What changed in this filing

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Item 2. Management’s Discussion and Analysis

2020-07-29 compared with 2020-04-29 · 74 added, 71 removed, 149 unchanged (49% of the section changed)

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Our Operations

We are a residential lot development company with operations in 50 markets in 21 states as of March 31, 2020.

We are a residential lot development company with operations in 51 markets in 22 states as of June 30, 2020.

In October 2017, we became a majority-owned subsidiary of D.R.

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Horton, utilizing available capital prior to its deployment into longer term lot development projects.

Economic fundamentals remained solid in the housing and residential lot development markets throughout most of the second quarter of fiscal 2020.

During the latter part of March and to date in April, the impacts of the COVID-19 pandemic (COVID-19) and the related widespread reductions in economic activity have affected our business operations and the demand for our residential lots.

Our lot sales pace has declined as homebuilders have slowed their purchases of lots to adjust to lower levels of home sales orders as a result of the pandemic.

In almost all municipalities across the U.S.

where social distancing and other restrictions have been issued, residential construction has been designated an essential business as part of critical infrastructure.

We have continued our lot development operations in those markets where allowed in order to supply homebuilders with finished lots for residential construction.

During the latter part of March 2020, the impacts of the COVID-19 pandemic (C-19) and the related widespread reductions in economic activity began affecting our business operations and the demand for our residential lots.

However, residential construction is designated an essential business as part of critical infrastructure in almost all municipalities across the U.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 the Centers for Disease Control and Prevention and other public health authorities.

Our results of operations can be affected by changes in economic conditions that negatively impact the housing and land development markets.

There is uncertainty regarding the extent and timing of disruption that COVID-19 and related government directives, actions and significant economic relief efforts will have on the U.S.

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 the U.S.

economy, capital markets and demand for our lots.

The extent to which COVID-19 impacts our operational and financial performance will depend on future developments, including the duration and spread of COVID-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 operate in this uncertain environment because of our relationship with D.R.

Horton, our low net leverage and strong liquidity position.

During this period of uncertainty, we intend to limit our land acquisition spending and carefully monitor lot development spending based on our current and anticipated future sales pace.

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.

Business Segment

We manage our operations through our real estate segment.

Our real estate segment 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.

Our real estate segment generates its revenues principally 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 results of operations are immaterial and therefore are included in our real estate 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.

Results of Operations

The following tables and related discussion set forth key operating and financial data as of and for the three and six months ended March 31, 2020 and 2019.

The following tables and related discussion set forth key operating and financial data as of and for the three and nine months ended June 30, 2020 and 2019.

Operating Results

Components of pre-tax income were as follows:

Three Months Ended March 31, Six Months Ended March 31,

Three Months Ended June 30, Nine Months Ended June 30,

2020 2019 2020 2019

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Selling, general and administrative expense 11.2 7.9 32.8 19.8

Equity in earnings of unconsolidated ventures (0.3) — (0.8) (0.6)

Equity in loss (earnings) of unconsolidated ventures 0.1 — (0.6) (0.5)

Gain on sale of assets — (1.5) (0.1) (2.4)

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Residential lots sold consist of:

Three Months Ended March 31, Six Months Ended March 31,

Three Months Ended June 30, Nine Months Ended June 30,

2020 2019 2020 2019

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Revenues consist of:

Three Months Ended March 31, Six Months Ended March 31,

Three Months Ended June 30, Nine Months Ended June 30,

2020 2019 2020 2019

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Residential lots sold and residential lot sales revenues have increased as we have grown our business primarily through our strategic relationship with D.R.

In the three months ended March 31, 2020, we sold 1,906 residential lots to D.R.

In the three months ended June 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 six months ended March 31, 2020, we sold 4,296 residential lots to D.R.

In the nine months ended June 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.

At March 31, 2020, our lot position consisted of 52,300 residential lots, of which approximately 35,800 were owned and 16,500 were controlled through option purchase contracts.

Of our total owned and controlled residential lots, approximately 14,200 are under contract to sell to D.R.

At June 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.

Additionally, D.R.

Horton has the right of first offer on approximately 14,400 of these lots based on executed purchase and sale agreements.

At March 31, 2020, lots owned included approximately 4,400 that are fully developed, of which approximately 2,100 are related to lot banking.

At March 31, 2020, we had approximately 200 lots under contract to sell to builders other than D.R.

Residential tract sales in the six months ended March 31, 2020 consists of approximately 580 residential tract acres sold to third parties for $22.8 million and approximately 36 residential tract acres to D.R.

Horton has the right of first offer on approximately 15,500 lots based on executed purchase and sale agreements.

At June 30, 2020, lots owned included approximately 6,000 that are fully developed, of which approximately 2,100 are related to lot banking.

At June 30, 2020, we had approximately 200 lots under contract to sell to builders other than D.R.

Residential tract sales in the three months ended June 30, 2020 consist of 30 residential tract acres sold to D.R.

Horton for $13.4 million.

Commercial tract sales in the three and six months ended March 31, 2020 consists of approximately 8 commercial tract acres sold to a third party for $2.5 million.

Commercial tract sales in the three and six months ended March 31, 2019 primarily consists of the sale of approximately 44 commercial tract acres from a consolidated joint venture for $14.8 million.

Cost of sales in the three and six months ended March 31, 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 six months ended March 31, 2020 was $2.4 million and $23.9 million, respectively.

Residential tract sales in the nine months ended June 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 ended June 30, 2020 consist of 8 commercial tract acres sold to a third party for $2.5 million.

Commercial tract sales in the nine months ended June 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 ended June 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 ended June 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 six months ended March 31, 2020 was $11.2 million and $21.7 million, respectively, compared to $6.2 million and $11.9 million in the prior year periods.

Our SG&A expenses primarily consist of employee compensation and related costs.

Our business operations employed 121 and 51 employees at March 31, 2020 and 2019, respectively.

Interest and other income principally represents interest earned on our cash deposits.

Our income tax expense for the three and six months ended March 31, 2020 was $3.3 million and $8.7 million compared to $3.6 million and $4.6 million in the prior year periods.

Our effective tax rate was 24.1% and 24.3% for the three and six months ended March 31, 2020 compared to 22.0% and 21.6% in the prior year periods.

SG&A expense in the three and nine months ended June 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 at June 30, 2020 and 2019, respectively.

Interest and other income primarily represents interest earned on our cash deposits.

Our income tax expense for the three and nine months ended June 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 ended June 30, 2020 compared to 17.9% and 20.3% in the prior year periods.

Our effective tax rate for the three and nine months ended June 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.

At March 31, 2020 and September 30, 2019, deferred tax assets, net of deferred tax liabilities, were $11.3 million and $20.7 million, offset by a valuation allowance of $3.3 million at both dates for the portion of the deferred tax assets that we have determined is more likely than not to be unrealizable.

The valuation allowance was recorded because it is more likely than not that a portion of our state deferred tax assets, primarily net operating loss (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.

At June 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.

At September 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.

Our unrecognized tax benefits totaled $1.6 million at March 31, 2020, all of which would affect our effective tax rate, if recognized.

We had no unrecognized tax benefits at June 30, 2020 as a result of the recognition of $1.6 million of previously unrecognized tax benefits during the three months ended June 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.

Liquidity and Capital Resources

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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.

At March 31, 2020, we had $438.2 million of cash and cash equivalents and $349.0 million of available borrowing capacity on our revolving credit facility.

At June 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 operate in this uncertain environment because of our relationship with D.R.

Horton, our low net leverage and strong liquidity position.

During this period of uncertainty, we intend to limit our land acquisition spending and carefully monitor lot development spending based on our current and anticipated future sales pace.

During late March and April, homebuilders have slowed their purchases of lots to adjust to lower levels of new home demand.

As a result of decreased demand, Forestar may need to amend the terms of existing lot sale contracts with homebuilders to adjust to current market conditions.

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.

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.

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.

At March 31, 2020, our ratio of debt to total capital (debt divided by stockholders’ equity plus debt) was 43.4% compared to 36.3% at September 30, 2019 and 17.8% at March 31, 2019.

At March 31, 2020, our ratio of net debt to total capital (debt net of unrestricted cash divided by stockholders’ equity plus debt net of unrestricted cash) was 19.5% compared to 8.8% at September 30, 2019 and 10.8% at March 31, 2019.

At June 30, 2020, our ratio of debt to total capital (debt divided by stockholders’ equity plus debt) was 43.1% compared to 36.3% at September 30, 2019 and 39.8% at June 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% at September 30, 2019 and 25.3% at June 30, 2019.

Over the long term, we intend to maintain our ratio of net debt to total capital at or below 40%.

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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 COVID-19 and the related disruption in the financial markets we may be limited in accessing the capital markets or the cost of accessing these markets could become more expensive.

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

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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 based on the book value of our real estate assets and unrestricted cash.

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.

At March 31, 2020, there were no borrowings outstanding and $31.0 million of letters of credit issued under the revolving credit facility, resulting in available capacity of $349.0 million.

There were no borrowings or repayments under the facility during the six months ended March 31, 2020.

At June 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 ended June 30, 2020.

In October 2019, the revolving credit facility was amended to extend its maturity date to October 2, 2022.

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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.

At March 31, 2020, we were in compliance with all of the covenants, limitations and restrictions of our revolving credit facility.

In February 2020, we issued $300 million principal amount of 5.0% senior notes issued in February 2020 pursuant to Rule 144A and Regulation S under the Securities Act.

At June 30, 2020, we were in compliance with all of the covenants, limitations and restrictions of our revolving credit facility.

In February 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 mature March 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.

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On or after March 1, 2023, the notes may be redeemed at 102.5% of their principal amount plus any accrued and unpaid interest.

The redemption price decreases annually on a ratable basis to par by March 1, 2026 in accordance with the indenture.

In accordance with the indenture, the redemption price decreases annually thereafter and the notes can be redeemed at par on or after March 1, 2026 through maturity.

The notes are guaranteed by each of our subsidiaries to the extent such subsidiaries guarantee our revolving credit facility.

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and allow to exist certain restrictions on the ability of subsidiaries to pay dividends or make other payments.

At March 31, 2020, we were in compliance with all of the limitations and restrictions associated with our senior note obligations.

On April 20, 2020, our Board of Directors authorized the repurchase of up to $30 million of debt securities.

The authorization becomes effective on April 30, 2020 and has no expiration date.

At June 30, 2020, we were in compliance with all of the limitations and restrictions associated with our senior note obligations.

Effective April 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 at June 30, 2020.

Shelf Registration Statement

In September 2018, we filed a shelf registration statement with the SEC registering $500 million of equity securities.

At March 31, 2020, $394.3 million remains available for issuance under the shelf registration statement.

At June 30, 2020, $394.3 million remains available for issuance under the shelf registration statement.

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.

At March 31, 2020, we had outstanding letters of credit of $31.0 million under the revolving credit facility and surety bonds of $174.6 million, issued by third parties to secure performance under various contracts.

At June 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.

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Operating Cash Flow Activities

In the six months ended March 31, 2020, net cash used in operating activities was $123.8 million compared to $283.5 million in the six months ended March 31, 2019.

The decrease in net cash used in operating activities was principally due to higher lot sales volume and net income in the current year, and a smaller increase in real estate assets in the current year.

In the nine months ended June 30, 2020, net cash used in operating activities was $205.7 million compared to $450.1 million in the nine months ended June 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 six months ended March 31, 2020, net cash provided by investing activities was $3.5 million compared to $0.7 million used in investing activities in the six months ended March 31, 2019.

In the nine months ended June 30, 2020, net cash provided by investing activities was $3.1 million compared to $0.8 million used in investing activities in the nine months ended June 30, 2019.

The cash provided by investing activities in the current year is primarily the result of distributions received from our unconsolidated ventures.

Financing Cash Flow Activities

In the six months ended March 31, 2020, net cash provided by financing activities was $175.7 million, consisting primarily of proceeds from the issuance of $300 million principal amount of 5.0% senior notes which was partially offset by the repayment of $118.9 million principal amount of our 3.75% convertible senior notes at maturity.

In the six months ended March 31, 2019, net cash provided by financing activities was $31.3 million, consisting primarily of proceeds from amounts drawn on the revolving credit facility totaling $40 million, partially offset by repayments totaling $5 million.

In the nine months ended June 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 ended June 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

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Factors and uncertainties that might cause such differences include, but are not limited to:

• the impact of COVID-19 on the economy and our business;

• the impact of C-19 on the economy and our business;

• the effect of D.R.

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• 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 this Quarterly Report on Form 10-Q, may also cause actual results to differ materially from those projected by our forward-looking statements.

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.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis