Forestar Group Inc (FOR) 2008 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Third Quarter 2008 Financial Results for Forestar Real Estate Group Inc. My name is Francine and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question and answer session towards the end of today's conference.

(Operator Instructions)

I would now like to turn the presentation over to your host for today's conference, Mr. Chris Nines, Chief Financial Officer. Please proceed, sir.

Thank you and good morning. This is Chris Nines, Chief Financial Officer of Forestar Real Estate Group. I would like to welcome each of you who have joined us by conference call or webcast this morning to discuss the results for third quarter 2008. Joining me this morning is Jim DeCosmo, President and CEO of Forestar Real Estate Group.

Let me remind you to please review the warning statements in our press release and our slides concerning forward-looking statements, as we will make forward-looking statements during this presentation.

This morning, Jim and I will provide an update on our value creation activities and financial results for third quarter 2008. At the completion of our presentation we will be happy to take your questions. Thanks for your interest in Forestar Real Estate Group and I will now turn the call over to Jim.

Thank you, Chris and good morning and welcome to everyone who's on the call and the webcast. Before Chris reviews the financials, I want to make a few comments that are relevant to the market's quarter and the current state of the business.

It's no surprise the housing markets continue to navigate through some pretty stiff headwinds. Fortunately, the majority of our active projects and investments are in the major markets of Texas, today's healthiest market. Our natural resources continues to perform well. Third quarter minerals production and pricing are up over the second quarter of this year and given our low basis assets, our active real estate principally located in the Texas markets, natural resources and healthy balance sheet, we're well position for this phase of the cycle.

The third component of our strategy is to grow the business. We fundamentally believe that the distress in housing and the financial markets that'll create the acquisition opportunities. Forestar will be well positioned. Now in the next few slides, I want to briefly comment on our performance related to our strategy.

In the third quarter we sold 1,774 undeveloped acres at an average price of approximately $4,800 an acre. As you'd expect in today's market most sales are predominately cash, which limits the buyer pool. We continue creating value through entitlements with a significant volume of active projects, 26 entitlement representing over 33,700 acres. Our low basis properties requiring minimal investment in entitlement position Forestar to realize significant future value. Real estate sales, 149 lots at an average price of just over $62,000 a lot and 23 commercial acres at an average price of just over $252,000 an acre.

In the third quarter we leased about 3,200 acres for approximately $1.1 million in revenue, an additional $600,000 in delay rental. Our royalty interest generated $7.8 million in revenue, which is driven by a net production of 437 MMcf of natural gas and over 23,000 barrels of oil and that is our net share. Even though oil and natural gas pricing has recently declined we continue to be encouraged by our progress in filling out our minerals team.

Flavious Smith, our Executive Vice President of Minerals has filled two of the three key positions in land and in engineering. Both individuals come to us with extensive experience and a proven track record in creating value through minerals.

Our fiber resources segment sold just over 260,000 tons of pulpwood and 36,000 tons of sawtimber yielding timber revenues of approximately $2.9 million. Our objective is to maximize timber revenues, while enhancing real estate values. Now due to low sawtimber prices we've intentionally limited our sawtimber sales. That's one of the benefits of timber -- trees left on the stump continue to grow volume, as well as value. We meet our contractual agreements yet remain disciplined during down timber markets holding volume for improved conditions.

Now let me turn it over to Chris to review financials for the quarter, as well as compare the financial metrics.

Thanks, Jim. Despite challenging market conditions net income for third quarter 2008 was $0.9 million, or $0.02 per diluted share outstanding compared with net income of $9.6 million, or $0.27 per diluted share in third quarter 2007 and second quarter 2008.

Third quarter 2008 financial results reflect the benefit of our low-cost operation and our natural resources value creation strategy. Third quarter 2008 weighted average diluted shares outstanding were 35.8 million shares. Now let me turn to our segment results.

We manage our operation through three business segments. Real estate, mineral resources, and fiber resources. Our real estate operation reported segment earnings of $1.7 million in third quarter 2008 compared with $13 million in third quarter 2007 and $0.9 million in second quarter 2008. Third quarter 2007 real estate segment results include a $7 million gain from the sale of 84 acres of commercial land for $190,000 per acre.

Second quarter 2008 real estate segment results include a $3.5 million pre-tax charge principally associated with our environment remediation activities at our San Joaquin River Project located near Antioch, California. Jim will walk you through our real estate sales and entitlement activity for third quarter 2008 in a few slides.

Mineral resources reported segment earnings of $8.2 million in third quarter 2008 compared with $6.8 million in third quarter 2007 and $23.2 million in second quarter 2008. Third quarter 2008 mineral resources segment earnings reflect higher royalty revenues driven by increased natural gas production, as well as higher oil and gas prices.

Second quarter 2008 mineral resources segment earnings include $18.5 million in bonus payments associated with leasing over 47,000 net mineral acres. Fiber resources reported segment earnings of $1.9 million in third quarter 2008 compared with $1.4 million in third quarter 2007 and second quarter 2008.

Now let me turn the call back over to Jim who will walk you through our real estate pipeline and the key performance indicators for our business.

Thanks, Chris. Our real estate value creation pipeline is comprised of four distinct value categories with the strategy being to create value by moving acreage and product through the value chain from the left to the right.

At the end of the third quarter we had approximately 317,000 low basis undeveloped acres of real estate principally located in and around Atlanta. The majority of this segment is comprised of acreage that we selected from the 2 million acre land portfolio once owned by Temple-Inland. We have just under 34,000 acres in the entitlement process; almost 15,000 acres entitled, and just over 2,800 acres in the development category here in our real estate portfolio of just over 368,000 acres.

In addition, we have about 25,000 lots in the entitled category and just over 4,700 lots in development for a total estimated lot count of just under 30,000. Lots in the development category are down for the third consecutive quarter. Not reflected in the acreage is our 58% ownership interest in the Ironstob venture which controls approximately 17,000 acres in north Georgia. This acreage is principally located in Paulding, Polk, and Haralson counties, with Paulding being one of the fastest growing counties in the US.

On the next two slides our real estate key performance indicators, a reconciliation of our progress in creating value by moving acreage through the pipeline. We sold 140 lots, excuse me, 149 lots in the third quarter of 2008 at an average price of just over $62,000 a lot. Our lot prices have continued to hold through the downturn due to the fact that a majority of our projects are in the major markets of Texas.

Markets that generally didn't get overheated in the first half of the decade, had little speculative activity, and maintained fairly balanced housing and lot inventories and have been leading job growth markets, which collectively provide a broader based price and support.

In the third quarter we sold 23 acres of commercial property at an average price of over $250,000 an acre and 1,774 acres of undeveloped land at an average price of $4,800 an acre.

Third quarter 2008 segment revenue and earnings were respectively $20.9 million and $1.6 million when we shift entitlement activities. At the end of third quarter we have secured entitlements on 16 projects and remain active entitling 20 additional projects in Georgia. Our 36 projects total over 34,000 acres of value creation and given our low-cost and low basis we're well positioned for recovery and prepared to compete.

When our underwriting and ongoing market analysis suggests that it's time to invest we'll compete on several fronts. Value, quality, amenities, and sustainability that together equates to superior lifestyle and use. This is true for both residential and commercial. As we've discussed before, we're equally focused on economic development, as well as commercial uses. We've highlighted a few of our commercial entitlement projects on previous calls.

Moving on to minerals. In the third quarter of 2008 we leased approximately 3,200 acres at $338 an acre. Royalty revenues generated approximately $7.8 million for the quarter. As you can see, the prices we report are higher than today's prices. As we've previously mentioned, our prices generally lag 60 to 90 days.

Third quarter 2008 gas production is up substantially over the second quarter of this year. This is the result of new wells that have come online and our strategy at work getting acreage in play, wells drilled, and oil and gas royalties up.

Fiber volume is up slightly and prices remain fairly stable in comparison to the second quarter. We continue to have a mix that's heavily weighted of pulpwood principally driven by real estate harvest prescriptions and depressed sawtimber prices. The third quarter 2008 revenue and earnings are generally in line with comparative quarters. We'll continue playing the harvest in a way that maximizes the long-term value of our real estate and fiber resources.

Going forward, we'll continue to stay focused on our cash flow and our balance sheet. In particular, our two most significant development commitments are Cibolo Canyons Resort in San Antonio and Palisades West and Austin Office Project and Venture with Cousins Properties (inaudible) fund advisers. In the third quarter these two projects alone accounted for approximately 50% of our investment in development. We expect both projects to be substantially funded by year-end.

Across the business, we'll minimize investments in development, reduce operating costs, and drive sales across all business segments. Our portfolio of properties, business model and strategy are a distinct advantage especially during these difficult conditions. We'll continue entitling our low-basis properties creating significant value and exercise stringent discipline when investing in development only in projects and markets that will generate subsequent sales.

Our fiber and mineral resources are well positioned and we believe the long-term fundamentals are in our favor. We'll continue to create realized value for mineral resources by leveraging our assets in our new organization. In the short period of time the new organization has been onboard we're very encouraged by the value creation opportunities we see throughout our mineral assets. I'm also confident that our new team brings the competencies and skill sets to develop the transparency and disclosures that better enable the valuation of our mineral resources.

In keeping with our ongoing initiative of continuing to improve our transparency and disclosures, I want to bring your attention to the additional table in the back of the release. The summary of both wholly-owned venture assets and projects that are not traditional subdivisions.

And in closing, there are many challenges in the markets yet these same issues that we believe will present opportunities execute our growth strategy. Once again, let me thank you for your interest in Forestar and for the time that you've taken out of your schedule to join us this morning. Now I'd like to open up the call to questions.

(Operator Instructions). Our first question comes from the line of John Olive from Credit Suisse. Please proceed.

Hey guys. Good morning. Can you hear me?

Yes. Good morning, John.

Good morning, Chris. I had a quick question on the mineral rights. I guess was -- how should we look at the 47,000 acres that were leased in the second quarter versus the 3,000 acres that were leased this quarter? Is that 47,000 acres sort of a one-time you know land rush? You know we had the I guess Haynesville Shale and everything else and I guess.

Is that sort of a one-time bump and we should look at 3,000 as normal? It's just a huge difference sequentially right? 47,000 versus 3,000 and I'm just kind of wondering given that enormous difference. What's a normalized way to look at this leasing activity?

John, we had commented on that at the end of the second quarter. 47,000 acres in a quarter is a significant number and a big number. What we had indicated was that the normal run rate is 20,000 to 25,000 acres a year. Of course that's historical. We hope that the continued development in the Haynesville, the James Lime, as well as the Cotton Valley will continue to generate some activity and some interest.

But I think that your point that 47,000 is a big number, we don't view that certainly as a run rate and that's why we had given the indication and the comment that we think that the 20,000, 25,000 acres a year is probably a better run rate or a norm for the time being anyway.

Could I ask you a follow-up on that then? So that would equate to about you know I guess about 5,000 or 6,000 a quarter so we had about 3,200 this quarter. Is this, I guess totally dependent on more the pricing of the commodity or is it the availability of financing for folks like Chesapeake or whatever else that are pulling back so that even the 3,000 would be - I mean that would be a run rate of what, 12 or 13 so --

And John, it's going to be fairly lumpy when you look at it quarter-to-quarter and if you go back and look at the historical numbers you'll see it's going to bounce around quite a bit. There could be quarters with very little leasing activity and there could be quarters with 10 to 12. The drivers are at - as we've stated before it's our minerals business and it drives activities, as well as the drilling. It's first the location and what kind of geology do you have there's always going to generate interest. And of course pricing is very important, so those are the fundamental drivers.

The other I think most recent driver has been the change in the shift in technology. A lot of what we see today especially in the Haynesville, our resource plays, shales, and tight sands and that's the future of oil and gas. So a majority of what we have in the ground today is conventional and the unconventional is still coming, so we're encouraged about the future for sure.

Okay. One last one, a different topic I guess. Just -- it looks like your total debt went up about $100 million year-over-year. I know you've called out Cibolo Canyons as the major investment there. Is there any other reason besides Cibolo Canyons that we saw $100 million total debt increase year-over-year?

John, let me say this. It's both Cibolo and Palisades West. Those two together were about $60 million in commitments and I'll tell you we started funding on a fairly heavily basis toward the end of 2007 so it's kind of like a $4 million to $6 million quarter run rate. So just for those two projects alone which are pretty close to being funded. What's that, $10 million, $15 million a quarter?

Yes.

Something in that neighborhood. So as I said in my comments they're just about funded -- in fact for Palisades it goes from projects requiring cash to when it becomes leased up and it will shift pretty quickly to something that generates cash.

Your next question comes from the line of Mike -- I'm sorry -- Mark Weintraub of Buckingham Research. Please proceed.

Thank you. Maybe just following up on Palisades and Cibolo. So when would you expect those projects to start being -- generating cash as opposed to using cash?

Mark, Palisades will start being occupied in the fourth quarter. There's two buildings there. One of them is approximately 210,000 feet, which will be fully occupied and leased by the [mutual] fund advisors, who will be occupying this quarter.

The other building is about 165,000 feet and I know that at least one floor of that has been leased which is about 32,000 -- so about 65% of it is going to be leased up by year-end. So given that there's not any debt on that project, it's all equity, there's no debt service we expect cash to be coming out of it pretty quick.

With regards to Cibolo, the latest estimates are for an opening sometime in the first half by 2010. And of course with that project we've disclosed on a number of occasions the way that our improvement district was structured we'll get 9% of the room revenues and 0.5% of sales and use.

Given the current market situation and as a new company the perhaps certain -- uncertainty risks that investors place on your stock, how important do you think and how viable is it for you to even in these difficult markets start generating some cash to show actually on a net positive basis?

You indicated that a lot of your needed funding is in place. How feasible and how high a priority is it for you to basically show that you have the team and the assets in place that even in this type of environment you can be a positive cash generator?

Mark, I've said in my comments that we're very focused on cash flow and the balance sheet. The investments that we make in development will certainly be minimized only in those projects that will generate sales.

I also commented that on the top line when we look at sales regardless of what business segment it is in we're going to do everything that's required to make sure that from a cash perspective this business stays very healthy. In fact, we have to in order to be able to grow this business.

It's not just a - we don't look at Forestar in the economic condition and climate that we have today, from a survival perspective. This is a great growth opportunity and that's where our focus is. So in order to be able to grow we've certainly got to have a stable cash position.

I guess I'm a little bit - struggling a little bit with that. They seem to be somewhat at odds because if you grow, I would imagine that means spending money to generate that growth, which seems to be somewhat at odds with the concept of generating as a company overall showing the world that you are going to act - that you can be a positive free cash generator even in these types of environments. Can you just help me out, understanding that?

Yes. Mark, I think you've got it right. We agree with you. We've got to have positive cash flow and generate some cash in order to be able to make acquisitions and that's what we're very focused on.

Okay. Well, I guess essentially, how do you - when -- you're stock is obviously trading at levels that imply very low valuations on the assets that you already have. How does that figure into your thought process? Presumably, it's going to be pretty hard to find potential acquisitions, which on a risk adjusted basis would be more attractive than where your own stock is trading at this point.

Sure. I think that's a valid point Mark. I think if you look at an acquisition of an asset, a project, whatever, an entity, whatever it may be you've got to compare it to what the potential returns are and the value that would be created by buying back your own stock and that's the commitment we make to all of our shareholders is that for whatever we invest, it's going to be at the highest return.

Okay. Thank you.

Thank you, Mark.

We have no further questions in the queue. I'd like to turn the call over to Mr. Jim DeCosmo.

Thank you. Once again, we'd like to thank everybody for their time this morning and their interest in Forestar and we hope everybody has a wonderful day. Thank you.

Thank you for your participation in today's conference. This concludes our presentation. You may now disconnect.