Forestar Group - 10-Q quarterly report FY

 

     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

          Yes o      No þ

     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.

          On December 28, 2007, Temple-Inland Inc. distributed 100% of the issued and outstanding shares of our common stock to the holders of record of Temple-Inland common stock. (Also on December 28, 2007, Temple-Inland distributed 100% of the issued and outstanding shares of Guaranty Financial Group, Inc., a wholly-owned subsidiary of Temple-Inland that operated Temple-Inland’s 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. Beginning in fiscal year 2008, we changed our fiscal year from a 52/53 week fiscal year ending the Saturday closest to December 31 to a calendar year.

          Our consolidated financial statements are our primary financial statements and 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 material intercompany accounts and transactions. Minority interest in consolidated pass-through 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 only distribution of accumulated earnings).

          We prepared these 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 of the information and disclosures required by U.S. generally accepted accounting principles 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. We make estimates and assumptions about future events. Actual results can, and probably will, differ from those we currently estimate. Examples of significant estimates include 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 Annual Report on Form 10-K for the fiscal year ended December 29, 2007.

          Beginning January 2008, two new accounting pronouncements were effective:

          In addition, there are three new accounting pronouncements that we will be required to adopt in 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 cost of assets we expect to convey to utility or improvement districts of $54,295,000 at first quarter-end 2008 and $40,843,000 at year-end 2007. These costs relate to water, sewer and other infrastructure assets for which the utility or improvement districts have agreed to reimburse us. We billed these districts $12,011,000 in first three months 2008 and $24,540,000 in first three months 2007.

          Depreciation expense, primarily related to commercial operating properties, was $400,000 in first three months 2008 and $507,000 in first three months 2007, and is included in other operating expense.

          At first quarter-end 2008, we had ownership interests ranging from 25 to 50 percent in 15 ventures that we account for using the equity method. Our two largest ventures at first quarter-end 2008 are CL Realty and Temco, in both of which we own a 50 percent interest and Cousins Real Estate Corporation owns the other 50 percent interest. Information regarding CL Realty and Temco 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:

          During first three months 2008, we invested $4,263,000 in these ventures and received $3,434,000 in distributions. During first three months 2007, we invested $1,615,000 in these ventures and received $2,089,000 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 first 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. 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, and a $25,000,000 swing line sublimit. Total borrowings under our senior credit facility (including the face amount of letters of credit) may not exceed a borrowing base formula. At first quarter-end 2008, we had $208,743,000 in unused borrowing capacity under our senior credit facility, which is subject to a $35,000,000 minimum liquidity requirement at the end of each quarter resulting in a net unused borrowing capacity of $173,743,000.

          At first quarter-end 2008, unamortized origination and other fees related to our credit facility were $9,573,000, which are included in other assets. Amortization of deferred financing fees in connection with our senior credit facility was $855,000 for first three months 2008 and none for first three months 2007.

          At first quarter-end 2008, commercial operating properties having a book value of $21,936,000 were subject to liens in connection with $16,288,000 of debt, and entitled, developed and under development land principally in consolidated ventures and having a book value of $162,217,000 was subject to liens in connection with $74,302,000 of principally non-recourse debt.

     We 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. During first quarter 2008, we entered into an interest rate swap agreement that matures in 2010 for a total notional amount of $100,000,000.

     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 4.00 percent (6.86% at first quarter-end 2008). At first quarter-end 2008, the fair value of this interest rate swap agreement was a $507,000 liability which is included in other liabilities. The interest rate swap agreement was designed to offset the cash flow variability of probable interest rate payments associated with our variable-rate debt. The hedged cash flows are the interest rate payments associated with the first $100,000,000 of our variable-rate borrowings. Our interest rate swap meets the conditions required for effectiveness under the variable cash flows methodology of SFAS No. 133, Accounting for Derivatives Instruments and Hedging Activities. The effectiveness of the hedge relationship will be periodically assessed by comparing the present value of the cumulative change in the expected future interest cash flows on the variable leg of the swap and the present value of the cumulative change in the expected future hedged cash flows.

          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.

          Liabilities in connection with environmental remediation 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 approximately 285 acres in several parcels in or near Antioch, California, portions of which were sites of a Temple-Inland paper manufacturing operation and related support facilities that need remediation. We estimate the cost we will likely incur to complete remediation activities will be about $5,790,000, of which $771,000 was paid during first three months 2008. The remaining balance of $5,019,000 is included in other accrued expenses.

          We do not believe that the outcome of any of these proceedings or matters should have a significant adverse effect on our financial position, long-term results of operations or cash flows. It is possible, however, that circumstances beyond our control or significant subsequent developments could result in additional charges related to these matters that could be significant to our results or cash flows in any one accounting period.

          Other comprehensive (loss) income is defined as the change in equity of a business enterprise during the period derived from non-owner sources. Our other comprehensive (loss) income consists of net (loss) income and the change in fair value of an interest rate swap agreement.

          Total other comprehensive (loss) income for first three months 2008 and 2007 consists of:

          For first three months 2008, we computed basic and diluted net loss per share based upon the weighted average number of common shares outstanding during the period. For first three 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 first quarter-end 2008, we did not include outstanding option awards or unvested restricted stock in our diluted weighted-average shares outstanding calculation because those items would have been anti-dilutive as a result of our net loss. We had 2,664,000 potentially dilutive awards at first quarter-end 2008.

          At first quarter-end 2008, Temple-Inland and Guaranty directors and employees held 83,000 stock-settled units on our stock. The following table summarizes outstanding stock option awards on our stock held by Temple-Inland and Guaranty directors and employees at first quarter-end 2008:

          In first quarter 2008, we changed our reportable segments to reflect our post-spin management of the assets and liabilities 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: 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 our commercial operating properties. Mineral resources manages our mineral interests, and fiber resources manages our timber and recreational leases.

          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. No single customer accounts for more than ten percent of our revenues.

          In February 2008, we granted awards under our 2007 Stock Incentive Plan. A summary of the awards 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. We recognize compensation costs based upon the current vested value of outstanding awards, which are included in other liabilities. The following table summarizes the activity of awards granted under our plan for first three months 2008:

          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. We recognize related compensation costs upon grant. The following table summarizes the activity of awards granted under our plan for first three months 2008:

          The total fair value of awards vested during first three months of 2008 was $956,000, of which $206,000 are deferred director fees.

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

          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 three months 2008:

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

          As we have limited historical experience as a stand alone company, we utilized other sources 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.

          During 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 period 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 first quarter-end 2008, following the adjustments described previously, follows:

          During first three months 2008, there were no payments for cash-settled awards.

          Restricted stock awards generally vest after three to six years, and provide for accelerated vesting upon retirement, death, disability or if there is a change in control. Compensation costs are recognized ratably over the service period.

          All outstanding restricted stock awards at year-end 2007 vested during 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 first quarter-end 2008, following the adjustments described previously, follows:

          The intrinsic value of options exercised during first three months 2008 was $128,000.

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

          Pre-tax share-based compensation expense included in general and administrative and other operating expense follows:

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

          Unrecognized share-based compensation for post-spin awards not vested was $8,699,000 at first quarter-end 2008. It is likely that this cost will be recognized as expense over the next four years. Unrecognized share-based compensation for pre-spin awards not vested was $2,241,000 at first quarter-end 2008. It is likely that this cost will be recognized as expense over the next three years.

          In connection with restricted stock vested and stock options exercised, we withheld shares having a value of $1,822,000 for payment of payroll taxes. These shares are accounted for as treasury stock. Payroll taxes on restricted stock and stock options is reflected in financing activities in our consolidated statement of cash flows.

          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 Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 29, 2007, 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 assets and liabilities 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:

          Unless otherwise indicated, information is presented as of March 31, 2008, and references to acreage owned includes all acres owned by ventures regardless of our ownership interest in a venture.

     Summary

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

          We manage our operations through three business segments: real estate, mineral resources and fiber resources. A summary of our consolidated results follows:

          Significant aspects of our results of operations in first three months 2008 follow:

          Current conditions in the residential development industry are difficult due to an 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. 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.

          We operate three business segments:

          We evaluate performance based on earnings before unallocated items and income taxes. Segment earnings consist of operating income and equity in earnings of unconsolidated ventures, less 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. The accounting policies of the segments are the same as those described in the accounting policy note to the consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 29, 2007.

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

          We own directly or through ventures about 372,000 acres of real estate located in ten states and 13 markets. Our real estate segment secures entitlements and develops infrastructure on our lands, primarily for single-family residential and mixed-use communities. We own approximately 303,000 acres in a broad area around Atlanta, Georgia, with the balance located primarily in Texas. We also actively invest in new projects principally in our strategic growth corridors, regions of accelerated growth across the southern half of the United States that possess key demographic and growth characteristics that we believe make them attractive for long-term real estate investment.

          A summary of our real estate results follows:

          Revenues and units sold consist of:

          Residential real estate revenues consist of the sale of single-family lots to national, regional and local homebuilders. In first three months 2008, residential real estate revenues decreased principally as a result of the sale of 192 high density lots for a lower average sales price per lot compared to 2007.

          In first three months 2008, undeveloped land sales revenue increased as a result of selling 1,349 acres for an average sales price of $4,600 per acre. In first three months 2007, we sold 268 acres of undeveloped land for an average sales price of $5,600 per acre.

          Information about our real estate projects and our real estate ventures follows:

          We own directly or through ventures about 622,000 net acres of oil and gas mineral interests. Our mineral resources segment is focused on maximizing the value from royalties and other lease revenues from our oil and gas mineral interests located in Texas, Louisiana, Alabama and Georgia. These operations have historically required low capital investment, and we use the cash flow generated by our mineral interests to accelerate real estate value creation activities.

          A summary of our mineral resources results follows:

          Equity in earnings of unconsolidated ventures for first three months 2008 includes our share of a lease bonus payment as a result of leasing 241 net mineral acres for $1,568,000.

          Revenues consist of:

          Other lease revenues for the first three months of 2008 includes a $2,021,000 lease bonus payment as a result of leasing approximately 5,100 net mineral acres. Royalties include our share of over 19,000 barrels of oil and approximately 256,000 thousand cubic feet (mcf) of natural gas production related to our royalty interests.

          Our fiber resources segment principally focuses on the management of our timber holdings. We have about 347,000 acres of timber on our undeveloped land and land in the entitlement process and over 18,000 acres of timber under lease. We sell wood fiber from our land, primarily in Georgia, and lease land for hunting and other recreational uses.

          A summary of our fiber resources results follows:

          Other operating income in the first three months of 2008 represents a gain from partial termination of a timber lease related to 409 acres of land sold from a venture.

          Revenues consist of:

          In first quarter 2008, we sold about 209,000 tons of fiber at an average price of $10 per ton, the majority of which was sold to Temple-Inland at market prices. In first quarter 2007, we sold about 280,000 tons of fiber at an average price of $11 per ton.

          The increase in interest expense was due to a higher average debt balance and higher borrowing costs.

          The increase in share-based compensation was principally a result of awards granted in the first quarter of 2008. In conjunction with these grants, we recognized accelerated expense for retirement eligible employees as well as immediate expense for fully vested awards to members of our board. The change was also due to an increase in the number of participants in our plan.

          The increase in general and administrative expenses in the first three months of 2008 was due to increased costs associated with our corporate functions now that we are a stand alone public company.

          Our effective tax rate was 38 percent in first three months 2008 and 37 percent in first three months 2007. We anticipate that our effective tax rate in 2008 will be about 38 percent.

     Sources and Uses of Cash

          Our principal operating cash requirements are for the acquisition and development of real estate, either directly or indirectly through ventures, taxes, interest and compensation. Our principal sources of cash are proceeds from the sale of real estate and timber, the cash flow from minerals and commercial operating properties and borrowings. Operating cash flows are also affected by the timing of the payment of real estate development expenditures and the collection of proceeds from the eventual sale of the real estate, the timing of which can vary substantially depending on many factors including the size of the project, state and local permitting requirements and availability of utilities. Working capital is subject to operating needs, the timing of sales of real estate and timber, the timing of collection of mineral royalties or mineral lease payments, collection of receivables, reimbursement from utility or improvement districts and the payment of payables and expenses.

          Cash flows from our real estate development activities are classified as operating cash flows. Cash flows related to minerals, timber and recreational leases are also classified as operating cash flows.

          In first three months 2008, net cash used in operating activities was $14,050,000. In first three months 2007, net cash used in operating activities was $45,199,000. In first quarter 2008, expenditures for real estate development and acquisitions exceeded non-cash cost of sales principally due to our continued development of existing real estate projects, principally in the major markets of Texas. In first quarter 2007, expenditures for real estate development and acquisitions significantly exceeded non-cash cost of sales due to the investment in three new real estate projects for $31,195,000.

          Capital contributions to and capital distributions from unconsolidated ventures are classified as investing activities. In addition, expenditures related to reforestation activities in our fiber resources segment are classified as investing activities.

          In first three months 2008, net cash used in investing activities was $2,142,000 as capital contributions to our unconsolidated ventures exceeded our capital distributions. In first three months 2007, net cash used in investing activities was $187,000, as capital distributions from our unconsolidated ventures exceeded our capital contributions.

          In first three months 2008, net cash provided by financing activities was $17,025,000. In first three months 2007, net cash provided by financing activities was $48,076,000. In first quarter 2008, the increase in our debt funded our expenditures for real estate development, principally in the major markets of Texas. In first quarter 2007, the increase in our debt and note payable to Temple-Inland funded our net expenditures for real estate development and acquisition.

          There have been no significant changes in our liquidity, contractual obligations and off-balance sheet arrangements since year-end 2007, except for an interest rate swap agreement entered into during first quarter 2008. This interest rate instrument expires in 2010 and is for a total notional amount of $100,000,000. It is non-exchange traded and is valued using third-party resources and models. At first quarter-end 2008, the fair value of our interest rate instrument was a $507,000 liability.

          A summary of our real estate projects in the entitlement process^(a) at March 31, 2008 follows:

     A summary of activity within our projects in the development process, which includes entitled^(a), developed and under development real estate projects, at March 31, 2008 follows: