Forestar Group - 10-Q quarterly report FY

 

 

(Exact Name of Registrant as Specified in Its Charter)

     Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

          Yes þ     No o

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

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     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

 

Please read the notes to the consolidated financial statements.

Please read the notes to the consolidated financial statements.

Please read the notes to the consolidated financial statements.

     Prior to December 28, 2007, we were a wholly-owned subsidiary of Temple-Inland Inc. On December 28, 2007, Temple-Inland distributed all our issued and outstanding shares of common stock to its stockholders, and at the same time distributed to its stockholders all the issued and outstanding shares of common stock of Guaranty Financial Group, Inc., another wholly-owned subsidiary of Temple-Inland that operated its financial services business. As a result of the spin-off, our financial statements prior to 2008 reflect the historical accounts of the real estate development, minerals and fiber operations contributed to us and have been derived from the historical financial statements and accounts of Temple-Inland. In 2008, we changed our fiscal year from a 52/53 week year ending the Saturday closest to December 31 to a calendar year.

     Our consolidated financial statements include all subsidiaries, ventures and other entities in which we have a controlling interest, and variable interest entities of which we are the primary beneficiary. We eliminate all significant intercompany accounts and transactions. Minority interest in consolidated entities is recognized before income taxes. We account for our investment in other entities in which we have significant influence over operations and financial policies using the equity method (we recognize our share of the entities’ income or loss and any preferential returns and treat distributions as a reduction of our investment). We account for our investment in other entities in which we do not have significant influence over operations and financial policies using the cost method (we recognize as income distribution of accumulated earnings).

     We prepared our unaudited interim financial statements in accordance with U.S. generally accepted accounting principles and Securities and Exchange Commission requirements for interim financial statements. As a result, they do not include all the information and disclosures required for complete financial statements. However, in our opinion, all adjustments considered necessary for a fair presentation have been included. Such adjustments consist only of normal recurring items unless otherwise noted. We make estimates and assumptions about future events. Actual results can, and probably will, differ from those we currently estimate including those related to allocating costs to real estate and measuring assets for impairment. These interim operating results are not necessarily indicative of the results that may be expected for the entire year. For further information, please read the financial statements included in our 2007 Annual Report on Form 10-K.

     Certain prior year items have been reclassified to conform to the current year’s presentation, including reclassification of cost of sales of $1,516,000 and general and administrative expenses of $1,048,000 to other operating expenses.

     In January 2008, two new accounting pronouncements were effective:

     In addition, there are three new accounting pronouncements that we will be required to adopt in first quarter 2009. Based on our current understanding, we do not expect that adoption of any of these pronouncements will have a significant effect on our earnings or financial position.

     Real estate consists of:

     Included in entitled, developed and under development land are the estimated costs of assets we expect to convey to utility or improvement districts of $63,542,000 at third quarter-end 2008 and $40,843,000 at year-end 2007, including $40,305,000 at third quarter-end 2008 and $25,516,000 at year-end 2007 related to our Cibolo Canyons mixed-use project near San Antonio, Texas. These costs relate to water, sewer and other infrastructure assets for which the utility or improvement districts have agreed to reimburse us, typically when these districts achieve adequate ad valorem tax base to support payment. We billed these districts $18,058,000 in first nine months 2008 and $27,282,000 in first nine months 2007, and we collected $374,000 in first nine months 2008 and $4,332,000 in first nine months 2007.

     Depreciation expense, primarily related to commercial operating properties, was $1,303,000 in first nine months 2008 and $1,493,000 in first nine months 2007 and is included in other operating expense.

