Forestar Group Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 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 ended September 30, 2020. 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 55 markets in 22 states as of June 30, 2021. In October 2017, we became a majority-owned subsidiary of D.R. Horton. Through our alignment with and support from D.R. Horton, we have grown 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 and consolidating market share in the fragmented U.S. lot development industry. 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 March 2020, the impacts of the COVID-19 pandemic and the related widespread reductions in economic activity began to temporarily affect our business operations and the demand for our residential lots. However, as economic activity and housing market conditions began to improve, our lot sales pace increased during the last half of fiscal 2020 and has remained strong throughout the first nine months of fiscal 2021. We believe we are well positioned to effectively operate through 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. However, multiple disruptions in the supply chain, combined with the improvement in economic conditions and strong demand for residential lots, have resulted in shortages in certain construction materials and tightness in the labor market, which has caused our development cycles to lengthen in certain markets. 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 generates revenues 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. 17 Table of Contents 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 June 30, 2021 and 2020. Operating Results Components of income before income taxes were as follows: Three Months Ended June 30, Nine Months Ended June 30, 2021 2020 2021 2020 (In millions) Revenues $ 312.9 $ 177.9 $ 907.1 $ 584.3 Cost of sales 257.1 157.1 753.8 510.3 Selling, general and administrative expense 16.9 11.2 48.7 32.8 Equity in loss (earnings) of unconsolidated ventures — 0.1 (0.2) (0.6) Gain on sale of assets — — — (0.1) Interest and other income (0.3) (0.8) (1.2) (4.2) Loss on extinguishment of debt 18.1 — 18.1 — Income before income taxes $ 21.1 $ 10.3 $ 87.9 $ 46.1 Lot Sales Residential lots sold consist of: Three Months Ended June 30, Nine Months Ended June 30, 2021 2020 2021 2020 Development projects 3,330 1,556 9,606 4,234 Lot banking projects 528 467 1,407 2,162 3,858 2,023 11,013 6,396 Average sales price per lot (1) $ 80,700 $ 79,900 $ 81,600 $ 83,800 _______________ (1) Excludes any impact from change in contract liabilities. Revenues Revenues consist of: Three Months Ended June 30, Nine Months Ended June 30, 2021 2020 2021 2020 (In millions) Residential lot sales: Development projects $ 274.8 $ 124.5 $ 797.0 $ 340.8 Lot banking projects 36.5 37.1 101.4 195.0 (Increase) decrease in contract liabilities (3.9) 2.8 (3.9) 2.1 307.4 164.4 894.5 537.9 Tract sales and other 5.5 13.5 12.6 46.4 $ 312.9 $ 177.9 $ 907.1 $ 584.3 18 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 ended June 30, 2021, we sold 3,719 residential lots to D.R. Horton for $300.4 million compared to 1,991 residential lots sold to D.R. Horton for $159.3 million in the prior year period. In the nine months ended June 30, 2021, we sold 10,466 residential lots to D.R. Horton for $860.0 million compared to 6,287 residential lots sold to D.R. Horton for $526.0 million in the prior year period. In the three months ended June 30, 2021, we sold 139 residential lots to builders other than D.R. Horton for $10.8 million compared to 32 residential lots sold to builders other than D.R. Horton for $2.3 million in the prior year period. In the nine months ended June 30, 2021, we sold 547 residential lots to builders other than D.R. Horton for $38.4 million compared to 109 residential lots sold to builders other than D.R. Horton for $9.8 million in the prior year period. Tract sales and other revenue in the three months ended June 30, 2021 primarily consisted of 7 tract acres sold to D.R. Horton for $3.0 million. Tract sales and other revenue in the nine months ended June 30, 2021 primarily consisted of 11 tract acres sold to third parties for $1.4 million and 21 tract acres sold to D.R. Horton for $6.0 million. Tract sales and other revenue in the three months ended June 30, 2020 primarily consisted of 30 tract acres sold to D.R. Horton for $13.4 million. Tract sales and other revenue in the nine months ended June 30, 2020 primarily consisted of 588 acres sold to third parties for $25.3 million and 66 tract acres sold to D.R. Horton for $20.6 million. Cost of sales in the three and nine months ended June 30, 2021 increased as compared to the prior year periods primarily due to the increases in the number of lots sold. Cost of sales related to tract sales and other revenue was $3.1 million and $7.4 million in the three and nine months ended June 30, 2021, respectively, compared to $12.8 million and $36.7 million in the three and nine months ended June 30, 2020. Selling, General and Administrative (SG&A) Expense and Other Income Statement Items SG&A expense in the three and nine months ended June 30, 2021 was $16.9 million and $48.7 million compared to $11.2 million and $32.8 million in the prior year periods. SG&A expense as a percentage of revenues was 5.4% in both the three and nine months ended June 30, 2021 compared to 6.3% and 5.6% in the prior year periods. Our SG&A expense primarily consists of employee