Anna Torma - SVP, Corporate Affairs Phil Weber - CEO Chuck Jehl - Treasurer and CFO Michael Quinley - President, Community Group

Mark Weintraub - Buckingham Research Steve Chercover - D.A. Davidson

Good day ladies and gentlemen and welcome to the Second Quarter 2016 Forestar Group Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the call over to Anna Torma. Please go ahead Ma'am.

Thanks and good morning. I would like to welcome each of you who have joined us by conference call or webcast this morning to discuss an update on Forestar's previously announced key initiatives and second quarter 2016 results. I'm Anna Torma, Senior Vice President of Corporate Affairs. Joining me on the call today is Phil Weber, Chief Executive Officer; and Chuck Jehl, Chief Financial Officer. This call is being webcast, and copies of the earnings release and presentation slides are now available on the Investor Relations section of our website at forestargroup.com. Before we get started, let me remind you to please review the warning statements in our press release and our slides as we will make forward-looking statements during the presentation. Now, let me turn the call over to Phil to provide an update on our key initiatives.

Thank you, Anna. Good morning and thanks for joining us. I'll make a few remarks and then turn it over to Chuck for results on the quarter. We'll then open it up for questions. As reflected in our slide deck over the past 10 months, we've made significant progress towards transforming Forestar. Our new Board and Management have been and remain focused on maximizing shareholder value with a heavy focus on realizing the highest after-tax value from our diverse portfolio. Let me highlight some of the key results we've achieved. First, our core community development business sold 773 residential lots during the first half of this year. We remain on track for 1600 to 1800 lot sales for the year. Second, we generated 366 million in total pretax cash proceeds from the non-core asset sales since the end of the third quarter of last year. Third, we exited the working interest oil and gas business and eliminated future capital allocations to it through the sale of the Bakken and Kansas, Nebraska assets for approximately $81 million earlier this year. Four, we significantly reduced leverage and strengthened our balance sheet by retiring nearly all of our high yield debt and some convertible securities. Fifth, we sold five of our ten multifamily assets and are working with our partners to maximize the sale proceeds from the remaining three venture-owned assets and the two sites we own in Austin and the last highlight here we made significant progress on our process to monetize our remaining Timberland asset. Let me now shift the cost reduction, which is Slide 4 in your deck. As reflected in the slide, we have cut our SG&A significantly and have a new target annual run rate of $33 million. We expect to achieve this target run rate with the completion of previously announced non-core asset sales. You can also see here that $7 million included in the $33 million annual SG&A run rate projections is project level cost. So taking that out people and non-property operating expenses are projected to be down to $26 million. We worked very hard and accomplished a great deal in short period of time. We’re committed to further reducing expenses as we monetize additional non-core assets. And so the next obvious question is great, now what? I want to make two points on that question. First, we have an outstanding Board that its very talented, experienced, actively engaged and has worked very closely with the management team throughout this transformation. All of the obvious questions on what's next have been and are actively being considered by the Board. To be more specific the Board and management are very much aware of the idea of economies of scale in the community development businesses and the challenges faced by a small cap public real estate company to recognize value over the long run. The Board is actively discussing these issues and others and the best next step for Forestar. Second point here as I pointed out on a pervious call, realizing the highest value from assets often involves the process that is better served by speaking in past tense about accomplishments instead of making forward predictions on expected results. This applies to Forestar’s real estate and natural resources assets as well as securities repurchases. So, let me close by reiterating that the Board and management are very focused on continuing to generate value for our shareholders and we carefully factor in the time value of money in all of our decisions. We will continue to share our process with all the stakeholders in a rational fashion and we look forward to updating you appropriately as additional decisions are made. Now I’m going to turn it over to Chuck, who will highlight the second quarter 2016 results.

Thank you, Phil. I would also like to welcome everyone joining us this morning. I’ll provide a review of our second quarter 2016 financial and segment results. On Slide 5, in second quarter of 2016 we began reporting our non-core oil and gas working interest asset results as discontinued operation, as we have substantially exited as Phil said all these assets with the completion of a Bakken/Three Forks sale in the second quarter 2016. We will no longer allocate these results for our segment results or continuing operations. In addition, we changed the name of our oil and gas segment to Mineral Resources to reflect this change and will only include the results of our own mineral interest going forward. Net income from continuing operations was $11.7 million or $0.28 per share compared with net income of continuing operations of $2.5 million or $0.06 per share in the second quarter 2015. Loss from discontinued operations net of income taxes was $2 million in second quarter 2016 or $0.05 per share and $37 million loss in second quarter 2015 or $0.87 per share. So after discounted operations, Forestar reported GAAP net income of $9.6 million or $0.23 per share in the second quarter 2016 compared with a net loss of approximately $34.5 million or $0.81 per share in the second quarter 2015. Now let’s look at our overview of our segment results in the second quarter. Real estate earnings were $73.3 million in the second quarter, compared with $15.5 million in second quarter 2015. I will provide additional details on the real estate segment results in just a moment. Let's turn to Mineral Resources. Mineral Resources segment earnings were $900,000 compared to $1.8 million in second quarter 2015. The decrease in earnings is primarily due to lower oil and gas prices and production volumes related to our own minerals, but was partially offset by cost reductions offsetting -- and was offset by lower operating cost over the year. Other segment results were a loss of $200,000 in second 2016 compared with breakeven results in second of 2015. Fiber revenues have decreased due to the deferral of timber harvest activity as a result of our initiative to explore the opportunistic sale of our timberland and undeveloped land. Now let's turn to Slide 6, which will take a more detailed look at activity of our real estate segment. Second quarter again 2016 real estate segment earnings were $73.3 million compared to $15.5 million last year. Significant item for the quarter are as follows. We sold the Radisson Hotel and Suites in Austin for $130 million, which generated $95.3 million in gain. We sold our 11 multifamily community in Austin for $60.2 million, generating a gain of $9.1 million and we also sold Dillon, a multifamily site in Charlotte for $26 million generating $1.2 million in gain. In addition we sold 5,425 acres of undeveloped land for an average price of $2,360 per acre, generating $10.6 million in segment earnings. This consisted principally of acreage sold in Texas. Now, let me turn to our core community development business for the quarter. As Phil mentioned or the release mentioned, we sold 489 residential lots in the second quarter, which was in line with second quarter 2015 levels, but was up approximately 72% over first quarter 2016. Average lot price was $66,600 per lot and average lot gross profit was approximately $23,900 per lot. We also sold three commercial track acres for over $376,000 an acre and 10 residential track acres for $35,500 per acre. During the quarter, we completed the review of five previously identified non-core community development assets. Of these five assets, two are legacy Texas properties purchased in 2006 targeted at second home resort purchasers, the others not located in our core markets. We approved business plan changes in the quarter related to these projects and incurred $48.8 million in non-cash impairment charges. We plan to exit these assets over time reducing our annual carrying cost and generating tax losses to offset tax gain from other non-core asset sales. In the appendix we provided a slide to provide additional information on the five communities or assets in which we took the non-cash charges in the quarter. Let me turn to the last slide and provide an update on our capital structure and the progress in transforming the capital structure. We have significantly reduced our outstanding debt in annual interest expense burden over the past three quarters, which has strengthened our balance sheet and created financial flexibility. We've used non-core asset sale proceeds to reduce leverage and the second quarter 2016 alone reduced our outstanding debt by nearly $261 million and reducing annual interest expense going forward by approximately $19.7 million. These actions were taken through a cash tender offer related to our 8.5 senior secured notes, open market purchases of both our senior secured notes and convertible notes and paying in full project level debt. As a result of these actions and at end of the second quarter 2016, our total debt to total capital ratio was 18% compared to 46% at the end of the third quarter 2015 with nearly $320 million in available liquidity of which $107 million was in cash on the balance sheet. We'd like to now open -- that’s our prepared comments for the call. We would like to now open it up for questions at this point.

Thank you. [Operator Instructions] And our first question will come from Mark Weintraub of Buckingham Research. Your line is now open.

Thank you for all the details and one question, so you had as you indicated previously identified the five non-core community development projects where you changed strategy on. Is it correct to conclude that this process is now been thoroughly done and there are no other community development projects that you’d identify as non-core. Is this something that’s ongoing and then we could get new indications sooner rather than later?

Hi, Mark, it’s Chuck and I will start by answering. As we announced previously, I believe it was at year end certain projects that were non-core community development, our process one of our key initiatives to review the entire portfolio, I would tell you that’s an ongoing process. But I’ll also tell you that two of these assets that I mentioned in my remarks were Texas Coast legacy Texas Coast property purchased over 10 years ago, two properties undeveloped North of Denver I think they are 30 to 40 miles North of Denver that are in our core MSAs that we develop in. And then an additional legacy project that we have in Bastrop Texas. So the point is, it’s a continual process that we do review and returns and what’s the best use of the investment and capital allocation, but our current intentions are obviously to develop our remaining projects and continue forward with those. So that’s my comment there on the question.

So is it fair to think of it that essentially you cleaned up the portfolio with these actions and showed the world can change from how you expect it to be but that you’ve essentially cleaned up the portfolio relative to the world as you see it today?

Yes, based on our current intention, yes. We've planned to develop the remaining projects out and the other thing I will tell you that is these projects, we considered not only the development dollars going in or whether we would develop this out. We also considered with the non-core asset sales and as we look at tax savings and tax consideration, these projects were older legacy assets with high tax basis and the decision was made that exiting these now in offsetting tax gains from other assets was a good strategy for the company. So we considered not only the future development of these, but also current cash needs and allocations and tax savings.

Makes a lot of sense and I guess what I am trying to get at and I realize this may not be a question that you can or would want to answer but, whether or not you’ve now pretty much gone through the portfolio identified the assets that would likely have meaningful write-down and they're now out of the portfolio or whether or not that is not a conclusion one can jump to that would be premature to conclude that?

I think significant impairments for the second quarter and based on our intentions to not develop these and change the business plan, I would say that we believe in our remaining 50 so odd projects in community development that our community development plans there to continue develop those out and realize value for shareholders.

Yeah, Mark this is Phil, I would add to that. It’s an ongoing process. We’re constantly reviewing our portfolio and at the present time it's our present intention to continue to develop all of the communities in our community development portfolio and take the action we’ve already talked about on the multi-family assets that we've got.

Okay. Thanks very much. Thanks Mark.

Thank you. [Operator Instructions] And our next question will come from Steve Chercover from D.A. Davidson. Your line is now open.

Thank you and good morning, everyone. So I haven’t had the opportunity to do this very well, but if we were to back out the asset sales like Radisson and Eleven and Dillon, what would the sustainable contribution from residential lots be? Should we look at that as like $73 million in earnings, less the $106 million in assets sales and add back the $48 million impairments, would that be the way to think of it going forward?

Yeah. Steve I think that’s the math. Yeah, you can definitely do that. And I think as we in the release and then as we file our Q next week, there will be more transparency into that and we lay out very well the gains and in the returns on each of those assets. So I think you can get to that number.

Okay. And then my second question was on the timberland that are being marketed. Can you characterize them with a typical southern plantations that were established by a timber company but operated for a decade by real estate company and what are the stocking levels that I guess first of all should we think of them as southern plantations?

Steve are you talking about what we sold in the quarter or what we're marketing for sales with LandVest that we previously announced?

Yeah. The $70,000 that’s being marketed by LandVest?

I am going to -- this is Phil. I am going to let Michael Quinley is here and he has been managing that process for us. So I am going to let him respond to that.

These are primarily timberland projects. They do have some of our portfolio as what we call the higher best used categories where they have certain categories for strategic enhancements like road improvements or they're in areas that have some type of maybe a Farm and RET program. We call those the Timber Plus, but these are just traditional timberland properties, which we've now decided to identify as take those as non-core and take those and monetize those for the shareholders.

But even in the south, we got two kind of timberlands, the ones that have been established effectively like a raw crop and then the other that are I guess more wild and haven’t been cultivated, so….

No these are really timber investments that we have improved as far as -- they're not just wild, they were SFI certified. We have different types of management practices. We do spanning throughout as Chuck mentioned earlier that we have delayed those as a result to not take chamber off of property that will be ending up selling.

So the stocking levels would be pretty good?

Yeah the stocking levels are pretty good and this is not something that we -- we're not clear cut, we're not in there. These are -- we have really good interest on these properties and it’s a valuable commodity. There is timber on the property on the property. We didn’t clear cut all this property 10 years ago but now we're looking at just out.

Yeah, Steve this Phil. We are in the middle of the process and as I said in my remarks, we're very pleased with the progress we've made and we feel very good about how this is progressing.

Yeah. Thank you, I appreciate that. And I wasn’t trying to -- I think it's great that you're not negotiating on the phone in public, that’s why I just wanted to get a characterization of how they were as opposed to you we’ve got a view on values. Okay. Thank you.

Thank you, Steve.

Thank you. And we have a follow-up question from Mark Weintraub from Buckingham Research. Your line is now open.

Thank you. Just coming back to the real estate lot sales and I think in the second quarter just ended the gross profit per lot was about 24,000 and I know -- I think it's like 25,000, 26,000 in the first quarter as well. Last year is a little bit north of that more in the 30s. I am just trying to get a sense to whether or not that’s primarily a function of mix whether it’s a function of particularly the Texas market having softened a little bit, how would you characterize this year versus what we were seeing last year?

Mark thank you, this is Phil. It’s a combination of mix. The other thing that and Michael Quinley can add more to this, but the other point I would make is if you compare it to last year you have to also compare last year to the previous year. The last year was exceptionally high and this year our margins are solid. It’s just they're not as high as last year partly due to mix, but also because last year was significantly higher than previous year and that was also a function of mix also.

Yeah. Mark if you look at the lot margins in 2015, they were higher due to multiple projects that had higher prices -- lot prices which produced higher margin. These projects were either sold out of those or we haven’t produced any lots that if sold thus far in 2016. We've had some properties that have some additional cost increases that have impacted margins, but if you look at the margins that we were producing in '16, they were really representative to kind of a normal margin. If you go back to what Phil was saying, if you look since 2016, our average margins on the lot sold is about $20,500 and our average lot sales price is about $55,000. So if you take those kind of percentages and then look at the $66,600 that Chuck about, we are hitting pretty much right on target.

Okay. That’s helpful and how would you characterize the market today? Is it -- has it softened a little bit or is it -- is it how would you characterize it?

Most of our markets, we continue to see to be fairly steady. The activity for those entry levels projects, they're just crazy aggressive. If you look at markets that are kind of slowing, you could say the Huston in our portfolio our Huston mix is only slowing in those really Northern and kind of for North markets in West and it’s on those products that are priced over $400,000. In our markets we're seeing our builder continue to do the takedowns without any kind of delay. However marked on the newer opportunities specifically those targeting kind of a second move up buyer, we're seeing a little change in negotiating terms, whereby the builder is requesting more of a lot option contract as opposed to guys that would previous buy in full. And as I said on that entry level product, in first move-up product it's becoming very, very aggressive, the builders are and so what we're seeing is just a very solid and steady market for us.

Great, and would you characterize your lots as more geared to that first move-up and entry level or how would you characterize the lots you have?

Mark it's a real mix, it’s a real mix and the great thing that we've got is we got market diversity in the different states that we operate in and we have different price points and different product mix. So it's very mixed portfolio.

Great, thank you for the color.

Thank you, Mark.

Thank you. [Operator Instructions]

No other questions. Great, thank you very much. Enjoy the rest of your summer. Have a great day. Good bye.

Ladies and gentlemen thank you for your participation in today's conference. This does conclude the program. And you may now disconnect. Everyone have a great day.