     At third quarter-end 2008, we had ownership interests ranging from 25 to 50 percent in 15 ventures that we account for using the equity method. We have no real estate ventures that are accounted for using the cost method. Our three largest ventures are CL Realty, Temco and Palisades West. We own a 50 percent interest in both CL Realty and Temco and Cousins Real Estate Corporation owns the other 50 percent interest. We own a 25 percent interest in Palisades West, Cousins Properties Incorporated owns a 50 percent interest and Dimensional Fund Advisors LP owns the remaining 25 percent interest. Information regarding these ventures follows:

Combined summarized balance sheet information for our ventures accounted for using the equity method follows:

Combined summarized income statement information for our ventures accounted for using the equity method follows:

     In first nine months 2008, we invested $14,962,000 in these ventures and received $7,051,000 in distributions. In first nine months 2007, we invested $10,932,000 in these ventures and received $5,293,000 in distributions. Distributions include both return of investments and distributions of earnings.

     Debt consists of:

          Our senior credit facility and other debt agreements contain terms, conditions and financial covenants customary for such agreements including minimum levels of interest coverage and limitations on leverage. At third quarter-end 2008, we had complied with the terms, conditions and financial covenants of these agreements.

     Our senior credit facility provides for a $175,000,000 term loan and a $290,000,000 revolving line of credit. At our option, we can borrow at LIBOR plus 4 percent or Prime plus 2 percent. We may, upon notice to the lenders, request an increase in the credit facility to provide for a total of $500,000,000. The revolving line of credit includes a $100,000,000 sublimit available for letters of credit, of which $24,548,000 was outstanding at third quarter-end 2008. Total borrowings under our senior credit facility (including the face amount of letters of credit) may not exceed a borrowing base formula, and there is a $35,000,000 minimum liquidity requirement at each quarter-end. At third quarter-end 2008, we had $187,452,000 in net unused borrowing capacity under our senior credit facility.

     All borrowings under the senior credit facility are secured by (a) a pledge of approximately 250,000 acres of undeveloped land, (b) assignments of current and future leases, rents and contracts, including our mineral leases, (c) a security interest in our primary operating account, (d) pledge of the equity interests in current and future material operating subsidiaries or joint venture interests, or if such pledge is not permitted, a pledge of the right to distributions from such entities, and (e) negative pledge (without a mortgage) on all other wholly-owned assets. The senior credit facility provides for releases of real estate provided that borrowing base compliance is maintained.

     At third quarter-end 2008, unamortized fees related to our senior credit facility were $7,817,000 and are included in other assets. Amortization of these fees was $2,622,000 for first nine months 2008 and is included in interest expense.

     At third quarter-end 2008, commercial operating properties with a book value of $21,333,000 were subject to liens in connection with $15,994,000 of debt. On October 1, 2008, we refinanced this debt through 2010 with interest payable at LIBOR plus 2.5 percent or Prime, at our option. At third quarter-end 2008, entitled, developed and under development land having a book value of $155,052,000 was subject to liens in connection with $80,592,000 of principally non-recourse debt.

     We periodically use interest rate agreements in the normal course of business to mitigate the risk inherent in interest rate fluctuations by entering into contracts with major U.S. securities firms.

     In first quarter 2008, we entered into a $100,000,000 notional amount interest rate swap agreement that matures in 2010. The swap agreement was designed to offset the cash flow variability of interest rate payments associated with the first $100,000,000 of our variable-rate borrowings. Under this swap agreement, we pay a fixed interest rate of 6.57 percent and receive a floating interest rate of one month LIBOR plus 4 percent (6.49 percent at third quarter-end 2008).

     At third quarter-end 2008, the fair value of the interest rate swap agreement was an $872,000 asset that is included in other assets. In third quarter 2008 the fair value of our interest rate swap agreement decreased and as a result we recognized an after-tax loss of $201,000 that is included in accumulated other comprehensive income. The fair value of the interest rate swap agreement was determined using quoted prices in active markets for identical assets (Level 1) under SFAS No. 157.

     The effectiveness of the hedge relationship is periodically assessed by comparing the present value of the cumulative change in the expected future cash flows on the variable leg of the swap and the present value of the cumulative change in the expected future hedged cash flows. In first nine months 2008, hedge ineffectiveness was not significant.

     We are involved in various legal proceedings that arise from time to time in the ordinary course of doing business and believe that adequate reserves have been established for any probable losses. We do not believe that the outcome of any of these proceedings should have a significant adverse effect on our financial position, long-term results of operations or cash flows. It is possible, however, that charges related to these matters could be significant to our results or cash flows in any one accounting period.

     Environmental remediation liabilities arise from time to time in the ordinary course of doing business and we believe we have established adequate reserves for any probable losses. We own 288 acres near Antioch, California, portions of which were sites of a Temple-Inland paper manufacturing operation that are in remediation. In second quarter 2008, we increased our reserves for environmental remediation by about $2,900,000. We estimate the cost we will likely incur to complete remediation activities will be about $5,600,000, which is included in other accrued expenses and will likely be paid in 2008 and 2009.

     Pursuant to our shareholder rights plan, each share of common stock outstanding is coupled with one-quarter of a preferred stock purchase right (Right). Each Right entitles our shareholders to purchase, under certain conditions, one one-hundredth of a share of newly issued Series A Junior Participating Preferred Stock at an exercise price of $100. Rights will be exercisable only if someone acquires beneficial ownership of 20 percent or more of our common shares or commences a tender or exchange offer, upon consummation of which they would beneficially own 20 percent or more of our common shares. We will generally be entitled to redeem the Rights at $0.001 per Right at any time until the 10^th business day following public announcement that a 20 percent position has been acquired. The Rights will expire on December 11, 2017.

     Please read Note 13 for information about additional shares of common stock that could be issued under terms of our share-based compensation plans.

     As a result of our spin-off from Temple-Inland, all of Temple-Inland’s outstanding share-based compensation awards were equitably adjusted into separate awards: one related to our common stock, one related to Temple-Inland common stock and one related to Guaranty common stock. All awards issued as part of this adjustment are subject to their original vesting schedules.

     At third quarter-end 2008, Temple-Inland and Guaranty directors and employees held 28,000 equity-settled restricted stock awards on our stock.

     The following table summarizes outstanding stock option awards on our stock held by Temple-Inland and Guaranty directors and employees at third quarter-end 2008:

     Other comprehensive income consists of:

     Our basic and diluted weighted average common shares outstanding are as follows:

     For third quarter and first nine months 2007, we computed basic and diluted net income per share based upon the number of shares of our common stock distributed by Temple-Inland on December 28, 2007.

     At third quarter-end 2008, the effect of 1,645,000 stock options and unvested shares of restricted stock were not included in the computation of diluted weighted average shares outstanding because their impact would have been anti-dilutive.

     In first quarter 2008, we changed our reportable segments to reflect our post-spin management of the operations transferred to us from Temple-Inland. All prior period segment information has been reclassified to conform to the current presentation. We manage our operations through three segments: real estate, mineral resources and fiber resources. Real estate secures entitlements and develops infrastructure on our lands for single-family residential and mixed-use communities and manages our undeveloped land and commercial operating properties. Mineral resources manages our mineral interests, and fiber resources manages our timber and recreational leases.

     Assets allocated by segment are as follows:

     We evaluate performance based on segment earnings before unallocated items and income taxes. Segment earnings consist of operating income, equity in earnings of unconsolidated ventures and minority interest expense in consolidated ventures. Unallocated items consist of general and administrative expense, share-based compensation, other non-operating income and expense and interest expense. All our revenues are derived from U.S. operations and all our assets are located in the U.S. For first nine months 2008, revenues from one customer of our mineral resources segment represent about 10% of our total revenues.

     Segment revenues and earnings are as follows:

     A summary of the awards granted under our 2007 Stock Incentive Plan follows.

     Cash-settled awards vest 50 percent after year one and 50 percent after year two from the date of grant and provide for accelerated vesting upon retirement, death, disability or if there is a change in control. The following table summarizes the activity of awards granted under our plan for first nine months 2008:

     The aggregate current value of non-vested awards as of September 30, 2008 is $78,000.

     Equity-settled awards in the form of restricted stock units granted to our directors are fully vested at the time of grant and payable upon retirement. The following table summarizes the activity of awards granted under our plan for first nine months 2008:

     The total fair value of awards vested in first nine months of 2008 was $1,350,000, of which $600,000 are deferred.

     Restricted stock awards vest after three years if we achieve a minimum one percent annualized return on assets over such three-year period. The following table summarizes the activity of awards granted under our plan for first nine months 2008:

The aggregate current value of non-vested awards as of September 30, 2008 is $2,301,000, or $14.75 per share.

     Stock options have a ten-year term, generally become exercisable ratably over three to four years and provide for accelerated or continued vesting upon retirement, death, disability or if there is a change in control. Options were granted with an exercise price equal to the market value of our stock on the date of grant. The following table summarizes the activity of awards granted under our plan for first nine months 2008:

     There was no aggregate intrinsic value for stock options outstanding or exercisable at September 30, 2008.

     Stock options are valued based upon the Black-Scholes option pricing model. Awards granted in first nine months 2008 were valued based upon the following assumptions:

     We have limited historical experience as a stand alone company so we utilized alternative methods in determining our valuation assumptions. The expected life was based on the simplified method utilizing the midpoint between the vesting period and the contractual life of the awards. The expected stock price volatility was based on historical prices of our peers’ common stock for a period corresponding to the expected life of the options. Pre-vesting forfeitures are estimated based upon the pool of participants and their expected activity.

     Prior to the spin-off, we participated in Temple-Inland’s share-based compensation plans, and as a result, certain of our directors and employees received share-based compensation in the form of restricted or performance stock units, restricted stock, or options to purchase shares of Temple-Inland’s common stock. Concurrent with Temple-Inland’s distribution of our common stock, all outstanding Temple-Inland awards were adjusted into three separate awards: one related to Forestar common stock, one related to Guaranty common stock and one related to Temple-Inland common stock.

     In 2007, the expense for share-based compensation awards granted to our employees under Temple-Inland’s plans was allocated to us by Temple-Inland. We continue to recognize share-based compensation expense over the remaining vesting periods associated with our employees’ and directors’ awards in Forestar, Guaranty and Temple-Inland stock.

     Cash-settled awards generally vest and are paid after three years from the date of grant or the attainment of defined performance goals, generally measured over a three-year period. A summary of cash-settled awards outstanding to our directors and employees at third quarter-end 2008, following the adjustments described previously, follows:

     In first nine months 2008, we paid $138,000 to settle vested cash awards.

     All outstanding restricted stock awards at year-end 2007 vested in first quarter 2008. The total fair value of these awards was $474,000.

     Stock options have a ten-year term, generally become exercisable ratably over four years and provide for accelerated or continued vesting upon retirement, death, disability or if there is a change in control. Options were granted with an exercise price equal to the market value of Temple-Inland common stock on the date of grant. A summary of stock option awards outstanding to our directors and employees at third quarter-end 2008, following the adjustments described previously, follows:

     The intrinsic value of options exercised in first nine months 2008 was $146,000.

     Pre-tax share-based compensation expense for post-spin and pre-spin awards consists of:

     The fair value of awards granted to retirement-eligible employees and expensed at the date of grant was $1,321,000 in first nine months 2008.

     Pre-tax share-based compensation expense is included in:

Unrecognized share-based compensation for post-spin awards not vested was $7,357,000 at third quarter-end 2008. It is likely that this cost will be recognized as expense over the next three years. Unrecognized share-based compensation for pre-spin awards not vested was $854,000 at third quarter-end 2008. It is likely that this cost will be recognized as expense over the next two years.

     In connection with restricted stock vested and stock options exercised, we withheld shares having a value of $1,840,000 for payment of payroll taxes in first nine months 2008. These shares are accounted for as treasury stock. Payroll taxes on restricted stock and stock options are reflected in financing activities in our consolidated statement of cash flows.

