Chuck Jehl - Treasurer and CFO Phil Weber - CEO Michael Quinley - President, Community Group

Mark Weintraub - Buckingham Research Chris Reynolds - Neuberger Berman John Dasher - Pinnacle

Good day, ladies and gentlemen and welcome to the Third Quarter 2016 Forestar Group Earnings Conference Call. At this time all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. I would like to introduce your host for today's conference Mr. Chuck Jehl. Sir, please go ahead.

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 key initiatives and third quarter 2016 results. I'm Chuck Jehl, Chief Financial Officer Forestar, joining me on the call today is Phil Weber, our Chief Executive Officer and Michael Finley, President of Community Development. This call is being webcast and copies of the earnings release and presentation slides are now available on the Investor Relations section of our Web site at forestagroup.com. Before we get started let me remain 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.

Good morning. Thank you for joining us today. November 4 of last year, just over a year ago was my first earnings call as CEO and also was Chuck's first as our new CFO. We laid out four key initiatives for the company to move forward. The first to reduce cost to match our size company and real estate focus; second to review our entire portfolio of assets and we made the point there were likely better owners of many of our non-core assets; third to review our capture structure with the goal of matching our leverage and liquidity targets to our core community development business; and fourth to review providing additional information on our non-core assets. One year later is reflected on Slide 3, our transformative results speak for themselves. Let me highlight a few key accomplishments, on Slide 3. We've taken to action to reduce SG&A by over $50 million and reduce headcount by over 50%. We've sold almost $425 million in non-core assets, reduced debt by approximately $320 million, significantly reduced leverage and now have a debt-to-cap of 18% versus 46% and we eliminated $23 million in annual interest expenses. We also provided additional information in our disclosures and discontinued entitlement activities on eight Georgia projects totaling 20,000 acres and determined 12 Georgia entitled assets would not be developed. In addition to the past accomplishments I just went through that are listed on Page 3, we are also making additional significant progress. I want to highlight a few key areas from Slide 4, which shows our core and remaining non-core assets at the end of Q3 2016. First, in addition to selling five multifamily communities, we have completed construction on all three remaining multifamily venture deals. They are all in lease-up and we expect to begin working with our partners to bring these communities to market for sales as we get closer to stabilization. Acklen is Nashville is 83% occupied, 85% leased, HiLine near Denver is 76% occupied and 79% leased and finally Elan in Houston is 52% occupied, 57% leased. Our remaining two multifamily sites in Austin are under contract and are in diligence. Second, we have completed the second round of our Timberland sales process and have reached agreements to sell over 58,000 acres of our Georgia and Alabama Timberland for an average price of nearly $1,800 per acre. We are expecting these deals to close by year end. We are separately negotiating the sale of the remaining 12,000 acres and mitigation banking credits in Georgia and the remaining roughly 4,000 acres we own in Texas. We are very pleased with the interest revel in these remaining acres and mitigation assets. Third, we have several non-core community development assets under contract and have provided an update on the status of these assets on Slide 13 in the appendix. These transactions will provide valuable tax offsets to the Radisson Hotel sale and other low basis non-core asset sales such as our Timberland to minimize taxes paid. Last example, here I want to mention you will also note on Slide 4, that we are under contract to sell are Central Texas, water assets. So, you can see a potential path by year-end 2016 for Forestar and a little over one year to have almost completely exited or have under contract to sell almost all of its none-core businesses, the hotel, oil and gas working interests, timberland, water leases and non-core community development assets. The remaining non-core assets are mostly owned mineral sets and either water royalty interest or own water rights are either cash flow positive or cost almost nothing to hold. And as with other non-core assets we have an active dialogue going on with some potential buyers of these assets. If we can get the right price we are open to selling. We also have a very valuable core community development business that is producing much needed finished lots in several of the top home building markets in the country. We have over 55 active real estate developments in 11 states and 15 markets and have developed lots for over 35 national, regional and local home builders in 2016. Builder demand for residential lots in our key communities remain steady. The last point I want to make this morning before turning it over Chuck, similar to the point we made on last quarter's call, we fully understand that all these results are good, but you want to know what is next? I want to close by reinforcing our Chairman, Jim Rubright's statement in our release, we remain focused on maximizing shareholder value including evaluating the next best step for Forestar. So thanks again for being with us this morning, and with that I will turn it over to Chuck.

