FORESTAR GROUP INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included in this quarterly report and with our annual report on Form 10-K for the fiscal year endedSeptember 30, 2019 . Some of the information contained in this discussion and analysis constitutes forward-looking statements that involve risks and uncertainties. Actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those described in the "Forward-Looking Statements" section following this discussion.
Our Operations
We are a residential lot development company with operations in 51 markets in 22 states as ofJune 30, 2020 . InOctober 2017 , we became a majority-owned subsidiary of D.R. Horton, Inc. Our alignment with and support from D.R. Horton provides us an opportunity to grow our business into a national, well-capitalized residential lot developer selling lots to D.R. Horton and other homebuilders. As our controlling shareholder, D.R. Horton has significant influence in guiding our strategic direction and operations. Our strategy is focused on making investments in land acquisition and development to expand our residential lot development business across a geographically diversified national platform. We are primarily investing in short duration, phased development projects that generate returns similar to production-oriented homebuilders. This strategy is a unique, lower-risk business model that we expect will produce more consistent returns than other public and private land developers. We also make short term investments in finished lots (lot banking) and undeveloped land with the intent to sell these assets within a short time period, primarily to D.R. Horton, utilizing available capital prior to its deployment into longer term lot development projects.
COVID-19
During the latter part of
However, residential construction is designated an essential business as part of critical infrastructure in almost all municipalities across theU.S. where we operate. We have implemented operational protocols to comply with social distancing and other health and safety standards as required by federal, state and local government agencies, taking into consideration guidelines of theCenters for Disease Control and Prevention and other public health authorities. Our lot sales pace declined throughout late March and April as homebuilders slowed their purchases of lots to adjust to expected lower levels of home sales orders as a result of the pandemic. However, as economic activity and housing market conditions began to improve during the latter part of the quarter our lot sales pace increased. Although our lot sales pace has improved, we remain cautious as to the impact C-19 may have on our operations and on the overall economy in the future. There is significant uncertainty regarding the extent to which and how long C-19 and its related effects will impact theU.S. economy, capital markets and demand for our lots. The extent to which C-19 impacts our operational and financial performance will depend on future developments, including the duration and spread of C-19 and the impact on our customers, trade partners and employees, all of which are highly uncertain and cannot be predicted.
We believe we are well positioned to effectively operate during changing economic conditions due to our low net leverage and strong liquidity position, our low overhead model and our strategic relationship with D.R. Horton.
Business Segment
We manage our operations through our real estate segment which is our core
business and generates substantially all of our revenues. The real estate
segment primarily acquires land and develops infrastructure for single-family
residential communities and its revenues generally come from sales of
residential single-family finished lots to local, regional and national
homebuilders. We have other business activities for which the related assets and
operating results are immaterial, and therefore, are included in our real estate
segment.
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Results of Operations
The following tables and related discussion set forth key operating and
financial data as of and for the three and nine months ended
Operating Results
Components of pre-tax income were as follows:
Nine Months Ended June
Three Months Ended June 30, 30,
2020 2019 2020 2019
(In millions)
Revenues $ 177.9 $ 88.2 $ 584.3 $ 192.0
Cost of sales 157.1 75.3 510.3 149.6
Selling, general and administrative expense 11.2 7.9 32.8 19.8
Equity in loss (earnings) of unconsolidated
ventures 0.1 - (0.6) (0.5)
Gain on sale of assets - (1.5) (0.1) (2.4)
Interest and other income (0.8) (1.9) (4.2) (4.1)
Income before income taxes $ 10.3 $ 8.4 $ 46.1 $ 29.6
Lot Sales
Residential lots sold consist of:
Nine Months Ended June
Three Months Ended June 30, 30,
2020 2019 2020 2019
Development projects 1,556 723 4,234 1,597
Lot banking projects 467 435 2,162 627
2,023 1,158 6,396 2,224
Average sales price per lot (a) $ 79,900 $
77,400
_______________
(a) Excludes any impact from change in contract liabilities.
Revenues
Revenues consist of:
Nine Months Ended June
Three Months Ended June 30, 30,
2020 2019 2020 2019
(In millions)
Residential lot sales:
Development projects $ 124.5 $ 59.0 $ 340.8 $ 129.7
Lot banking projects 37.1 30.6 195.0 45.5
Decrease (increase) in contract liabilities 2.8 (2.0) 2.1 (3.6)
164.4 87.6 537.9 171.6
Residential tract sales 13.4 - 43.5 -
Commercial tract sales - - 2.5 18.5
Other 0.1 0.6 0.4 1.9
$ 177.9 $ 88.2 $ 584.3 $ 192.0
17-------------------------------------------------------------------------------- Table of Contents Residential lots sold and residential lot sales revenues have increased as we have grown our business primarily through our strategic relationship with D.R. Horton. In the three months endedJune 30, 2020 , we sold 1,991 residential lots to D.R. Horton for$159.3 million , compared to 995 residential lots sold to D.R. Horton for$75.2 million in the prior year period. In the nine months endedJune 30, 2020 , we sold 6,287 residential lots to D.R. Horton for$526.0 million , compared to 1,903 residential lots sold to D.R. Horton for$145.4 million in the prior year period. AtJune 30, 2020 , our lot position consisted of 50,700 residential lots, of which approximately 38,300 were owned and 12,400 were controlled through purchase contracts. Of our owned lots, approximately 14,100 are under contract to sell to D.R. Horton. Additionally, D.R. Horton has the right of first offer on approximately 15,500 lots based on executed purchase and sale agreements. AtJune 30, 2020 , lots owned included approximately 6,000 that are fully developed, of which approximately 2,100 are related to lot banking. AtJune 30, 2020 , we had approximately 200 lots under contract to sell to builders other than D.R. Horton. Residential tract sales in the three months endedJune 30, 2020 consist of 30 residential tract acres sold to D.R. Horton for$13.4 million . Residential tract sales in the nine months endedJune 30, 2020 consist of 580 residential tract acres sold to third parties for$22.8 million and 66 residential tract acres to D.R. Horton for$20.6 million . Commercial tract sales in the nine months endedJune 30, 2020 consist of 8 commercial tract acres sold to a third party for$2.5 million . Commercial tract sales in the nine months endedJune 30, 2019 primarily consist of the sale of 44 commercial tract acres from a consolidated joint venture for$14.8 million . Cost of sales in the three and nine months endedJune 30, 2020 increased as compared to the prior year periods primarily due to the increases in the number of lots sold. Cost of sales related to residential and commercial tract sales in the three and nine months endedJune 30, 2020 was$12.8 million and$36.7 million , respectively.
Selling, General and Administrative (SG&A) Expense and Other Income Statement Items
SG&A expense in the three and nine months endedJune 30, 2020 was$11.2 million and$32.8 million , respectively, compared to$7.9 million and$19.8 million in the prior year periods. Our SG&A expense primarily consists of employee compensation and related costs. Our business operations employed 128 and 63 employees atJune 30, 2020 and 2019, respectively.
Interest and other income primarily represents interest earned on our cash deposits.
Income Taxes
Our income tax expense for the three and nine months endedJune 30, 2020 was$0.2 million and$8.9 million compared to$1.5 million and$6.0 million in the prior year periods. Our effective tax rate was 1.9% and 19.3% for the three and nine months endedJune 30, 2020 compared to 17.9% and 20.3% in the prior year periods. Our effective tax rate for the three and nine months endedJune 30, 2020 includes a tax benefit of$2.3 million related to the NOL carryback provisions of the recently enacted CARES Act, which allows us to carryback a portion of our 2018 NOL. The carryback provisions result in the recognition of previously unrecognized tax benefits and the revaluation of deferred tax assets due to the utilization of NOLs at a higher tax rate in the carryback period. Our effective tax rate for all periods includes an expense for state income taxes and nondeductible expenses and a benefit related to noncontrolling interests. AtJune 30, 2020 , we had deferred tax assets, net of deferred tax liabilities, of$3.2 million . The deferred tax assets were offset by a valuation allowance of$3.3 million , resulting in a net deferred tax liability of$0.1 million , which is included in accrued expenses and other liabilities on our consolidated balance sheets. AtSeptember 30, 2019 , deferred tax assets, net of deferred tax liabilities, were$20.7 million , partially offset by a valuation allowance of$3.3 million . The valuation allowance for both periods was recorded because it is more likely than not that a portion of our state deferred tax assets, primarily NOL carryforwards, will not be realized because we are no longer operating in some states or the NOL carryforward periods are too brief to realize the related deferred tax asset. We will continue to evaluate both the positive and negative evidence in determining the need for a valuation allowance on our deferred tax assets. Any reversal of the valuation allowance in future periods will impact our effective tax rate. We had no unrecognized tax benefits atJune 30, 2020 as a result of the recognition of$1.6 million of previously unrecognized tax benefits during the three months endedJune 30, 2020 . All of the$1.6 million of recognized tax benefits affected our tax rate and was attributable to the NOL carryback provisions of the CARES Act allowing previously uncertain tax attributes to be recognized. 18
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Liquidity and Capital Resources
Our strategic relationship with D.R. Horton has provided us with an opportunity for substantial growth. Since our merger with D.R. Horton, we have funded our growth with available cash, borrowings under our revolving credit facility and the issuance of senior unsecured notes and common stock. AtJune 30, 2020 , we had$355.6 million of cash and cash equivalents and$348.4 million of available borrowing capacity on our revolving credit facility. We have no senior note maturities until fiscal 2024. We believe we are well positioned to effectively operate during changing economic conditions because of our low net leverage and strong liquidity position, our low overhead model and our strategic relationship with D.R. Horton. During late March and April, homebuilders slowed their purchases of lots to adjust to expected lower levels of new home demand. However, as economic activity and housing market conditions began to improve during the latter part of the quarter our lot sales pace increased. The extent to which C-19 impacts our operational and financial performance will depend on future developments, including the duration and spread of C-19 and the impact on our customers, trade partners and employees, all of which are highly uncertain and cannot be predicted. If economic and housing market conditions are adversely affected for a prolonged period and there is decreased demand for our lots, we may need to amend the terms of existing lot sale contracts with homebuilders to adjust to current market conditions. These amendments could include changes in the timing, amount and pricing of lots to be purchased, the amount of earnest money deposits, and other payment terms. Such amendments, if significant, could adversely impact our future results of operations and liquidity position. AtJune 30, 2020 , our ratio of debt to total capital (debt divided by stockholders' equity plus debt) was 43.1% compared to 36.3% atSeptember 30, 2019 and 39.8% atJune 30, 2019 . Our ratio of net debt to total capital (debt net of unrestricted cash divided by stockholders' equity plus debt net of unrestricted cash) was 25.2% compared to 8.8% atSeptember 30, 2019 and 25.3% atJune 30, 2019 . Over the long term, we intend to maintain our ratio of net debt to total capital at or below 40%. We believe that the ratio of net debt to total capital is useful in understanding the leverage employed in our operations. We believe that our existing cash resources and revolving credit facility will provide sufficient liquidity to fund our near-term working capital needs and debt obligations. Our ability to achieve our long-term growth objectives will depend on our ability to obtain financing in sufficient amounts. We regularly evaluate alternatives for managing our capital structure and liquidity profile in consideration of expected cash flows, growth and operating capital requirements and capital market conditions. We may, at any time, be considering or preparing for the purchase or sale of our debt securities, the sale of our common stock or a combination thereof. However, due to the current economic uncertainties related to C-19, we may be limited in accessing the capital markets or the cost of accessing these markets could become more expensive.
Bank Credit Facility
We have a$380 million senior unsecured revolving credit facility with an uncommitted accordion feature that could increase the size of the facility to$570 million , subject to certain conditions and availability of additional bank commitments. The facility also provides for the issuance of letters of credit with a sublimit equal to the greater of$100 million and 50% of the revolving credit commitment. Borrowings under the revolving credit facility are subject to a borrowing base calculation based on the book value of our real estate assets and unrestricted cash. Letters of credit issued under the facility reduce the available borrowing capacity. AtJune 30, 2020 , there were no borrowings outstanding and$31.6 million of letters of credit issued under the revolving credit facility, resulting in available capacity of$348.4 million . There were no borrowings or repayments under the facility during the nine months endedJune 30, 2020 .
In
The revolving credit facility includes customary affirmative and negative covenants, events of default and financial covenants. The financial covenants require a minimum level of tangible net worth, a minimum level of liquidity, and a maximum allowable leverage ratio. These covenants are measured as defined in the credit agreement governing the facility and are reported to the lenders quarterly. A failure to comply with these financial covenants could allow the lending banks to terminate the availability of funds under the revolving credit facility or cause any outstanding borrowings to become due and payable prior to maturity. AtJune 30, 2020 , we were in compliance with all of the covenants, limitations and restrictions of our revolving credit facility. 19
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Senior Notes
InFebruary 2020 , we issued$300 million principal amount of 5.0% senior notes pursuant to Rule 144A and Regulation S under the Securities Act. The notes matureMarch 1, 2028 with interest payable semi-annually and represent senior unsecured obligations that rank equally in right of payment to all existing and future senior unsecured indebtedness. The notes may be redeemed prior to maturity, subject to certain limitations and premiums defined in the indenture agreement. On or afterMarch 1, 2023 , the notes may be redeemed at 102.5% of their principal amount plus any accrued and unpaid interest. In accordance with the indenture, the redemption price decreases annually thereafter and the notes can be redeemed at par on or afterMarch 1, 2026 through maturity. The notes are guaranteed by each of our subsidiaries to the extent such subsidiaries guarantee our revolving credit facility. The annual effective interest rate of the notes after giving effect to the amortization of financing costs is 5.2%. We also have$350 million principal amount of 8.0% senior notes due 2024 outstanding.
In
The indentures governing the senior notes require that, upon the occurrence of both a change of control and a rating decline (each as defined in the indenture), we offer to purchase the notes at 101% of their principal amount. If we or our restricted subsidiaries dispose of assets, under certain circumstances, we will be required to either invest the net cash proceeds from such asset sales in our business within a specified period of time, repay certain senior secured debt or debt of our non-guarantor subsidiaries, or make an offer to purchase a principal amount of the notes equal to the excess net cash proceeds at a purchase price of 100% of their principal amount. The indentures contain covenants that, among other things, restrict the ability of us and our restricted subsidiaries to pay dividends or distributions, repurchase equity, prepay subordinated debt and make certain investments; incur additional debt or issue mandatorily redeemable equity; incur liens on assets; merge or consolidate with another company or sell or otherwise dispose of all or substantially all of our assets; enter into transactions with affiliates; and allow to exist certain restrictions on the ability of subsidiaries to pay dividends or make other payments. AtJune 30, 2020 , we were in compliance with all of the limitations and restrictions associated with our senior note obligations. EffectiveApril 30, 2020 , our Board of Directors authorized the repurchase of up to$30 million of our debt securities. The authorization has no expiration date. All of the$30 million authorization was remaining atJune 30, 2020 .
Shelf Registration Statement
In
Contractual Obligations and Off-Balance Sheet Arrangements
In support of our residential lot development business, we issue letters of credit under our revolving credit facility and we have a surety bond program that provides financial assurance to beneficiaries related to the execution and performance of certain development obligations. AtJune 30, 2020 , we had outstanding letters of credit of$31.6 million under the revolving credit facility and surety bonds of$206.2 million , issued by third parties to secure performance under various contracts. We expect that our performance obligations secured by these letters of credit and bonds will generally be completed in the ordinary course of business and in accordance with the applicable contractual terms. When we complete our performance obligations, the related letters of credit and bonds are generally released shortly thereafter, leaving us with no continuing obligations. We have no material third-party guarantees. 20
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Operating Cash Flow Activities
In the nine months endedJune 30, 2020 , net cash used in operating activities was$205.7 million compared to$450.1 million in the nine months endedJune 30, 2019 . The net cash used in operating activities in both periods reflects our strategy of continuing to grow our land development operations.
Investing Cash Flow Activities
In the nine months ended
Financing Cash Flow Activities
In the nine months endedJune 30, 2020 , net cash provided by financing activities was$175.4 million , consisting primarily of proceeds from the issuance of$300 million principal amount of 5.0% senior notes, partially offset by the repayment of$118.9 million principal amount of our 3.75% convertible senior notes at maturity. In the nine months endedJune 30, 2019 , net cash provided by financing activities was$339.1 million , consisting primarily of proceeds from the issuance of$350 million principal amount of 8.0% senior notes, while amounts drawn and repaid on the revolving credit facility totaled$85 million each.
Critical Accounting Policies and Estimates
There have been no significant changes in our critical accounting policies or estimates from those disclosed in our 2019 Annual Report on Form 10-K.
New and Pending Accounting Pronouncements
Please read Note 1-Basis of Presentation to the consolidated financial statements included in this Quarterly Report on Form 10-Q.
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Forward-Looking Statements
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 risks
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:
•the impact of C-19 on the economy and our business;
•the effect of D.R. Horton's controlling level of ownership on us and the
holders of our securities;
•our ability to realize the potential benefits of the strategic relationship
with D.R. Horton;
•the effect of our strategic relationship with D.R. Horton on our ability to
maintain relationships with our vendors and customers;
•demand for new housing, which can be affected by a number of factors including
the availability of mortgage credit, job growth and fluctuations in interest
rates;
•competitive actions by other companies;
•accuracy of estimates and other assumptions related to investment in and
development of real estate, the expected timing and pricing of land and lot
sales and related cost of real estate sales;
•our ability to comply with our debt covenants, restrictions and limitations;
•our ability to hire and retain key personnel;
•changes in governmental policies, laws or regulations and actions or
restrictions of regulatory agencies;
•general economic, market or business conditions where our real estate
activities are concentrated;
•our ability to achieve our strategic initiatives;
•our ability to obtain future entitlement and development approvals;
•our ability to obtain or the availability of surety bonds to secure our
performance related to construction and development activities and the pricing
of bonds;
•obtaining reimbursements and other payments from governmental districts and
other agencies and timing of such payments;
•the levels of resale housing inventory in our projects and the regions in which
they are located;
•fluctuations in costs and expenses, including impacts from shortages in
materials or labor;
•the opportunities (or lack thereof) that may be presented to us and that we may
pursue;
•the strength of our information technology systems and the risk of
cybersecurity breaches; and
•the conditions of the capital markets and our ability to raise capital to fund
expected growth.
Other factors, including the risk factors described in Item 1A of our 2019
Annual Report on Form 10-K, as supplemented by Part II, Item 1A in our Quarterly
Report on Form 10-Q for the quarter ended March 31, 2020 and in this Quarterly
Report on Form 10-Q, 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.
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