is planned to be filed mid-next week. After this call, we will post an updated investor presentation to Four Star's investor relations site under Events and Presentations for your reference. Now I will turn the call over to Dan Bartok, CEO of Four Star.

Thank you, Jessica, and good afternoon, everyone. In addition to Jessica, I am pleased to be joined on the call today by Jim Allen, our Chief Financial Officer who joined the four-star team last quarter, and by Colin Dawson, D.R. Horton's Vice President of Corporate Finance and Treasurer. To begin, we'd like to again express our gratitude to our country's dedicated field of healthcare workers and to all who are on the front lines caring for our communities. Our thoughts remain with those affected by this pandemic, and our priority continues to be the health and safety of our people and the communities that we serve. Now we'll talk about the current environment and our quarterly results. As we indicated on our last call, our lot sales pace declined throughout the second half of March and April as home builders slowed their purchases of lots to adjust to expected lower levels of home sales as a result of the pandemic. As housing market conditions Improved in May and June, Four Star was able to quickly respond to the increased demand for residential lots and deliver solid third quarter results. Our lot sales pace increased steadily throughout the quarter, resulting in third quarter lot deliveries of over 2,000 lots, an increase of 75% from the same quarter in the prior year. Even with the improvement in market conditions and demand, we remain cautious as to the impact COVID-19 may have on our operations or on the overall economy in the future. However, we believe that we are well positioned to successfully operate during changing market conditions because of our low net leverage and strong liquidity position, our low overhead model, and our relationship with D.R. Horton. We remain uniquely positioned to consolidate market share in the underserved lot development market that lacks well-capitalized and national participants. Jim will now discuss our third quarter financial results.

Thank you, Dan. In the third quarter, net income attributable to Four Star increased 46% to $10.1 million or 21 cents per diluted share compared to $6.9 million or 16 cents per diluted share in the prior year quarter. The current quarter results included $2.3 million income tax benefit related to the NOL carryback provisions of the recently enacted CARES Act. Four Star's third quarter revenues increased 102% from the prior year quarter to $178 million, which included $13.4 million of revenues from residential tracts sold. Residential lots sold during the quarter totaled 2,023 lots, an increase of 75% from the prior year quarter. The average lot sales price for the quarter was $79,900. 77% of lots sold in the quarter were from development projects with the remainder from lot banking. Of Four Star's total lots sold, approximately 2,000 lots were sold to D.R. Horton during the quarter. Our pre-tax income for the quarter was $10.3 million with a pre-tax profit margin of 5.8%. Our gross profit margin was 11.7% in the third quarter and SG&A expense as a percentage of revenues was 6.3%. Our gross and pre-tax margins are expected to fluctuate due to the quarterly mix of our lot deliveries and the timing of track sales. Dan?

It is too early to predict the ultimate impact of the pandemic on the economy. and on future market prices and terms for residential lots. In the second half of March and April, we worked with our customers to adjust lot sales contracts to delay the timing of takedowns as builders adjusted to fewer home sales as a result of the pandemic. Since then, housing market conditions have improved and the velocity of our lot sales increased throughout the quarter. We have not seen broad-based home price reductions, and therefore we have not experienced any material changes to the pricing of our finished lots. As we manage through these evolving market conditions, we will continue to work closely with each D.R. Horton division and our other builder customers on a project-by-project basis to balance our finished lot prices and absorptions to maximize the returns on our inventory investments. Although we temporarily restricted our land purchase activity in late March, April, and in May, we have now returned to more normalized levels of land and lot development investment. We also paused our hiring efforts during that time, but are back to recruiting and hiring for the further expansion of Four Star's operations. We are pleased with the progress we have made so far building out our local teams and are really excited to continue doing so. As we noted last quarter, due to the uncertainty in the U.S. economy and our business operations from COVID-19, we withdrew our guidance for fiscal 2020 and 2021. Although we don't yet have enough visibility to reinstate full guidance today, based on today's market conditions, we now expect to deliver between 8,700 and 9,000 lots for the full year of fiscal 2020. And to grow our lot deliveries, to a range of 10,500 and 11,500 lots in fiscal 2021. We plan to provide more guidance for fiscal 2021, and we have sufficient visibility in the market conditions. Jessica?

During the third quarter, investments in lots, land, and development totaled $230 million, of which $100 million was for land and $130 million was for land development. For the nine months into June, investments in lots, land, and development totaled $730 million. Four Star's lot position at June 30th was 50,700 lots, of which 38,300 lots are owned and 12,400 lots are controlled through purchase contracts. 14,100, or 37%, of Four Star's owned lots are under contract to sell to Deer Horton. representing approximately $1 billion of future Four Star revenue. Another 15,500 of Four Star's owned lots are subject to a right of first offer to deal Horton under the master supply agreement. Four Star is targeting a three to four year owned inventory of land and lots. Jim?

Four Star remains focused on maintaining a strong balance sheet with ample liquidity and modest leverage. At June 30th, we had approximately $700 million of liquidity, including $350 million of unrestricted cash and approximately $350 million of available capacity on a revolving credit facility. Debt at June 30th totaled $641 million, with no senior note maturities until fiscal 2024, and our net debt-to-capital ratio at quarter end was 25.2%. At June 30th, stockholders' equity was $846 million and book value per share was $17.61, up 6% from one year ago. Dan?

Four Star is uniquely positioned to consolidate market share in the highly fragmented lot development industry through housing market and economic cycles. At scale, we continue to expect our operating model to produce financial results and returns that are similar to or better than most mid-cap home builders, with long-term pre-tax profit margins of approximately 10%. Before we turn to questions, I'd like to briefly touch on Four Star's investment highlights, again from my perspective. We have a unique lot manufacturing business model, very different than a typical land developer. We have no unentitled land. We are focused on developing lots for affordably priced housing. We have an experienced management team that knows how to navigate through market cycles. We have a strong balance sheet and liquidity position with low net leverage. We are profitable at current operating levels and continue to expect to manage our business at an SG&A percentage lower than a typical home builder. And most importantly, we have a unique competitive advantage due to our relationship with DR Horton, which de-risks the expansion of our operating platform and allows us to have a footprint that is more geographically diverse than most public home builders. In closing, and as I've already mentioned, Four Star is extremely well positioned to operate through uncertain economic conditions because of our low net leverage, strong liquidity position, low overhead model, and relationship with DR Horton. Sherry, at this time, will now open up the line for questions.

Thank you. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. And for participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. We ask that you please limit to one question and one follow-up question. Our first question is from John Lovell with Bank of America. Please proceed.

Hey, guys, thank you for taking my questions tonight. The first one, Dan, if I heard the outlook correctly for 10,000 deliveries in 2020, and I think – I'm sorry, I apologize. That was the prior guidance. So it was 8.7 to 9,000 versus 10,000 prior, and then for 2021, it looks like that guidance was brought down slightly as well. I mean, is that just simply conservatism just given – the current environment where there's, you know, uncertainty, or is there something else that we should consider?

Well, clearly, I think, you know, market conditions are uncertain. You know, we did take a little pause in buying land and took our foot off the gas on lot development. We've really returned to normal conditions. But, yes, I would say that primarily it's really uncertainty as we look forward.

Okay, that's helpful. And then on the G&A side, it looks like that was pretty flat sequentially despite the uptick in revenue. Were there costs that you were able to pull out that were sort of, you know, one time in nature, if you will? In other words, that will kind of come back in as we proceed to the next couple of quarters? Or is that, you know, level sort of sustainable?

I think that we are continuing to hiring. You know, obviously we slowed up our hiring process. you know, during that quarter as compared to prior quarters. So I think that as we continue to build out our platform, you'll see some increase in the total dollars of GNA as kind of on the same prior trend. And obviously the percentage of revenue, I think as we've said many times, you know, it could be lumpy from month to month and quarter to quarter, but we think we're on a pretty good trend right now.

Yeah, so, John, for reference, their employee count at the end of June was 128, which was only up seven people during the quarter, which reflects the hiring pause that they took. If you look at December to March, their head count was actually up closer to 25 or 30 people.

Got it. That's helpful. If I could squeeze one more in here. Dan, I think you had mentioned 146 sales, lot sales from April 1st to April 23rd, which would imply somewhere around 940 or 950 per month. May and June. Is there anything that would stop you guys from doing above that level in the next quarter here on a monthly basis?

I don't think there's anything that stops us. We do have the developed lots on the ground. Clearly, it was a quarter that was hurt in the early part of the quarter, but no, I feel good about where we stand on a go-forward basis. The inventory is there and the lot's Following those are under development.

Great. Thanks very much, guys.

Our next question is from Ryan Gilbert with BTIJ. Please proceed.

Hey, thanks, guys. So I guess just building on the last question there, I think one of the themes over the last couple of months has been the pickup in demand that we've seen has been I think a lot stronger than many of us have expected, including homebuilders. And so, you're seeing homebuilders really start to accelerate their land development, land acquisition activities from demand. And, you know, at the same time, it seems like, you know, you also paused land acquisition development activities and now are, I guess, you know, trying to re-accelerate that. So, I'm just, I'm wondering about, or I guess if you could just talk about the opportunity that you're seeing to really meet that stronger demand for lots from home builders as they try to meet home buyer demand. And then the extent that you can re-accelerate your own land development, land acquisition activities, and then, you know, maybe just thinking about the original pre-COVID guidance around the billing of land spend, if that's still, it seems like based on the third quarter spend, that should still be on the table. But, yeah, if you could just talk about that, that would be really helpful. Thanks.

Yeah, I guess starting with your last point there, yeah, you know, it's still pretty lumpy, but I feel pretty good about, you know, regaining that original intended land and development spend for the year. I think that billion dollars is clearly in line with where we expect to be. You know, and again, I think as positioning ourselves, just to back up a little bit, As you know, once I buy that piece of land, it's usually a year before my first revenue event, so I don't really see it having much impact in the near term, that slight pause we took. I think that we have the lot inventory with over 36,000 lots owned and over 50,000 owned and controlled. I feel very good about being able to hit demand as it develops. Again, it's kind of strange times out there, as we all know. No one would have expected this kind of demand with what's happening in the economy and the COVID. But I think we're well positioned to meet that demand if it materializes.

And Ryan, their monthly land back and development will be broken out in the presentation that's on the website after the call. But just for reference, All In, they spent $52 million in April, $56 million in May, and that jumped up to $119 million in June. So they really did, you know, tone it back really mainly on the land purchase side and still spent, you know, decent land development dollars, but then picked it back up in June.

Okay, got it. And I guess just following up there, are you seeing higher demand from builders materializing, or is this still an event that's, you know, still to, you know, TBD?

I'd say that today we are seeing higher demand, not only from Horton, but as we talked about third-party building before, I think my phone is ringing more now than it ever has. We've heard it. Looking for positions. So I feel really good about where we are. I think we're really well positioned. So, yeah, I feel good.

Okay, great. And then just lastly, the – Sequential drop in gross margin I think was a little surprising just given it looks like the land banking percentage went down sequentially. Could you talk about, you know, what drove that sequential dip?

It's really just a function of the track sale in the quarter. So if you think about a track sale similarly to lot banking in that they're underwriting it to a return, not to a gross margin, and they didn't hold that track sale for very long. And so the gross margin was pretty low, but the return was attractive.

Got it. Okay. Thanks very much.

Our next question is from Truman Patterson with Wells Fargo. Please proceed.

Hey, good afternoon. This is actually Trevor Allison on for Truman. Thank you for taking my question. The first question is given the strong home builder demand we have seen recently, we've been hearing about potential constraints when it comes to labor and equipment for development over the next coming quarters. Are you anticipating any increased competition and therefore increased costs for development in the back half of the year?

At this point, we're not. Most of the development that we are undertaking right now has already been contracted for. Actually, as all the other developers and builders kind of hit the stop button, we did a pause and did some repricing, but continued developing. And I think that we actually got some price concessions for some future development. Will things increase later in the year? They may. The good news for us is that even if costs go up, most of those lots haven't been priced yet, so we should be able to account for that in our pricing policy.

Okay, great. And second, given the strong demand, again, that we've been seeing, we would expect, given builders' thirst for lots of time, that lots would be selling at more of a premium. Are you actually seeing any changes in lot prices? And do you have any lots that aren't already spoken for in a contract? Is there any difference in pricing between those lots and the lots you've got under contract?

To the extent that we have lots under contract, obviously we're not seeing any change in those. We're definitely seeing some increased demand and some pricing power in lots that we have on the ground that are ready to be delivered today, and we're taking advantage of that where we can.

Okay, great. And if I could sneak just one more in. Can you talk about any variants you're seeing by region? Are you seeing any specific areas that are looking like an opportunity going forward? Thank you.

Well, I think generally it's pretty broad-based, but I think Florida, Texas, and the Carolinas have shown the best strength, which is where we're really well-positioned, and I think that strategy has paid off. When you look at what's happened with with demand in the Northeast, and I think in California is probably where it's weakest, and we just don't have big positions there right now. Okay, great. Thank you.

Our next question is from Anthony Pettinari with Citi. Please proceed.

Hey, good afternoon. You know, builders have talked about COVID delays, you know, anywhere between a couple days to a couple weeks to their cycle times, you know, from orders to delivery. In terms of your timeframe, you know, from initial capital outlay, maybe the first phase delivery, is COVID or kind of COVID-related restrictions pushed out at times at all, or do you anticipate that going forward?

You know, we really haven't seen any push out as of right now. And actually what we saw is a little maybe acceleration in development time as other builders kind of stopped development projects. We were able to pick up multiple crews on certain sites, which allowed us to develop faster. But I also don't see that as a long-term change. I think it was kind of a blip here over the last few months and will probably continue maybe for another couple of months. In the long term, I think we have really good relationships with our contractors, you know, leveraging a little bit, in some cases, Horton's relationships with our site contractors, and I don't really see any increased development times at this point.

Okay, that's helpful. And then just pulling on the last question, maybe, you know, I think a lot has been made of kind of post-COVID de-urbanization as a trend, and I'm just wondering if if you've seen that sort of manifest itself in greater interest in specific types of lots or price points or sizes or geographies, you know, in terms of mix, is this recovery kind of playing out maybe differently than what you were expecting pre-COVID, or is it maybe too soon to tell?

Well, I don't think it changes our strategy at all. I mean, we have been focused on, you know, kind of the suburban affordable price points. I think that You know, if the de-urbanization trends continue, I think we're well-positioned to capitalize on that because that is really where our land and lot positions is at.

Okay. That's helpful. I'll turn it over.

And our next question is from Michael Renault with J.P. Morgan. Please proceed.

Hi. This is Elad Hellman on for Mike. Congrats on the corridor. Hope you all are doing well, and thanks for taking my question. My first question was just the higher mix of deliveries on development projects this quarter. And I know it's supposed to be volatile quarter to quarter, the 77%. But I was just curious within the new guidance that you gave, are you still expecting it to sort of come out to two-thirds development projects over the next couple of years?

Well, I think it will vary from quarter to quarter. But at this point, I think, you know, I think that that is probably still good guidance as a two-thirds, one-third.

Okay, great. And my second question is just you could provide a little more color on the residential tract sales this quarter. You know, what was the thought process behind that if demand was pretty strong in May and June? And how should we think about the level of residential tract sales for the rest of the year and next year?

Well, it's really not our core business of selling off tracks. This particular situation was a land parcel we tied up that was actually adjacent to a DR Horton property, and we were trying to figure out a way to co-develop. It ended up being much more complicated, and as we figured it out over a few-month period, we thought the best execution was for us to just sell that parcel and move on. So I think, you know, we only held it for a couple of months but made a good return on it, and it just seemed to be, you know, really getting rid of the complexity of, you know, we're trying to have things that are shovel-ready and really move our inventory quickly, and we knew that that one wasn't going to fit that box. So it was time to move on.

And so the track sales will be lumpy. Don't expect them every quarter, as Dan said, not part of their core business, but they could still have some here and there.

Okay, great. Thank you. And we do have a follow-up question from Ryan Gilbert with BTIJ. Please proceed.

Hey. Thanks, guys. I just wanted to get a progress update on building out or I guess your efforts building out the corporate and back office functions so you can start relying on the shared services agreement somewhat less and maybe timing for, you know, having a fully built out corporate office. Thanks.

Well, we've made a lot of progress. Obviously, getting Jim on board was a big plus for us, and he's starting to build out a team under him, which I think from an accounting support was going to accelerate less reliance on the Horton back office there. There are certain pieces we look to maintain, like IR and HR and IT, so those things we'd like to keep as long as they'll allow us to. I think in all the other areas we're making good progress. I don't really have a timeline in mind yet, but I think we're making good progress.

Great. Thank you. We have reached the end of our Q&A session. I would like to turn the call back over to Dan Bartok for closing remarks.

Thank you, Sherry. Thank you to everyone on the four-star team for your focus and hard work. We look forward to working together to continue growing and improving our operations over the coming years. We appreciate everyone's time on the call today and look forward to speaking with you again in November to share our year-end results. Thank you.

Thank you. This does conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.