Thank you, Phil. I would like to move to Slide 5 and discuss our financial results. As a reminder in the second quarter of 2016, we began reporting our non-core oil and gas working interest result as discontinued operations, which at third quarter end 2016, we have divested substantially all of these properties. Let me turn to the results. Net income from continuing operations was $16.8 million, or $0.40 per share compared with a net loss from continuing operations of $57.3 million or $1.67 per share in third quarter 2015. Loss from discontinued operations net of taxes was $7.2 million in third quarter 2016 or $0.17 per share loss and $106.9 million in third quarter 2015 or $3.12 loss per share. So, after discontinued operations, Forestar reported net income of $9.7 million or $0.23 per share in third quarter 2016 compared with a net loss of approximately $164.2 million or $4.79 loss per share in third quarter 2015. Now, let's look at our overview of segment results for third quarter 2016. Real estate segment earnings were $15 million in third quarter 2016 compared to $5.2 million in third quarter 2005. I will provide additional details on the real estate segment results in a moment. Now, let me turn to mineral resources. Mineral resources segment earnings were $1.2 million compared with approximately $100,000 in net income in third quarter 2015. Mineral resources earnings increased in third quarter 2016 compared with third quarter 2015 principally do you to a non-cash impairment charge of $1.8 million in 2015 related to non-operated wells on our own mineral interests. In addition, in third quarter 2016, royalty revenues declined due to both lower oil and gas production and prices. Other segment results were a loss of $200,000 in the quarter of -- third quarter 2016, compared to a loss of $100,000 in third quarter 2015. Fiber revenues have decreased due to deferral of timber harvest activity as a result of our initiative to sell our timberland undeveloped land. Now, let's turn to our real estate activity in more detail. Third quarter real estate segment results as I mentioned were $15 million compared to $5.2 million third quarter 2016. Significant items for the quarter as follows. We sold 332 residential lots in third quarter 2016 which was in line with third quarter 2015 levels. Average lot prices were nearly $70,000 per lot and average lot gross profit was approximately$26,100 per lot. We also sold 110 commercial track acres for $76,200 per acre and 243 residential track acres for $26,800 per acre. I would like to make a note on the commercial acre sold 108 acres were from San Joaquin river project in Antioch, California that was sold for $7 million. This sale generated over $37 million in tax losses to offset tax gains in 2016, minimizing income taxes paid as we divest non-core assets and transform our company. In additional, in the quarter we sold approximately 6500 acres of undeveloped land for an average price of $2410 per acre. This generated approximately $12.8 million in earnings and consisted principally of acreage sold in Texas. We recorded $7.6 million in non-cash impairments in third quarter 2016 primarily associated with a multifamily site in Austin, Texas, which is under contract to be sold and two non-core community development projects which are also under contract to be sold. As Phil mentioned, on Slide 13 and the appendix provides an update of our non-core community development assets. We plan to exit these assets -- the non-core assets in the near-term as you can see a majority of which are under contract to be sold or in the case of Antioch a portion has closed in the third quarter. These combined sales will generate approximately $110 million in tax losses to offset tax gains from other non-core asset sales and will reduce annual operating costs by approximately $2.6 million. Now, let me turn to our final slide and make a few comments on our core community development business. We sold 1,105 residential lots in the first nine months of 2016 and continue to project 2016 lot sales in the 1600 to 1800 range from our core asset. At the end of Q3, we have over 2,080 lots, finished vacant developed lots and lots under development under contract with builders. This represents over 70% of our available and total finished and lots under development inventory. This is the highest number of lot under option contract in over five years. We also have over 10,000 remaining lots located in our key markets where we are already selling to current homebuilders and the lots are located in some of the strongest housing market. As Phil mentioned builder demand for our residential lots remain steady. Thank you for joining us this morning. Your interest in Forestar. Those are our prepared comments and we would now like to open the call up for a few questions.

Thank you. [Operator Instructions] Our first question comes from the line of Mark Weintraub with Buckingham Research. Your line is open. Please go ahead.

Good morning. Obviously, tremendous amount going on. So, I will try to ask some of the questions hopefully, they are relevant and reasonable ones. First off, on the non-core community development project update that you highlighted that the sales could trigger up to $110 million in tax losses to offset tax gains from the other sales? Can you share with us order of magnitude, what the proceeds from those sales might amount to.

Yes. Hello, Mark. Good morning. This is Chuck. We are working -- Antioch was already sold as I mentioned and it was sold for $7 million for 108 acres of that project. And that generated as I mentioned about $37.4 million roughly in tax losses. The remainder of the assets are on Slide 13. They are under contract and we are continuing to get those to closing and the team is working very hard. We prefer not to discuss the prices on those as we continue to move those closer to closing. So, there will be more announced on that as we get those transactions closed.

Okay. Fair enough. On the $37.4 million tax loss, now there wasn't a book loss associated with that, if not, not to that magnitude. Can you just help explain where you would have a tax loss that was very different than the book loss and is that also the case potentially from the other non-core community development projects that were going to trigger up to $110 million of tax loses?

Right. Mark, it's a good question. On Antioch that's a legacy asset that we spun out with from Temple Inland that was a former mill site of Temple Inland. The reason that one as such significant tax loss over book and I will tell you we did not have a book loss on that. The $7 million, it was basically very close to breakeven for book, so there is no GAAP loss. The tax loss was many years of remediation environmental costs that were incurred not only by Forestar but also Temple Inland carried over it's spin offs. So, this has been a legacy asset with very high tax bases and as we have looked and as we have gone through our initiative to review every asset in the portfolio, we saw this as an opportunity to monetize now with some of the divestments on our other high gain assets. So it was an opportunity for us to shelter and offset. As it relates to the other community development assets and I think I talked about this on prior calls. Under the IRS rules, you capitalize certain costs for tax that you expense for book and on certain of these communities, we have got higher built in loss tax basis than book and as we have evaluated the assets to exit with cash tax consideration and business plan changes that has driven our decision to exit these non-core assets.

So, would it be fair to say that while there may be book losses related to the remaining non-core community development projects being sold, they would be substantially less in all likelihood than the tax loss benefits that you identified?

Mark, if you recall in the second quarter, we provided an update, we incurred year-to-date non-cash impairment including non-core community development and the multifamily assets we plan to exit about $57 million in non-cash impairments on the book side, GAAP side. So, with the transactions of these that are under contract to be closed, I don't anticipate any material additional non-cash impairments on the books.

Okay. That's very helpful. And I have other questions, but if there are folks in queue, I'm happy to circle back around. So, whatever is -- that's from perspective.

Thanks. Go ahead, Mark.

Just on the timberland side, so you basically -- I'm sorry you had said that how much acre, was it 58,000 or something was under contract?

Well, Mark, I will let Phil and Michael jump in as well. But, we reached an agreement and are moving towards and putting those under contracts, over $58,000. Of the roughly 70,000 that we mentioned that in the east that we are planning to sell and have been marketing.

Okay. And now you did also have some acreage in California that historical was kind of in that grouping. What's the status of the California acreage?

Mark, so that is not -- in California what you are thinking of the entitlement process acres which we -- I think the quarter had about 440,038 acres in that category. That is excluded from the timberland sales. That's the 700 acres you are talking about is our Hidden Creek entitlement project in Los Angeles county.

Right. So that doesn't include any of that so that 70,000 doesn't include any of the entitlement and process. Okay, good.

No, sir.

Okay. And is there any color that you would be comfortable providing an understanding the 12,000 remaining versus the 58,000 that are -- where agreement has been -- is in process?

Yes. Michael Quinley has been managing this, so why don't you talk about what we are doing there.

Mark, good morning. We are in conversations. And we are marketing it as part of the whole package that we started marketing earlier this year, when we released it. We had identified it is non-core, we continued to work through opportunities and we are happy with the activity. It's been very steady. And we are hopeful that we will have something to announce on this transaction soon.

Yes. I would just add to that. On several of those parcels in the 12,000 acres there is mitigation, banking credits and so in someway that's a different set of buyers that are interested in buying timberland that also has mitigation credit. And there are some timberland owners that aren't interested in owning mitigation credits. So it's a different set of buyers for those assets, is part of why we pulled them out of the package.

Okay. So the -- having the mitigation credit, you have been -- so you've been paid for those mitigation credits already or is there certain things that can and cannot be done on those lands or there is value yet to be received for those mitigation credits?

We have sold some credits already. We will sell additional credit with the sale of surface, in some cases and we also have some additional mitigation credits and so it's a combination of both.

Okay. That's good for now. Thanks so much.

Thanks Mark.

Thank you. And our next question comes from the line of Chris Reynolds with Neuberger Berman. Your line is open. Please go ahead.

Good morning, gentlemen. I have a couple of questions. Can you provide commentary about your -- how your balance sheet will look after the divestitures, which you have outlined that you expect to close at the end of the year. For intensive purposes debt free right now and you have one convertible issue outstanding. But, I just want to understand what the priorities for use of the cash will be and also the impact of capital gains on subsequent divestitures, it sounds like you will be able to offset most of the gains. Can you confirm that?

Hi, Chris. This is Chuck. Yes, as it relates to the balance sheet, we don't usually give guidance on the projections. But, as we have got the non-core assets that are in the slides that we are working to close. And we exited the quarter with about $122 million in cash on the balance sheet at Q3 end. And as you mentioned the converts are outstanding. That on a net cash basis net of that debt we were on a consolidated basis about $10 million net cash for the quarter. So, as Phil's opening comments we've really strengthened the balance sheet and over the last year and paid down the high interest 8.5% coupon debt and continued to evaluate all options as we execute these non-core asset sales and as we move forward. So, everything is kind of on the table to be reviewed as we execute and we get these remaining assets to vote. So, and your other question was on the tax losses on the shelter? We are projecting and you can see in our tax provision when the Qs fall, which I believe fell last night. Our effective tax rate for year-to-date nine months of 2016 was an 18% tax rate. We had a nice benefit in the third quarter due to the initiatives and the assets we are selling. So we believe with the decisions we are making to divest these certain high basis non-core assets as well as legislation that's available on the timberland sale for [indiscernible] saving. We believe that we have an opportunity to shelter and minimize a lot of taxes. So, we are working very hard to minimize taxes paid.

Okay. And I have a follow-up on the balance sheet. The goodwill and other intangible assets of roughly $43 million, were those assets -- will that that entry be affected by any subsequent divestitures?

That's a good question. The $43 million is made up of -- $38 million is related to our mineral assets -- enterprise value the minerals. And then, we have got the remaining portion call it $4 million, $5 million that's related to goodwill and intangibles on our water assets. So, as we on a book perspective, as we monetize and evaluate those non-core assets over time that would obviously be allocated to the GAAP side or the book side. Goodwill for taxes disallowed, so there is no tax basis. So, again, that's a -- yes.

Okay. And I have one final question. And I apologize if you covered this. But, the investment in Cibolo Canyons where the J.W. Marriott is located. Do you have an investment basis in that currently? Or is that part of an asset that you are looking to dispose of?

Yes. This is our investment in the 10-Q, back in the MDA (sic) MD&A, we have a write-up on Cibolo and there is two components of Cibolo Canyons. There is the master plan community as well as the resort hotel spa and golf development, which we don't have ownership in. Our net investment in Cibolo Canyons at third quarter end is about $55 million divested in that project. And we have -- Cibolo is a great project for the company and we have 1830 residential lots which we have sold I guess about 1,100 to-date. So we have got 700 plus lots ahead of us there in that master plan community and a bit of commercial acre. So that is a core asset that we have in the portfolio.

Okay. Thank you so much.

You bet.

Thank you. And our next question is a follow-up question from Mark Weintraub with Buckingham Research. Your line is open. Please go ahead.

Thank you. And just finally, obviously with Cibolo that the lots are part of the core asset and how do you think of the rent agreement for lack of a better terminology with the resort itself?

Yes, Mark. Talking about the hotel occupancy?

Yes.

The other 9%. So that something as you recall in 2014, the district Cibolo Canyons, special improvement district monetized and we received a little over $46 million in proceeds. We are the beneficiary of the residual of that over the debt service that's paid. So, it's a nice revenue stream for us and but we are always looking at opportunities to -- if there is a better holder of that revenue stream. But, it's a nice revenue stream for the company today and we get the residual through 2030, 2040 on that after debts.

Okay. And then on the multifamily side on Page 4. You listed the five sites, two under contract, the ones that aren't Acklen, HiLine, Elan, how long have they -- since when they have been completed, can you give us a sense as to where you are in those projects and how feasible is it to be getting closer to 95% type leasing situations. Maybe a little bit more color just on the health of those projects.

Mark, I just want to make sure, you are asking where are we on Acklen, HiLine and Elan, or are you asking about the sites in Austin?

On these three, you tell us where you are, you're 80% occupied and 85% leased in Acklen. Are we still kind of in a building phase where that would be expected to increase meaningfully over the next three to six months or kind of just the sense as to -- in particular with the Elan, how long is it been in process that you have been, where is that likely to be going? Is that going to be all likelihood of 90%, 95% leased within the next six months or kind of where are we in those projects.

So, we were at [indiscernible] occupancy on all of these roughly August, September of this year. And so Acklen and HiLine, I would talk about those kind of in the same light as you look at where they are occupied and leased, they are leasing up. This occupancy is getting closer to 90%. And we are planning with our partners would be to probably bring those to markets as we get closer to the 90% occupancy for 90 days which is eligibility for agency financing. Elan in Houston because there is quite a bit of additional supply in the sub- market we are in, is probably going to take us longer to lease that up and get that to stabilization. So, I would see us getting near stabilization on Acklen by year end. I would see us getting to stabilization on HiLine in the first quarter. And I would see Houston pushing out probably to possibly end of the second quarter or would be even third quarter before we get to stabilization.

Great. Exactly what I was trying to get. Thanks so much.

And I would add to that. I mean we have the option of doing a presale on these assets. We believe they are great properties and sought after communities. And I think our view is, it's in the best interest for us to continue to work towards stabilizing them and selling them. We get increase from people who want to know, where we have been selling them now? And there is a chance we could accelerate selling one or two of these -- if we chose to do that. These are really good assets, we are very pleased with how they are leasing up. The Houston one is a little more challenged as you would expect. And we will be very strategic about how we exit them.

Thank you.

Thank you. And our next question comes from the line of John Dasher with Pinnacle. Your line is open. Please go ahead.

Hi. We are a fairly new shareholder and we had a question about the 6% tangible equity units, which I guess were issued about three years or so ago. Reading the disclosure in the 10-K, it looks like on or around December 15, you are going to issue between 6.5 million and 7.9 million new shares. Is that correct? Am I reading this correctly?

Hi, John. Yes, you are. And the debt portion of that security will pay the final amortizing note payment and interest in December and then also for the contract -- stock contract settlement will issue between that range of shares and that's still a good range. And I will point out in our diluted EPS based on where the current stock is trading. It would be closer to the 7.8 million shares.

Okay. So closer to where the stock is currently trading, it would be closer to the 7.8.

That's right.

What would make it --

And that is what -- a stock price below $19.09 roughly is where that would be.

Okay. So and does that occur immediately on December 15, 2016 or what's the timing exactly of those new shares being issues?

Yes, sir. It will be right around December 15, 16, it's the time.

Okay. And you're going to pay-off the remaining balance of the note, which I think was about $2.2 million.

Yes. It was $2.2 million at the end of third quarter. That obviously will be paid off.

Okay. So this whole entity or issue will be put to bed December 15.

Yes, sir.

Okay. Great. Thanks very much.

Thank you. And that is the end of our Q&A session for today. And I would like to turn the conference back over to Chief Financial Officer, Chuck Jehl for any closing remarks.

Okay. Thank you for your interest in Forestar. And I would appreciate you calling in and thanks for the questions. Have a great day.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a great day.