Forestar Group - 10-Q quarterly report FY

 

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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 material 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 $1,348,000 and general and administrative expenses of $646,000 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 cost of assets we expect to convey to utility or improvement districts of $57,234,000 at second 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, typically when these districts achieve adequate tax bases to support payment. We billed these districts $14,814,000 in first six months 2008 and $26,140,000 in first six months 2007, and we collected $374,000 in first six months 2008 and $1,047,000 in first six months 2007.

     Depreciation expense, primarily related to commercial operating properties, was $852,000 in first six months 2008 and $1,006,000 in first six months 2007 and is included in other operating expense.

     At second 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 two largest ventures 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:

     In first six months 2008, we invested $11,339,000 in these ventures and received $5,258,000 in distributions. In first six months 2007, we invested $2,202,000 in these ventures and received $4,393,000 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 second 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, of which $22,048,000 was outstanding at second 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 second quarter-end 2008, we had $175,703,000 in net unused borrowing capacity under our senior credit facility.

     All borrowings under the 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 credit facility provides for releases of real estate provided that borrowing base compliance is maintained.

     At second quarter-end 2008, unamortized fees related to our credit facility were $8,695,000 and are included in other assets. Amortization of these fees was $1,739,000 for first six months 2008 and is included in interest expense.

     At second quarter-end 2008, commercial operating properties with a book value of $21,666,000 were subject to liens in connection with $16,142,000 of debt, and entitled, developed and under development land having a book value of $148,990,000 were subject to liens in connection with $75,882,000 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. In first quarter 2008, we entered into a $100,000,000 notional amount interest rate swap agreement that matures in 2010.

     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 (6.47% at second quarter-end 2008). The interest rate swap 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 is 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. In first six months 2008, hedge ineffectiveness was not significant.

     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. At second quarter-end 2008, the fair value of the interest rate swap agreement was a $1,066,000 asset which is included in other assets. The effective change in fair value of our interest rate swap agreement, net of taxes, was $994,000 in second quarter 2008 and is included in other comprehensive income.

     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.

     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 288 acres near Antioch, California, portions of which were sites of a Temple-Inland paper manufacturing operation that need 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 $6,250,000, 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 second quarter-end 2008, Temple-Inland and Guaranty directors and employees held 82,000 equity-settled 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 second quarter-end 2008:

     Other comprehensive income consists of:

     We computed net income per share by dividing income by weighted average shares outstanding using the following:

     For second quarter and first six 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 second quarter-end 2008, the effect of 1,434,000 stock options and unvested 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.

     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 six months 2008, revenues from one customer of our mineral resources segment represent about 14% of our total revenues.

     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 six 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. The following table summarizes the activity of awards granted under our plan for first six months 2008:

     The total fair value of awards vested in first six months of 2008 was $1,147,000, of which $397,000 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. The following table summarizes the activity of awards granted under our plan for first six 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 six months 2008:

     Stock options are valued based upon the Black-Scholes option pricing model. Awards granted in first six months 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.

     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 second quarter-end 2008, following the adjustments described previously, follows:

     In first six 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 second quarter-end 2008, following the adjustments described previously, follows:

     The intrinsic value of options exercised in first six months 2008 was $128,000.

     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 six months 2008.

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

     Unrecognized share-based compensation for post-spin awards not vested was $8,085,000 at second 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 $1,266,000 at second 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 $1,832,000 for payment of payroll taxes in first six 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 33 percent in second quarter 2008 and first six months 2008 and 37 percent in second quarter 2007 and first six months 2007. We anticipate that our effective tax rate in 2008 will be about 34 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 Heartland, Habitat, Harvest and Horticulture Act of 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 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 June 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 six 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 $9,596,000, or $0.27 per diluted share, in second quarter 2008, compared with $14,432,000, or $0.41 per diluted share, for second quarter 2007. Net income for first six months 2008 was $9,358,000, or $0.26 per diluted share, compared with $15,093,000 or $0.43 per diluted share, for first six months 2007.

     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.

     Market conditions in the oil and gas industry are strong, with continued long-term growth in demand for oil and gas expected. As a result, oil and gas prices are at near record levels.

     A summary of our consolidated results follows:

     Significant aspects of our results of operations follow:

     We own directly or through ventures about 371,000 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 302,000 acres in a broad area around Atlanta, Georgia, with the balance located primarily in Texas. We also 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:

     In second quarter 2008 and first six months 2008, costs and expenses include a $3,500,000 charge principally related to environmental remediation activities.

     Revenues and units sold consist of:

     Residential real estate revenues principally consist of the sale of single-family lots to national, regional and local homebuilders. In first six months 2008, residential real estate revenues declined as a result of decreased demand for single-family lots due to the overall decline in the housing industry. We expect this trend to continue throughout 2008.

     In second quarter 2008, we sold 175 lots in our owned and consolidated projects for average revenue per lot of $58,600 as compared to 356 lots sold in second quarter 2007 for average revenue per lot of $50,400. In first six months 2008, we sold 499 lots in our owned and consolidated projects for average revenue per lot of $48,900 (primarily in the major markets of Texas), as compared to 650 lots sold in first six months 2007 for average revenue per lot of $52,500.

     In second quarter 2007 and in first six months 2007, commercial real estate revenues include $12,400,000 related to the sale of 38 acres of undeveloped real estate on which we recognized a gain of $9,945,000.

     In second quarter 2008, undeveloped land revenues decreased as a result of selling 504 acres for an average price of $5,900 per acre as compared to 886 acres sold in second quarter 2007 at an average price of $7,000 per acre. In first six months 2008, undeveloped land revenues increased as a result of selling 1,853 acres for an average price of $5,000 per acre as compared to 1,154 acres sold in first six months 2007 at an average price of $6,700 per acre.

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

     The increase in acres in the entitlement process at second quarter-end 2008 is primarily due to the movement of about 10,000 acres into the entitlement process from undeveloped land which was partially offset by the movement of about 3,600 acres into entitled, developed and under development land.

     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. We have about 122,000 net acres under lease and about 26,000 net acres held by production.