compensation and related costs. Our business operations employed 232 and 128 employees at June 30, 2021 and 2020, respectively. Equity in earnings of unconsolidated ventures in all periods reflects our share of earnings in ventures that we account for using the equity method. Loss on extinguishment of debt of $18.1 million in the three and nine months ended June 30, 2021 was due to the redemption of our $350 million principal amount of 8.0% senior notes due 2024 in May 2021. Interest and other income primarily represents interest earned on our cash deposits. Income Taxes Our income tax expense for the three and nine months ended June 30, 2021 was $5.2 million and $21.5 million compared to $0.2 million and $8.9 million in the prior year periods. Our effective tax rate was 24.6% and 24.5% for the three and nine months ended June 30, 2021 compared to 1.9% and 19.3% 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 net operating loss (NOL) carryback provisions of the Coronavirus Aid, Relief, and Economic Security Act, which allowed us to carryback a portion of our 2018 NOL. The carryback provisions resulted 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 June 30, 2021, we had deferred tax liabilities, net of deferred tax assets, of $8.5 million. The deferred tax assets were partially offset by a valuation allowance of $1.3 million, resulting in a net deferred tax liability of $9.8 million. At September 30, 2020, deferred tax liabilities, net of deferred tax assets, were $4.2 million. The deferred tax assets were partially offset by a valuation allowance of $1.5 million, resulting in a net deferred tax liability of $5.7 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. 19 Table of Contents Land and Lot Position Our land and lot position at June 30, 2021 and September 30, 2020 is summarized as follows: June 30, 2021 September 30, 2020 Lots owned 64,200 42,400 Lots controlled through land and lot purchase contracts 32,400 18,100 Total lots owned and controlled 96,600 60,500 At June 30, 2021, our lot position consisted of approximately 96,600 residential lots, of which 64,200 were owned and 32,400 were controlled through purchase contracts. Of our total owned residential lots, approximately 21,500 were under contract to sell to D.R. Horton. Additionally, D.R. Horton has the right of first offer on approximately 17,900 of these lots based on executed purchase and sale agreements. At June 30, 2021, lots owned included approximately 4,400 that were fully developed, of which approximately 600 are related to lot banking. At June 30, 2021, we had approximately 900 lots under contract to sell to builders other than D.R. Horton. Liquidity and Capital Resources At June 30, 2021, we had $116.0 million of cash and cash equivalents and $349.8 million of available borrowing capacity on our revolving credit facility. We have no senior note maturities until fiscal 2026. We believe we are well positioned to effectively operate through 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. At June 30, 2021, our ratio of debt to total capital (debt divided by stockholders’ equity plus debt) was 42.1% compared to 42.4% at September 30, 2020 and 43.1% at June 30, 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 37.8% compared to 22.1% at September 30, 2020 and 25.2% at June 30, 2020. 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. 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. Subject to 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. Bank Credit Facility In April 2021, our senior unsecured revolving credit facility was amended to increase its capacity to $410 million with an uncommitted accordion feature that could increase the size of the facility to $600 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. The maturity date of the facility was extended to April 16, 2025. Borrowings and repayments under the facility were $25 million each during the nine months ended June 30, 2021. At June 30, 2021, there were no borrowings outstanding and $60.2 million of letters of credit issued under the revolving credit facility, resulting in available capacity of $349.8 million. 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. At June 30, 2021, we were in compliance with all of the covenants, limitations and restrictions of our revolving credit facility. 20 Table of Contents Senior Notes We have outstanding senior notes as described below that were issued pursuant to Rule 144A and Regulation S under the Securities Act of 1933, as amended. The notes represent senior unsecured obligations that rank equally in right of payment to all existing and future senior unsecured indebtedness and may be redeemed prior to maturity, subject to certain limitations and premiums defined in the respective indenture. The notes are guaranteed by each of our subsidiaries to the extent such subsidiaries guarantee our revolving credit facility. In April 2021, we issued $400 million principal amount of 3.85% senior notes that mature May 15, 2026 with interest payable semi-annually. On or after May 15, 2023, the notes may be redeemed at 101.925% 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 after May 15, 2025 through maturity. The annual effective interest rate of the notes after giving effect to the amortization of financing costs is 4.1%. The net proceeds from this issuance were primarily used to redeem our $350 million principal amount of 8.0% senior notes due April 15, 2024 on May 7, 2021. The redemption price of $365.6 million included a call premium of $14.0 million and accrued and unpaid interest of $1.6 million. We recognized an $18.1 million loss on extinguishment of debt upon the redemption of the notes. Our $300 million principal amount of 5.0% senior notes mature March 1, 2028 with interest payable semi-annually. On or after March 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 after March 1, 2026 through maturity. The annual effective interest rate of the notes after giving effect to the amortization of financing costs is 5.2%. 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 respective 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 our ability and the ability of 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. At June 30, 2021, 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, 2021. Other Note Payable We also have a note payable of $12.5 million that was issued as part of a transaction to acquire real estate for development. The note is non-recourse and is secured by the underlying real estate, accrues interest at 4.0% per annum and matures in October 2023. Issuance of Common Stock We have an effective shelf registration statement filed with the SEC in September 2018, registering $500 million of equity securities, of which $100 million was reserved for sales under our at-the-market equity offering program that became effective August 2020. During the three and nine months ended June 30, 2021, we issued 0.4 million and 1.4 million shares of common stock under our at-the-market equity offering program for proceeds of $9.3 million and $32.6 million, respectively, net of commissions and other issuance costs. At June 30, 2021, $361.0 million remained available for issuance under the shelf registration statement, of which $66.7 million is reserved for sales under our at-the-market equity offering program. 21 Table of Contents 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 June 30, 2021, we had outstanding letters of credit of $60.2 million under the revolving credit facility and surety bonds of $436.6 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. Operating Cash Flow Activities In the nine months ended June 30, 2021, net cash used in operating activities was $340.6 million compared to $205.7 million in the nine months ended June 30, 2020. The cash used in operating activities in both periods was primarily due to the increase in real estate as we continue to grow our land development operations. Investing Cash Flow Activities In the nine months ended June 30, 2021, net cash provided by investing activities was $1.7 million compared to $3.1 million in the nine months ended June 30, 2020. The cash provided by investing activities in both periods was primarily the result of distributions received from our unconsolidated ventures. Financing Cash Flow Activities In the nine months ended June 30, 2021, net cash provided by financing activities was $60.6 million compared to $175.4 million in the nine months ended June 30, 2020. Cash provided by financing activities in the nine months ended June 30, 2021 was primarily the result of proceeds from the issuance of $400 million principal amount of 3.85% senior notes and the issuance of common stock under our at-the-market equity offering program for net proceeds of $32.6 million, which were partially offset by the redemption of our $350 million principal amount of 8.0% senior notes and the related call premium of $14.0 million. Net proceeds in the prior year period primarily consisted of 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. Critical Accounting Policies and Estimates There have been no significant changes in our critical accounting policies or estimates from those disclosed in our 2020 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. 22 Table of Contents 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 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 customers; • the impact of COVID-19 on the economy and our business; • the cyclical nature of the homebuilding and lot development industries and changes in economic, real estate and other conditions; • competitive conditions in our industry; • changes in our business strategy and our ability to achieve our strategic initiatives; • continuing liabilities related to assets that have been sold; • the impact of governmental policies, laws or regulations and actions or restrictions of regulatory agencies; • the cost and availability of property suitable for residential lot development; • general economic, market or business conditions where our real estate activities are concentrated; • our dependence on relationships with national, regional and local homebuilders; • 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; • our ability to succeed in new markets; • the conditions of the capital markets and our ability to raise capital to fund expected growth; • our ability to manage and service our debt and comply with our debt covenants, restrictions and limitations; • the volatility of the market price and trading volume of our common stock; • our ability to hire and retain key personnel; and • the strength of our information technology systems and the risk of cybersecurity breaches and our ability to satisfy privacy and data protection laws and regulations. Other factors, including the risk factors described in Item 1A of our 2020 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. 23 Table of Contents