     Our effective tax rate was 27 percent in third quarter 2008 and 33 percent in the first nine months 2008. Our effective tax rate was 35 percent in third quarter 2007 and 36 percent for the first nine months 2007. We anticipate that our effective tax rate in 2008 will be about 33 percent.

     The 2008 rate reflects a one-time tax benefit for the adjustment of deferred taxes resulting primarily from a federal income tax rate change for qualified timber gains due to the Food, Conservation and Energy Act of 2008 which was enacted in June 2008.

     Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the financial statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 2007 Annual Report on Form 10-K.

     This Quarterly Report on Form 10-Q and other materials we have filed or may file with the Securities and Exchange Commission contain “forward-looking statements” within the meaning of the federal securities laws. These forward-looking statements are identified by their use of terms and phrases such as “believe,” “anticipate,” “could,” “estimate,” “likely,” “intend,” “may,” “plan,” “expect,” and similar expressions, including references to assumptions. These statements reflect our current views with respect to future events and are subject to risk and uncertainties. We note that a variety of factors and uncertainties could cause our actual results to differ significantly from the results discussed in the forward-looking statements. Factors and uncertainties that might cause such differences include, but are not limited to:

     Other factors, including the risk factors described in Part II, Item 1A of this Quarterly Report on Form 10-Q and in Item 1A of our 2007 Annual Report on Form 10-K, may also cause actual results to differ materially from those projected by our forward-looking statements. New factors emerge from time to time and it is not possible for us to predict all such factors, nor can we assess the impact of any such factor on our business or the extent to which any factor, or combination of factors, may cause results to differ materially from those contained in any forward-looking statement.

     Any forward-looking statement speaks only as of the date on which such statement is made, and, except as required by law, we expressly disclaim any obligation or undertaking to disseminate any updates or revisions to any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events.

     In first quarter 2008, we changed our reportable segments to reflect our post-spin management of the operations transferred to us from Temple-Inland. All prior period segment information has been reclassified to conform to the current presentation. We manage our operations through three business segments:

     Our strategy is to maximize and grow long-term stockholder value through:

     Unless otherwise indicated, information is presented as of September 30, 2008, and references to acreage owned include all acres owned by ventures regardless of our ownership interest in a venture.

     Our operations are affected to varying degrees by supply and demand factors and economic conditions including availability of mortgage credit; changes in interest rates; new housing starts; real estate values; employment levels; market prices for oil, gas and timber; and the overall strength of the U.S. economy.

     There have been no significant changes in our critical accounting policies or estimates in first nine months 2008 from those disclosed in our 2007 Annual Report on Form 10-K.

     Please read Note 3 to the Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q.

     Net income was $872,000, or $0.02 per diluted share, in third quarter 2008, compared with $9,596,000, or $0.27 per diluted share, for third quarter 2007. Net income for first nine months 2008 was $10,230,000, or $0.28 per diluted share, compared with $24,689,000, or $0.70 per diluted share, for first nine months 2007.

     Current conditions in the residential development industry are difficult due to the oversupply of housing, declining sales volume for existing and new homes, flat to declining sales prices and a significant tightening of mortgage credit. A decline in consumer confidence is also evident. Some home builders are experiencing liquidity shortfalls and are unwilling or unable to close committed lot purchases. All geographic markets and products have not been affected to the same extent or with equal severity, but most have experienced declines. It is likely these conditions will continue throughout 2008 and into 2009.

     Market conditions in the oil and gas industry have declined as oil and gas prices have decreased. Exploration and production companies have reduced capital expenditures for lease acquisition and production due to reduced oil and gas pricing and tightened credit markets. These conditions may impact the demand for new mineral leases.

     Fiber demand from the pulp and paper industry is stable. Pulpwood prices in our market areas have increased modestly due to balanced demand for containerboard. Sawtimber prices have declined due to the decrease in demand for lumber products consistent with the decline in the housing industry.

     A summary of our consolidated results follows: