Item 1B.
Unresolved Staff Comments.
None.
Our principal executive offices are located in Austin, Texas, where we lease approximately 32,000 square feet of office space. We also lease office space in Atlanta, Georgia; Dallas, Texas; Denver, Colorado; Fort Worth, Texas; and Lufkin, Texas. We believe these offices are suitable for conducting our business.
For a description of our properties in our real estate, oil and gas and other natural resources segments, see “Business - Real Estate”, “Business - Oil and Gas” and “Business - Other Natural Resources”, respectively, in Part I, Item 1 of this Annual Report on Form 10-K.
Item 3.
Item 3.
Legal Proceedings.
We are involved directly or through ventures in various legal proceedings that arise from time to time in the ordinary course of doing business. We believe we have established adequate reserves for any probable losses and that the outcome of any of the proceedings should not have a material adverse effect on our financial position or long-term results of operations or cash flows. It is possible, however, that charges related to these matters could be significant to results of operations or cash flow in any single accounting period.
Item 4.
Item 4.
Mine Safety Disclosures.
Not Applicable.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
Our common stock is traded on the New York Stock Exchange. The high and low sales prices in each quarter in 2013 and 2012 were:
Shareholders
Our stock transfer records indicated that as of March 5, 2014, there were approximately 3,501 holders of record of our common stock.
Dividend Policy
We currently intend to retain any future earnings to support our business and do not anticipate paying cash dividends in the foreseeable future. The declaration and payment of any future dividends will be at the discretion of our Board of Directors after taking into account various factors, including without limitation, our financial condition, earnings, capital requirements of our business, the terms of any credit agreements or indentures to which we may be a party at the time, legal requirements, industry practice, and other factors that our Board of Directors deems relevant.
Issuer Purchases of Equity Securities(a)
_____________________
(a)
On February 11, 2009, we announced that our Board of Directors authorized the repurchase of up to 7,000,000 shares of our common stock. We have purchased 2,002,145 shares under this authorization, which has no expiration date. We have
no repurchase plans or programs that expired during the period covered by the table above and no repurchase plans or programs that we intend to terminate prior to expiration or under which we no longer intend to make further purchases.
(b)
Includes shares withheld to pay taxes in connection with vesting of restricted stock awards and exercises of stock options.
Performance Graph
In 2013, we composed an index of our peers consisting of Alexander & Baldwin, Inc., AV Homes Inc., Approach Resources, Inc., BRE Properties, Inc., Consolidated-Tomoka Land Co., Cousins Properties Incorporated, Contango Oil and Gas Co., Goodrich Petroleum Corp., Magnum Hunter Resources Corp., Matador Resources Co., Penn Virginia Corp., Petroquest Energy Inc., Post Properties, Inc., Potlatch Corporation, PS Business Parks, Inc., Resolute Energy Corp., The St. Joe Company, and Tejon Ranch Co. In 2012, we changed our peer group to represent a mix of real estate and oil and gas exploration companies following our acquisition of Credo. Our 2012 custom peer group (Old Custom Peer Index) consisted of AV Homes Inc., Matador Resources Co., Approach Resources, Inc., Bluegreen Corporation, BRE Properties, Inc., Consolidated-Tomoka Land Co., Cousins Properties Incorporated, Contango Oil and Gas Co., Goodrich Petroleum Corp., Magnum Hunter Resources Corp., Penn Virginia Corp., Petroquest Energy Inc., Post Properties, Inc., Potlatch Corporation, Resolute Energy Corp., The St. Joe Company, and Tejon Ranch Co. Our cumulative total shareholder return for the last five years compared to the Russell 2000 Index, New Custom Peer Index, and to the Old Custom Peer Index was as shown in the following graph (assuming $100 invested on January 1, 2008):
Pursuant to SEC rules, returns of each of the companies in the Peer Index are weighted according to the respective company’s stock market capitalization at the beginning of each period for which a return is indicated.
Item 6.
Item 6.
Selected Financial Data.
_____________________
(a)
Real estate segment earnings (loss) include non-cash impairments of $1,790,000 in 2013, $45,188,000 in 2011, $11,271,000 in 2010 and $10,619,000 in 2009. Real estate segment earnings (loss) also include the effects of net (income) loss attributable to noncontrolling interests.
(b)
In 2012, general and administrative expense includes $6,323,000 in costs associated with our acquisition of Credo and in 2011 includes $3,187,000 associated with proposed private debt offerings that we withdrew as a result of deterioration of terms available to us in the credit markets.
(c)
Gain on sale of assets in 2011, 2010 and 2009 represents gains from timberland sales in accordance with our strategic initiatives announced first quarter 2009 and completed in 2011.
(d)
In 2010, other corporate non-operating income principally represents interest income related to a loan to a third-party equity investor in the resort development located at our Cibolo Canyons project. We received payment in full plus interest in fourth quarter 2010.
(e)
In 2013, income tax expense includes a benefit from recognition of $6,326,000 of previously unrecognized tax benefits upon lapse of the statute of limitations for a previously reserved tax position.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Caution Concerning Forward-Looking Statements
This Annual Report on Form 10-K 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:
•
general economic, market or business conditions in Texas or Georgia, where our real estate activities are concentrated;
•
our ability to achieve some or all of our strategic initiatives;
•
the opportunities (or lack thereof) that may be presented to us and that we may pursue;
•
our ability to hire and retain key personnel;
•
significant customer concentration;
•
future residential, multifamily or commercial entitlements, development approvals and the ability to obtain such approvals;
•
obtaining approvals of reimbursements and other payments from special improvement districts and timing of such payments;
•
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, impairment of long-lived assets, income taxes, share-based compensation, oil and gas reserves, revenues, capital expenditures and lease operating expense accruals associated with our oil and gas working interests, and depletion of our oil and gas properties;
•
the levels of resale housing inventory and potential impact of foreclosures in our mixed-use development projects and the regions in which they are located;
•
fluctuations in costs and expenses;
•
demand for new housing, which can be affected by a number of factors including the availability of mortgage credit;
•
demand for multifamily communities, which can be affected by a number of factors including local markets and economic conditions;
•
competitive actions by other companies;
•
changes in governmental policies, laws or regulations and actions or restrictions of regulatory agencies;
•
our realization of the expected benefits since our acquisition of CREDO Petroleum Corporation (Credo);
•
risks associated with oil and gas exploration, drilling and production activities;
•
fluctuations in oil and gas commodity prices;
•
government regulation of exploration and production technology, including hydraulic fracturing;
•
the results of financing efforts, including our ability to obtain financing with favorable terms, or at all;
•
our ability to make interest and principal payments on our debt and satisfy the other covenants contained in our senior secured credit facility, indentures and other debt agreements;
•
our partners’ ability to fund their capital commitments and otherwise fulfill their operating and financial obligations;
•
the effect of limitations, restrictions and natural events on our ability to harvest and deliver timber;
•
inability to obtain permits for, or changes in laws, governmental policies or regulations affecting, water withdrawal or usage;
•
the final resolutions or outcomes with respect to our contingent and other liabilities related to our business; and
•
our ability to execute our growth strategy and deliver acceptable returns from acquisitions and other investments.
Other factors, including the risk factors described in Item 1A of this 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.
Strategy
Our strategy is:
•
Recognizing and responsibly delivering the greatest value from every acre; and
•
Growing through strategic and disciplined investments.
2014 Strategic Initiatives
On February 13, 2014, we announced Growing FORward, new strategic initiatives designed to further enhance shareholder value by:
•
Growing segment earnings through strategic and disciplined investments,
•
Increasing returns, and
•
Repositioning non-core assets.
Results of Operations for the Years Ended 2013, 2012 and 2011
A summary of our consolidated results by business segment follows:
In 2013, we essentially achieved our 2012 Triple in FOR strategic initiatives to triple total segment EBITDA, oil and gas production and total residential lot sales compared with our four-year average from 2008 to 2011. Significant aspects of our results of operations follow:
•
Real estate segment earnings benefited from the sale of Promesa, a 289-unit multifamily property we developed in Austin, for $41,000,000, which generated approximately $10,881,000 in segment earnings. In addition, segment earnings also benefited from increased residential lot sales activity, residential and commercial tract sales and interest income associated with yield accretion from a loan we hold secured by a mixed-use community in Houston.
•
Oil and gas segment earnings decreased principally due to lower oil and gas production volumes associated with royalties and due to reduced lease bonus and delay rental payments received from our owned mineral interests, which were partially offset by higher working interest production volumes and prices attributable to our exploration and production operations principally as result of our acquisition of Credo in third quarter 2012.
•
Other natural resources segment earnings benefited from higher levels of timber harvesting activity driven by increased customer demand compared to 2012. In addition, segment earnings also benefited from a $3,828,000 gain from a partial termination of a timber lease related to land sold from a consolidated venture near Atlanta, Georgia.
•
Share-based compensation increased principally as result of our higher stock price in 2013 and its impact on cash-settled awards.
•
Real estate segment earnings benefited from a $11,675,000 gain from the sale of our 25 percent ownership interest in Palisades West LLC, a $10,180,000 gain from the sale of Broadstone Memorial, a 401-unit multifamily investment property in Houston, $8,247,000 in earnings from an unconsolidated venture’s sale of Las Brisas, a 414-unit multifamily property near Austin, a $3,401,000 gain from a consolidated venture’s bulk sale of 800 acres near Dallas, and increased residential lot and commercial tract sales activity.
•
Oil and gas segment earnings benefited from increased lease bonus revenues, higher production volume and earnings attributable to exploration and production operations from our acquisition of Credo in third quarter 2012, partially offset by lower oil and gas prices and increased depletion and production severance taxes due to higher production volumes.
•
Other natural resources segment earnings increased principally as a result of higher levels of harvesting activity.
•
General and administrative expense includes $6,323,000 in transaction costs paid to outside advisors associated with our acquisition of Credo in 2012.
•
Share-based compensation increased principally as a result of our higher stock price in 2012 and its impact on cash-settled awards.
•
Interest expense includes a $4,448,000 loss on extinguishment of debt in connection with amendment and extension of our term loan.
•
Real estate segment earnings were negatively impacted by $45,188,000 of non-cash impairment charges principally associated with residential development projects located near Atlanta, Denver, and the Texas gulf coast and with our decision to acquire certain assets from CL Realty and TEMCO, ventures in which we owned a 50 percent interest. Segment earnings were positively impacted by increased undeveloped land sales and higher residential lot and tract sales. In addition, segment earnings were positively impacted by $3,083,000 as result of settled litigation and reallocation from us to noncontrolling financial interests of a previously recognized loss related to foreclosure of a lien on a property owned by a consolidated venture.
•
Oil and gas segment earnings declined primarily due to lower lease bonus revenues which was partially offset by increased oil production volumes and higher average oil prices.
•
Other natural resources segment earnings decreased principally due to lower harvest volume as a result of selling over 217,000 acres of timberland since year-end 2008 and increased costs associated with developing our water resources initiatives.
•
General and administrative expenses includes $3,187,000 in costs paid to outside advisors associated with proposed private debt offerings that we withdrew as a result of deterioration of terms available to us in the credit markets.
•
Gain on sale of assets represents the sale of about 57,000 acres of timberland for $87,061,000 in accordance with our 2009 strategic initiatives which we completed in 2011.
Current Market Conditions
U.S. single-family residential market conditions continued to improve in 2013, driven by a growing demand for homes and a tightening supply of homes available for sale. Housing demand has been fueled primarily by job growth, high housing affordability largely due to relatively low mortgage rates, and increased consumer confidence. Inventories of unsold homes are at historically low levels in many areas. In addition, declining finished lot inventories and supply of developable raw land is increasing demand for our developed lots, principally in the major markets of Texas. However, challenging mortgage qualification requirements for purchasers continue to impact housing markets. Multifamily market conditions continue to be strong, with many markets experiencing healthy occupancy levels and positive rent growth. This improvement has been driven primarily by limited housing inventory, reduced single-family mortgage credit availability, and the increased propensity to rent among the 18 to 34 year old demographic of the U.S. population.
Oil prices have continued to strengthen over the last year and generally have been stronger over the last two and one-half years. Gas prices are up over 35 percent from year ago levels, but are significantly lower than realized prices over the last decade. Prolonged cold weather throughout the 2012 - 2013 heating season has taken working gas in storage below the midpoint of the five year average causing gas prices to recover from their lows of a year ago. Exploration and development activity continues to be oil focused due to the premium price of oil over gas when comparing energy equivalency and due to the U.S. being net importers of crude oil while current estimates of domestic gas producing supplies are believed to be sufficient.
Business Segments
We manage our operations through three business segments:
•
Real estate,
•
Oil and gas, and
•
Other natural resources.
We evaluate performance based on earnings before unallocated items and income taxes. Segment earnings consist of operating income, equity in earnings of unconsolidated ventures’, gain on sale of assets, interest income on loans secured by real estate and net (income) loss attributable to noncontrolling interests. Items not allocated to our business segments consist of general and administrative expenses, share-based compensation, gain on sale of strategic timberland, interest expense and other corporate non-operating income and expense. The accounting policies of the segments are the same as those described in the accounting policy note to the consolidated financial statements.
We operate in cyclical industries. Our operations are affected to varying degrees by supply and demand factors and economic conditions including changes in interest rates, availability of mortgage credit, consumer and home builder sentiment, new housing starts, real estate values, employment levels, changes in the market prices for oil, gas, and timber, and the overall strength or weakness of the U.S. economy.
Real Estate
We own directly or through ventures about 130,000 acres of real estate located in ten states and 14 markets. Our real estate segment secures entitlements and develops infrastructure on our lands, primarily for single-family residential and mixed-use communities. We own about 95,000 acres in a broad area around Atlanta, Georgia, with the balance located primarily in Texas. We target investments principally in our strategic growth corridors, regions 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. We own and manage our projects either directly or through ventures. Our real estate segment revenues are principally derived from the sales of residential single-family lots and tracts, undeveloped land and commercial real estate and from the operation of income producing properties, primarily a hotel and multifamily properties we may develop and sell as a merchant builder.
A summary of our real estate results follows:
In 2013, revenues include $41,000,000 from the sale of Promesa, a 289-unit multifamily property we developed in Austin, and $31,595,000 associated with our multifamily construction contracts we received as a general contractor associated with the development of two multifamily venture properties. We are reimbursed for costs paid to subcontractors plus earn a development and construction fee on certain projects, both of which are included in commercial and income producing properties revenue. Revenues associated with multifamily construction contracts were $10,977,000 in 2012.
In 2013, cost of sales include $32,149,000 related to multifamily construction contract costs we incurred as general contractor and paid to sub-contractors associated with our development of two multifamily venture properties, compared to $10,977,000 in 2012. In addition in 2013, cost of sales includes $29,707,000 in carrying value related to Promesa, a 289-unit multifamily property we developed as a merchant builder and sold and a $554,000 loss we incurred as general contractor for one of our multifamily construction projects. Cost of sales includes non-cash impairment charges of $1,790,000 in 2013 associated with a master-planned community and golf club near Dallas. We did not have any non-cash impairment charges in 2012. In 2011, we recorded non-cash impairment charges of $11,525,000 principally associated with owned and consolidated residential development projects near Denver and the Texas gulf coast.
Interest income represents yield accreted from a loan we hold secured by a mixed-use community in Houston in which we have a first lien position.
In 2012, gain on sale of assets principally includes a $11,675,000 gain from the sale of our 25 percent ownership interest in Palisades West LLC, a $10,180,000 gain from the sale of Broadstone Memorial, a 401-unit multifamily investment property in Houston, and a $3,401,000 gain from a consolidated venture’s bulk sale of 800 acres in Dallas.
In 2012, segment results include $8,247,000 in earnings associated with an unconsolidated venture’s sale of Las Brisas, a 414-unit multifamily property near Austin, for $40,400,000. Equity in earnings from unconsolidated ventures includes $11,013,000 in earnings related to this sale, of which ($2,766,000) was allocated to net income attributable to noncontrolling interests.
Equity in earnings (loss) of unconsolidated ventures include non-cash impairment charges of $33,663,000 in 2011 principally associated with our decision to acquire certain assets from our CL Realty and TEMCO ventures. In 2011, as a result of entering into the agreement with CL Realty to acquire certain assets, we offset $2,164,000 of deferred gains against our share of venture losses.
Revenues in our owned and consolidated ventures consist of:
Residential real estate revenues principally consist of the sale of single-family developed lots to national, regional and local homebuilders. In 2013 and 2012, residential real estate revenues increased principally as a result of higher lot sales volume due to increased demand for finished lot inventory by homebuilders in markets where supply has diminished.
In 2013 and 2012, commercial tract sales benefited from increased demand in our Texas markets as commercial credit became more readily available to third-party purchasers. In 2013, we sold 99 commercial acres for $17,398,000 or $176,000 per acre from our owned and consolidated projects located in San Antonio, Dallas, Austin and Houston, which generated combined segment earnings of $11,687,000. In 2012, we sold 83 commercial acres for $9,551,000 or $114,800 per acre from our owned and consolidated projects located in San Antonio, Houston, Dallas and Fort Worth, of which, $929,000 of profit was deferred as result of our continued involvement in post-closing construction obligations and will be recognized using the percentage of completion method. These sales generated combined segment earnings of $5,359,000.
Market conditions for undeveloped land sales remains challenging due to limited credit availability, low consumer confidence and alternate investment options to buyers in the marketplace. In 2013, undeveloped land sales generated $10,788,000 in segment earnings due to sale of 6,700 acres for $22,757,000, or approximately $3,400 per acre. In 2012, undeveloped land sales include the sale of 6,800 acres for $12,800,000 in three retail transactions resulting in combined segment earnings of $9,700,000. In 2011, undeveloped land sales include the bulk sale of 9,700 acres in Georgia for $17,980,000, resulting in segment earnings of $13,396,000.
In 2013, segment results benefited from the sale of Promesa, a 289-unit multifamily property in Austin which we developed as a merchant builder and operated until the sale. As a result, we recognized segment earnings of $10,881,000 related to its sale for $41,000,000. In addition, in 2013, income producing properties revenue increased primarily as a result of construction revenues of $31,595,000 associated with our multifamily guaranteed maximum price construction contracts as general contractor compared to construction revenues of $10,977,000 in 2012.
In 2013, revenues related to our 413 guest room hotel in Austin were down $1,140,000 when compared with 2012, primarily from lower food and beverage revenues due to increased renovation activity.
Other revenues primarily result from sale of stream and impervious cover credits to homebuilders.
Units sold in our owned and consolidated ventures consist of:
Operating expenses consist of:
In 2013 and 2012, employee compensation and benefits increased when compared with 2011, primarily due to higher incentive compensation as a result of our improved operating results and value creation activities. In 2013, the increase in higher incentive compensation was somewhat offset by a decrease in other employee compensation and benefits expense primarily related to staffing changes.
Other operating expenses for 2013 includes a $776,000 loss on retirement of assets associated with capital improvements at our hotel and a $583,000 loss on sale of assets related to a project in Austin.
Information about our real estate projects and our real estate ventures follows:
We underwrite real estate development projects based on a variety of assumptions incorporated into our development plans, including the timing and pricing of sales and leasing and costs to complete development. Our development plans are periodically reviewed in comparison to our return projections and expectations, and we may revise our plans as business conditions warrant. If as a result of changes to our development plans the anticipated future net cash flows are reduced such that our basis in a project is not fully recoverable, we may be required to recognize a non-cash impairment charge for such project.
Our net investment in owned and consolidated real estate by geographic location at year-end 2013 follows:
Approximately 64 percent of our net investment in real estate is in the major markets of Texas.
As of year-end 2013, multifamily community projects under various stages of development are as follows:
_____________________
(a)
Acquired development site planned for future construction.
(b)
We may develop and own these projects directly or through ventures. In January 2014, we formed a venture to develop our Westmont project in which our ownership interest is 30 percent.
(c)
Estimated project costs represent the estimated costs of the project through stabilization. Significant estimation is required to derive these costs and final costs may differ from these estimates. The projected stabilization dates are also estimates and are subject to change as the project proceeds through the development process.
(d)
Estimated stabilization represents the quarter within which we estimate the project will achieve 90% economic occupancy.
Oil and Gas
Our oil and gas segment is focused on the exploration, development and production of oil and gas on our owned and leasehold mineral interests.
We lease portions of our 590,000 owned net mineral acres located principally in Texas, Louisiana, Georgia and Alabama to other oil and gas companies in return for a lease bonus, delay rentals and a royalty interest, and we may negotiate an option to participate in oil and gas exploration and development or we may elect to drill as an operator. At year-end 2013, we have about 30,000 net acres under lease to others with expiration dates ranging between 2014 to 2018, and about 36,000 net acres leased that are held by production related to our owned mineral interests and 547 gross productive wells operated by others on our owned mineral acres.
On September 28, 2012, we acquired 100 percent of the outstanding common stock of Credo in an all cash transaction for $14.50 per share, representing an equity purchase price of approximately $146,445,000. In addition, we paid in full $8,770,000 of Credo’s outstanding debt. Credo was an independent oil and gas exploration, development and production company based in Denver, Colorado. The acquired assets included leasehold interests in the Bakken and Three Forks formations of North Dakota, the Lansing - Kansas City formation in Kansas and Nebraska, and the Tonkawa and Cleveland formations in Texas.
With this acquisition, we became an independent oil and gas exploration, development and production company. As of year-end 2013, our leasehold interests include 247,000 net mineral acres leased from others principally located in Nebraska and Kansas primarily targeting the Lansing - Kansas City formation, in the Texas Panhandle primarily targeting the Tonkawa and Cleveland formations, and in North Dakota primarily targeting the Bakken and Three Forks formations. Our leasehold interests include approximately 7,000 net mineral acres in the Bakken and Three Forks formations. We have 37,000 net acres held by production and 464 gross oil and gas wells with working interest ownership, of which 182 are operated by us.
A summary of our oil and gas results follows:
Our 2013 oil and gas results include full year results attributed to exploration and production operations related to our acquisition of Credo, which generated $50,894,000 in revenues and $7,112,000 in segment earnings.
Oil and gas segment earnings decreased in 2013 principally due to lower oil and gas production volumes, lower oil prices associated with royalties, and reduced lease bonus and delay rental payments received from our owned mineral interests, which were partially offset by higher working interest production volumes and prices and earnings attributable to exploration and production operations as result of our acquisition of Credo in third quarter 2012. In addition, dry hole and seismic exploration costs were $10,486,000 in 2013 compared with $1,754,000 in 2012. This increase is as a result of higher level of drilling activity in Kansas and Nebraska.
In 2013, gain on sale of $1,333,000 is related to assigning our leasehold interests in 1,365 net mineral acres in Oklahoma to third parties for a three-year term.
Equity in earnings of unconsolidated ventures includes our share of royalty revenue from producing wells in the Barnett Shale gas formation.
Revenues consist of:
_____________________
(a)
Oil production includes revenues from oil, condensate and natural gas liquids (NGLs). In 2013, 2012 and 2011, NGLs accounted for $1,639,000, $2,685,000, and $1,051,000 of oil production revenues.
In 2013, oil and gas production revenues from exploration and production operations increased due to our acquisition of Credo at third quarter-end 2012. Increased oil production contributed $32,766,000 and higher oil prices contributed $5,643,000. Increased gas production contributed about $2,299,000 and higher gas prices contributed $51,000. In 2013, oil and gas production royalty revenues from our owned mineral interests decreased principally as a result of lower production volumes and lower oil prices. Decreased oil production volume negatively impacted revenues by $7,293,000 and lower oil prices by $329,000. Decreased gas production volume negatively impacted revenues by $1,022,000, offset by higher gas prices increasing revenues by $718,000 compared with 2012.
In 2012, oil and gas production revenues from exploration and production operations related to our acquisition of Credo at third quarter-end 2012 contributed $9,318,000 and $817,000 of oil production and gas production revenues. In 2012, oil and gas production royalty revenues from our owned mineral interests increased principally as a result of increased oil and gas production which was partially offset by decreases in oil and gas prices. Decrease in oil price is due to impact of decrease in prices of NGLs. Increased oil production contributed about $9,955,000 which was offset by about $2,392,000 due to a decrease in oil prices. Increased gas production contributed about $1,257,000 which was offset by about $1,991,000 due to a decrease in gas prices.
In 2013, other revenues include $2,486,000 in lease bonus payments received from leasing 9,200 owned mineral acres to third parties for an average of about $270 per acre and $588,000 related to delay rental payments received compared to $5,319,000 in lease bonus payments received from leasing 8,900 owned mineral acres to third parties for an average of about $600 per acre and $2,219,000 related to delay rental payments received in 2012.
Oil and gas produced and average unit prices related to our royalty and working interests follows:
_____________________
(a)
Oil production includes natural gas liquids (NGLs).
(b)
Gas is converted to barrels of oil equivalent (BOE) using the conversion of six Mcf to one barrel of oil.
In 2013, operations acquired with Credo produced approximately 526,400 barrels of oil at an average price of $90.66 per barrel and 856 MMcf of gas at an average price of $3.70 per Mcf.
In fourth quarter 2012, operations acquired with Credo produced approximately 116,600 barrels of oil at an average price of $79.94 per barrel and 225 MMcf of gas at an average price of $3.64 per Mcf.
At year-end 2013, there were 1,011 productive gross wells of which 547 were operated by others on our owned mineral acres and 473 wells on our leased mineral acres, of which 182 were operated by us. At year-end 2012, there were 936 productive gross wells of which 542 were operated by others on our owned mineral acres and 394 wells were associated with our third quarter acquisition of Credo, of which 136 were operated by us. At year-end 2011, there were 530 productive gross wells that were operated by others on our owned mineral acres.
Cost of oil and gas producing activities consists of:
Depletion and amortization represent non-cash costs of producing oil and gas associated with our working interests and are computed based on the units of production method. Production costs principally represent our share of production severance taxes related to both our royalty and working interests and lease operating expenses associated with working interest wells. Exploration costs principally represent exploratory dry hole costs, geological and geophysical and seismic study costs. In 2013 and 2012, cost of oil and gas producing activities includes $38,825,000 and $6,892,000 related to operations acquired from Credo in third quarter 2012.
Operating expenses consist of:
In 2013, operating expenses increased as a result our acquisition of Credo in third quarter 2012 and staffing to operate as an independent exploration, development and production company.
Oil and Gas Owned Mineral Interests
A summary of our oil and gas owned mineral interests(a) at year-end 2013 follows:
_____________________
(a)
Includes ventures.
(b)
Includes leases in primary lease term or for which a delayed rental payment has been received. In the ordinary course of business, leases covering a significant portion of leased owned mineral acres may expire from time to time in a single reporting period.
(c)
Acres being held by production are producing oil or gas in paying quantities.
(d)
Texas, Louisiana, California and Indiana net acres are calculated as the gross number of surface acres multiplied by our percentage ownership of the mineral interest. Alabama and Georgia net acres are calculated as the gross number of surface acres multiplied by our estimated percentage ownership of the mineral interest based on county sampling.
Oil and Gas Mineral Interests Leased
A summary of our net oil and gas mineral acres leased from others at year-end 2013, principally as a result of operations acquired from Credo, follows:
_____________________
(a)
Excludes approximately 8,000 net acres of overriding royalty interests.
Other Natural Resources
Our other natural resources segment manages our timber holdings, recreational leases and water resource initiatives. We have about 117,000 acres of timber we own directly or through ventures, primarily in Georgia, and about 14,000 acres of timber under lease. Our other natural resources segment revenues are principally derived from the sales of wood fiber from our land and leases for recreational uses. In addition, we have water interests in about 1.5 million acres, including a 45 percent nonparticipating royalty interest in groundwater produced or withdrawn for commercial purposes or sold from approximately 1.4 million acres in Texas, Louisiana, Georgia and Alabama and about 20,000 acres of groundwater leases in central Texas. We have not received significant revenue or earnings from these interests.
A summary of our other natural resources results follows:
In 2013, other natural resources segment earnings increased principally as a result of higher average prices and increased harvesting activity compared with 2012 and a $3,828,000 gain associated with partial termination of a timber lease related to 2,400 acres of undeveloped land sold in Georgia from a consolidated venture.
Revenues consist of:
Fiber sold consists of:
In 2013, total fiber tons sold increased principally as a result of accelerated harvesting levels to meet customer demand. The majority of our fiber sales were to International Paper at market prices.
Information about our recreational leases follows:
Operating expenses consist of:
The increase in employee compensation and benefits in 2013 compared with 2012 was primarily due to staff additions to support our water operations. The decrease in professional and consulting services in 2013 when compared to 2012 was primarily due to additional professional fees incurred in 2012 related to obtaining or extending groundwater leases.
Items Not Allocated to Segments
Unallocated items represent income and expenses managed on a company-wide basis and include general and administrative expenses, share-based compensation, gain on sale of strategic timberland, interest expense and other corporate non-operating income and expense. General and administrative expenses principally consist of accounting and finance, tax, legal, human resources, internal audit, information technology and our board of directors. These functions support all of our business segments and are not allocated.
General and administrative expense
General and administrative expenses consist of:
In 2013 and 2012, employee compensation and benefits increased primarily due to higher incentive compensation associated with our improved operating results and value creation activities. In 2012, professional services include $6,323,000 in transaction costs paid to outside advisors associated with our acquisition of Credo. In 2011, professional services include $3,187,000 in costs paid to outside advisors associated with proposed private debt offerings that we withdrew as a result of deterioration in terms available to us in the capital markets.
Share-based compensation expense
Our share-based compensation expense fluctuates because a portion of our awards are cash settled and as a result are affected by changes in the market price of our common stock. In 2013 and 2012, share-based compensation increased when compared with 2011 principally as a result of increase in our stock price and its impact on cash-settled awards. Our share price increased by 23 percent in 2013 since year-end 2012 and increased by 15 percent in 2012 since year-end 2011.
Gain on sale of assets
Gain on sale of assets represents gains associated with our 2009 strategic initiatives, which we completed in 2011. In 2011, we recognized gains of $61,784,000 from the sale of 57,000 acres of timberland.
Interest expense
The increase in interest expense in 2013 is primarily due to additional interest expense associated with the issuance of 3.75% convertible senior notes in February 2013 when compared with interest expense in 2012, which includes $4,448,000 loss on extinguishment of debt in connection with the 2012 amendment and extension of our term loan. Interest expense in 2012, excluding loss on extinguishment of debt, decreased when compared with 2011 principally due to lower interest rates and lower average levels of debt outstanding.
Income taxes
Our effective tax rate and the benefit attributable to noncontrolling interests was 17 percent and five percent in 2013, 31 percent and seven percent in 2012, and 25 percent and six percent in 2011. Our 2013 rate includes a 15 percent benefit from the recognition of previously unrecognized tax benefits due to lapse of the statute of limitations for a previously reserved tax position as well as benefits from percentage depletion. Our 2012 rate includes benefits from percentage depletion and a detriment from nondeductible acquisition expenses and our 2011 rate includes benefits from percentage depletion and charitable contributions related to timberland conservation.
We have not provided a valuation allowance for our federal deferred tax asset because we believe it is likely it will be recoverable in future periods based on considerations including taxable income in prior carryback years, future reversals of existing temporary differences, tax planning strategies and future taxable income. If these sources of income are not sufficient in future periods, we may be required to provide a valuation allowance for our deferred tax asset.
Capital Resources and Liquidity
Sources and Uses of Cash
We operate in cyclical industries and our cash flows fluctuate accordingly. Our principal cash requirements are for the acquisition and development of real estate and investment in oil and gas leasing and production activities, either directly or indirectly through ventures, taxes, interest and compensation. Our principal sources of cash are proceeds from the sale of real estate and timber, the cash flow from oil and gas and income producing properties, borrowings, and reimbursements from utility and improvement districts. Our cash flows are affected by the timing of the payment of real estate development expenditures and the collection of proceeds from the eventual sale of the real estate, the timing of which can vary substantially depending on many factors including the size of the project, state and local permitting requirements and availability of utilities, and by the timing of oil and gas leasing and production activities. Working capital is subject to operating needs, the timing of sales of real estate and timber, oil and gas leasing and production activities, collection of receivables, reimbursement from utility and improvement districts and the payment of payables and expenses.
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 be in discussions with respect to the purchase or sale of our common stock, debt securities, convertible securities or a combination thereof.
Cash Flows from Operating Activities
Cash flows from our real estate development activities, undeveloped land sales, income producing properties, timber sales, income from oil and gas properties and recreational leases and reimbursements from utility and improvement districts are classified as operating cash flows.
In 2013, net cash provided by operations was $88,777,000 primarily due to higher earnings and due to the sale of Promesa, a 289-unit multifamily property we developed and sold for $41,000,000, of which $10,881,000 is included in pre-tax income and $29,707,000 of carrying value is included in real estate cost on sales on the statement of cash flows. These cash flows were partially offset by real estate development and acquisition expenditures, which includes the acquisition of one community development site in Nashville for $6,841,000, an additional tract on a previously acquired multifamily site in Charlotte for $4,849,000 and the acquisition of a multifamily site in Littleton, Colorado for $13,553,000.
In 2012, net cash used for operations was $22,218,000 principally due to expenditures for real estate development and acquisitions significantly exceeding non-cash real estate cost of sales, principally as result of acquiring real estate assets from CL Realty and Temco for $47,000,000. Subsequent to closing of this acquisition, we received $23,370,000 from the ventures, representing our pro-rata share of distributable cash. We invested $17,334,000 in construction of a 289-unit multifamily development property near Austin which was completed at year-end 2012. We acquired two multifamily development sites in Charlotte and Nashville for $16,651,000, acquired a single-family development project near Dallas for $8,951,000 and we paid $21,678,000 in federal and state taxes, net of refunds. In addition, we received $24,294,000 in net proceeds from a consolidated venture’s bulk sale of 800 acres near Dallas, $10,759,000 in reimbursements from two new multifamily ventures which represents our venture partners’ pro-rata share of costs we previously incurred and $8,524,000 in reimbursements from utility and improvement districts.
In 2011, net cash provided by operations was $39,852,000 principally due to the sale of 57,000 acres of timberland in accordance with our 2009 strategic initiatives generating net proceeds of $86,018,000. Expenditures for development and acquisitions exceeded non-cash real estate cost of sales principally due to our acquisition of a non-performing loan secured by a lien on approximately 900 acres of developed and undeveloped land near Houston for $21,137,000 and $32,789,000 in real estate acquisitions principally located in various Texas markets. We received $10,461,000 in reimbursements from utility and
improvement districts, of which $8,656,000 was related to our Cibolo Canyons project and was accounted for as a reduction of our investment. We paid $25,335,000 in federal and state income taxes, net of refunds.
Cash Flows from Investing Activities
Capital contributions to and capital distributions from unconsolidated ventures, business acquisitions and investment in oil and gas properties and equipment are classified as investing activities. In addition, proceeds from the sale of property and equipment, software costs and expenditures related to reforestation activities are also classified as investing activities.
In 2013, net cash used for investing activities was $103,927,000 principally due to our investment of $96,069,000 in oil and gas properties and equipment associated with our exploration and production operations. In addition, we invested $11,828,000 in property and equipment, software and reforestation of which $7,245,000 is related to capital expenditures on our 413 guest room hotel in Austin.
In 2012, net cash used for investing activities was $105,119,000 principally due to our acquisition of Credo for approximately $152,915,000 including debt, net of cash acquired. In addition, we invested $21,416,000 in oil and gas properties and equipment. Partially offsetting our investment in Credo and oil and gas properties were proceeds received from the sale of our 25 percent ownership interest in Palisades West LLC for $32,095,000 and $29,474,000 in net proceeds from the sale of Broadstone Memorial, a 401-unit multifamily investment property in Houston. We also invested $2,735,000 in property and equipment, software and reforestation and received $10,336,000 in net distributions from unconsolidated ventures, of which $6,850,000 is associated with a venture’s sale of Las Brisas, a 414-unit multifamily property near Austin.
In 2011, net cash used for investing activities was $4,895,000. We invested $4,304,000 in oil and gas properties and equipment associated with our working interests and $2,044,000 in property, equipment, software and reforestation. Net cash return of investment in our unconsolidated ventures was $1,060,000.
Cash Flows from Financing Activities
In 2013, net cash provided by financing activities was $197,096,000 principally due to net proceeds of $120,795,000 from the issuance of 3.75% convertible senior notes and net proceeds of $144,998,000 from the issuance of 6.00% tangible equity units partially offset by net debt repayments of $106,076,000, of which $68,000,000 is related to payoff of debt outstanding under our revolving line of credit and $18,902,000 is related to paying off a loan associated with Promesa. We plan to use the remaining net proceeds from the issuance of our convertible senior notes and tangible equity units for general corporate purposes, including investments in oil and gas exploration and drilling and real estate acquisition and development.
In 2012, net cash provided by financing activities was $119,415,000. Our net increase in borrowings of $129,416,000 was principally used to fund our acquisition of Credo and our real estate development and acquisition expenditures and our investment in oil and gas properties. We paid $5,883,000 in financing fees primarily related to the amendment and extension of our senior secured credit facility. Also, in 2012, our other consolidated debt decreased by $57,491,000, of which $26,500,000 was due to the sale of Broadstone Memorial, a 401-unit multifamily investment property in Houston and the buyer’s assumption of the debt and $30,991,000 was due to our consolidated venture’s bulk sale of 800 acres in Dallas and the buyer’s assumption of debt. We also purchased about 94,450 shares of our common stock for $1,409,000 which was offset by $1,159,000 in proceeds from exercise of stock options.
In 2011, net cash used for financing activities was $22,040,000 as we repurchased about 907,000 shares of our common stock for $12,977,000 and incurred $3,750,000 in deferred financing fees primarily related to supplementing and amending our senior secured credit facility.
Real Estate Acquisition and Development Activities
We secure entitlements and develop infrastructure, primarily for single family residential and mixed-use communities. We also develop and own directly or through ventures multifamily communities as income producing properties, primarily in our target markets. Once these multifamily communities reach stabilization, we market the properties for sale.
We categorize real estate development and acquisition expenditures as operating activities on the statement of cash flows. These development and acquisition expenditures include costs for development of residential lots and mixed-used communities and multifamily community projects we develop and sell as a merchant builder.
A summary of our real estate acquisition and development expenditures is shown below:
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(a)
Includes reimbursements received from the ventures for land and pre-development costs.
Drilling and Other Exploration and Development Activities
In 2013, we drilled or participated as a non-operator in approximately 120 gross wells (47 net). At year-end 2013, there were 1,011 gross productive wells.
In 2013, we acquired leasehold interests principally in Nebraska, Kansas, Texas, Oklahoma and North Dakota for $35,806,000 representing over 100,000 net mineral acres. Also, leasehold interests of approximately 30,000 net mineral acres expired in the normal course of business in year 2013.
Regional allocation of our capital expenditures incurred and paid for drilling and completion activity in 2013 is shown below:
Our total cash capital expenditures for leasehold acquisitions, drilling and completion costs were $96,069,000 in 2013. Our accrued capital expenditures for leasehold acquisitions and drilling and completion costs at year-end 2013 were $12,976,000 and are included in other accrued expense in our consolidated balance sheets. These oil and gas property additions will be reflected as cash used for investing activities in the period the accrued payables are settled.
Liquidity
At year-end 2013, our senior secured credit facility provides for a $200,000,000 term loan maturing September 14, 2017, and a $200,000,000 revolving line of credit maturing September 14, 2015 (with a one-year extension option). Both the term loan and the revolving loan bear interest, at our option, using either (i) the LIBOR rate plus 4% or (ii) 3% plus the greater of (a) KeyBank prime rate, (b) Federal funds rate plus one-half percent, or (c) LIBOR rate plus 1%. The term loan and revolving line of credit may be prepaid at any time without penalty. The revolving line of credit includes a $100,000,000 sublimit for letters of credit, of which $3,653,000 is outstanding at year-end 2013. Total borrowings under our senior secured credit facility (including the face amount of letters of credit) may not exceed a borrowing base formula.
At year-end 2013, net unused borrowing capacity under our senior secured credit facility is calculated as follows:
Our net unused borrowing capacity during 2013 ranged from a high of $196,347,000 to a low of $164,685,000. This facility is used primarily to fund our operating cash needs, which fluctuate due to timing of residential real estate sales, undeveloped land sales, oil and gas leasing and production activities and mineral lease bonus payments received, timber sales, payment of accounts payables and expenses and capital expenditures.
Our senior secured credit facility and other debt agreements contain financial covenants customary for such agreements including minimum levels of interest coverage and limitations on leverage. At year-end 2013, we were in compliance with the financial covenants of these agreements.
The following table details our compliance with the financial and other covenants calculated as provided in the senior secured credit facility:
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(a)
Calculated as EBITDA (earnings before interest, taxes, depreciation, depletion and amortization), plus non-cash compensation expense, plus other non-cash expenses, divided by interest expense excluding loan fees. This covenant is applied at the end of each quarter on a rolling four quarter basis.
(b)
Calculated as total gross revenues (excluding revenues of the Credo entities), plus our pro rata share of the operating revenues from unconsolidated ventures, divided by capital expenditures. Capital expenditures are defined as consolidated development and acquisition expenditures plus our pro rata share of unconsolidated ventures’ development and acquisition expenditures. This covenant is applied at the end of each quarter on a rolling four quarter basis.
(c)
Calculated as total funded debt divided by adjusted asset value. Total funded debt includes indebtedness for borrowed funds, secured liabilities, reimbursement obligations with respect to letters of credit or similar instruments, and our pro-rata share of joint venture debt outstanding. Adjusted asset value is defined as the sum of unrestricted cash and cash equivalents, timberlands, high value timberlands, raw entitled lands, entitled land under development, minerals business, Credo asset value, special improvement district receipts (SIDR) reimbursements value, Cibolo resort special improvement district hotel occupancy tax (SIDHT) value and other real estate owned at book value without regard to any indebtedness and our pro rata share of joint ventures’ book value without regard to any indebtedness. This covenant is applied at the end of each quarter.
(d)
Calculated as the amount by which consolidated total assets (excluding Credo acquisition goodwill over $50,000,000) exceeds consolidated total liabilities. At year-end 2013, the requirement is $572,799,000 computed as: $460,765,000 plus 85 percent of the aggregate net proceeds received by us from any equity offering, plus 75 percent of all positive net income, on a cumulative basis. This covenant is applied at the end of each quarter.
(e)
Calculated as the total collateral value of timberland, high value timberland and our minerals business, raw entitled land that is part of mortgaged property, Credo asset value, SIDR reimbursements value, SIDHT value divided by total aggregate loan commitment. This covenant is applied at the end of each quarter.
To make additional investments, acquisitions, or distributions, we must maintain available liquidity equal to 10 percent of the aggregate commitments in place. At year-end 2013 the minimum liquidity requirement was $40,000,000, compared with $353,549,000 in actual available liquidity based on the net unused borrowing capacity under our senior secured credit facility plus unrestricted cash and cash equivalents. As of year-end 2013, we were in compliance with these requirements. The failure to maintain such minimum liquidity does not constitute a default or event of default of our senior secured credit facility. In addition, we may elect to make distributions so long as the total leverage ratio is less than 30%, the interest coverage is greater than 3.0:1.0, the revenues / capital expenditures ratio exceeds 1.5:1.0, and available liquidity is not less than $125,000,000. At year-end 2013, our total leverage ratio exceeded 30 percent and as a result we are prohibited from making distributions until the above conditions are satisfied.
3.75% Convertible Senior Notes due 2020
On February 26, 2013, we issued $125,000,000 aggregate principal amount of 3.75% Convertible Senior Notes due 2020 (Notes). The Notes pay interest semiannually at a rate of 3.75 percent per annum and mature on March 1, 2020. The Notes have an initial conversion rate of 40.8351 per $1,000 principal amount (equivalent to a conversion price of approximately $24.49 per share of common stock and a conversion premium of 37.5 percent based on the closing share price of $17.81 per share of our common stock on February 20, 2013). The initial conversion rate is subject to adjustment upon the occurrence of certain events. Prior to November 1, 2019, the Notes are convertible only upon certain circumstances, and thereafter are convertible at any time prior to the close of business on the second scheduled trading day prior to maturity. Upon conversion, holders will receive cash, shares of our common stock or a combination thereof at our election.
Net proceeds from the offering were used to repay $68,000,000 under our revolving line of credit, the balance to be used for general corporate purposes, including investments in oil and gas exploration and drilling and real estate acquisition and development.
6.00% Tangible Equity Units
On November 27, 2013, we issued $150,000,000 aggregate principal amount of 6.00% tangible equity units (Units). The total offering was 6,000,000 Units, including an over-allotment option of 600,000 exercised by the underwriters, each with a stated amount of $25.00. Each Unit is comprised of (i) a prepaid stock purchase contract to be settled by delivery of a number of shares of our common stock, par value $1.00 per share to be determined pursuant to a purchase contract agreement, and (ii) a senior amortizing note due December 15, 2016 that has an initial principal amount of $4.2522, bears interest at a rate of 4.50% per annum and has a final installment payment date of December 15, 2016. The aggregate principal amount of the senior amortizing notes is $25,619,000. The aggregate number of shares we may issue upon settlement of the stock purchase contracts will between 6,547,900 shares (the minimum settlement rate) and 7,857,500 (the maximum settlement rate).
Net proceeds of $144,998,000 from the issuance of the Units are designated for general corporate purposes, including investments in strategic growth opportunities.
Contractual Obligations
At year-end 2013, contractual obligations consist of:
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(a)
Items included in our balance sheet.
Interest payments on debt include interest payments related to our fixed rate debt and estimated interest payments related to our variable rate debt. Estimated interest payments on variable rate debt were calculated assuming that the outstanding balances and interest rates that existed at year-end 2013 remain constant through maturity.
Purchase obligations are defined as legally binding and enforceable agreements to purchase goods and services. Our purchase obligations include commitments of $11,907,000 for land acquisition and development related to community development projects and commitments of $39,017,000 for engineering and construction contracts associated with multifamily projects. The multifamily project obligations typically are reimbursed by equity method ventures on jointly owned projects or funded by construction loan draws on wholly-owned projects.
Our operating leases are for timberland, facilities, equipment and groundwater. In 2008, we entered into a 10-year agreement to lease approximately 32,000 square feet in Austin, Texas as our corporate headquarters. At year-end 2013, the remaining contractual obligation is $6,853,000. Also included in operating leases is a long-term timber lease of about 14,000 acres that has a remaining lease term of 12 years and a remaining contractual obligation of $3,857,000 and about 20,000 acres of groundwater leases in central Texas with remaining contractual obligations of $2,019,000.
Off-Balance Sheet Arrangements
From time to time, we enter into off-balance sheet arrangements to facilitate our operating activities. At year-end 2013, our off-balance sheet unfunded arrangements, excluding contractual interest payments, purchase obligations, operating lease obligations and venture contributions included in the table of contractual obligations, consist of:
Performance bonds, letters of credit and recourse obligations provided on behalf of certain ventures would be drawn on due to failure to satisfy construction obligations as general contractor or for failure to timely deliver streets and utilities in accordance with local codes and ordinances. In connection with our unconsolidated venture operations, at year-end 2013 we have provided performance bonds and letters of credit aggregating $26,587,000, of which $26,577,000 is related to the development and construction of a 257-unit multifamily property in Austin estimated to be completed in second quarter 2014.
In 2012, CJUF III RH Holdings, an equity method venture in which we own a 25 percent interest, obtained a senior secured construction loan in the amount of $23,936,000 to develop a 257-unit multifamily property in downtown Austin, of which $18,492,000 was outstanding at year-end 2013. We have a construction completion guaranty, a repayment guaranty for 20 percent of the principal balance and unpaid accrued interest, and a standard non-recourse carve-out guaranty. The repayment guaranty will reduce from 20 percent to 0 percent upon achievement of certain conditions.
In 2012, FMF Peakview, an equity method venture in which we own a 20 percent interest, obtained a senior secured construction loan in the amount of $31,550,000 to develop a 304-unit multifamily property in Denver, of which $12,533,000 was outstanding at year-end 2013. We have a construction completion guaranty, a repayment guaranty for 25 percent of the principal and unpaid accrued interest, and a standard non-recourse carve-out guaranty.
On January 17, 2014, a venture in which we own a 30 percent interest obtained a senior secured construction loan in the amount of $51,950,000 to develop a 320-unit multifamily project located in Nashville, Tennessee. The loan is secured by a lien on the project land and improvements to be constructed, and by a collateral assignment of present and future leases and rents. We provided the lender with a guaranty of completion of the improvements; a guaranty of repayment of 25 percent of the principal, repayment of all accrued and unpaid interest, and payment of all operating expenses of the project (except for certain expenses); and a standard nonrecourse carve-out guaranty. The principal guaranty will reduce from 25 percent to zero percent of the principal upon achievement of certain conditions.
At year-end 2013, we participate in three equity method partnerships that are variable interest entities. The partnerships have total assets of $11,304,000 and total liabilities of $43,910,000, which includes $27,277,000 of borrowings classified as current maturities. These partnerships are managed by third parties who intend to extend or refinance these borrowings; however, there is no assurance that this can be done. Although these borrowings are guaranteed by third parties, we may under certain circumstances elect or be required to provide additional equity to these partnerships. We do not believe that the ultimate resolution of these matters will have a significant effect on our earnings or financial position. Our investment in these partnerships is $17,000 at year-end 2013.
Cibolo Canyons - San Antonio, Texas
Cibolo Canyons consists of the JW Marriott® San Antonio Hill Country Resort & Spa development owned by third parties and a mixed-use development we own. We have about $77,957,000 invested in Cibolo Canyons at year-end 2013.
Resort Hotel, Spa and Golf Development
In 2007, we entered into agreements to facilitate third-party construction and ownership of the JW Marriott ® San Antonio Hill Country Resort & Spa, which includes a 1,002 room destination resort and two PGA Tour ® Tournament Players Club ® (TPC) golf courses. Under these agreements, we agreed to transfer to third-party owners 700 acres of undeveloped land, to provide $30,000,000 cash and to provide $12,700,000 of other consideration principally consisting of golf course construction materials, all of which has been provided.
In exchange for our commitment to the resort, the third-party owners assigned to us certain rights under an agreement between the third-party owners and a legislatively created Special Improvement District (SID). This agreement includes the right to receive from the SID nine percent of hotel occupancy revenues and 1.5 percent of other resort sales revenues collected as taxes by the SID through 2034. The amount we receive will be net of annual ad valorem tax reimbursements by the SID to the third-party owners of the resort through 2020. In addition, these payments will be net of debt service, if any, on bonds issued by the SID collateralized by hotel occupancy tax and other resort sales tax through 2034.
The amounts we collect under this agreement are dependent on several factors including the amount of revenues generated by and ad valorem taxes imposed on the resort and the amount of any applicable debt service incurred by the SID. As a result, there is significant uncertainty as to the amount and timing of collections under this agreement. Until these uncertainties are clarified, amounts collected under the agreement will be accounted for as a reduction of our investment in the resort development. The resort began operations in January 2010.
In 2013, we received $4,400,000 in reimbursements from the SID. Since inception, we have received $15,156,000 in reimbursements and have accounted for this as a reduction of our investment. At year-end 2013, we have $28,118,000 invested in the resort development.
Mixed-Use Development
The mixed-use development we own consists of 2,100 acres planned to include about 1,566 residential lots and about 150 commercial acres designated for multifamily and retail uses, of which 810 lots and 130 commercial acres have been sold through year-end 2013.
In 2007, we entered into an agreement with the SID providing for reimbursement of certain infrastructure costs related to the mixed-use development. Reimbursements are subject to review and approval by the SID and unreimbursed amounts accrue interest at 9.75 percent. The SID’s funding for reimbursements is principally derived from its ad valorem tax collections and bond proceeds collateralized by ad valorem taxes, less debt service on these bonds and annual administrative and public service expenses.
Because the amount of each reimbursement is dependent on several factors, including timing of SID approval and the SID having an adequate tax base to generate funds that can be used to reimburse us, there is uncertainty as to the amount and timing of reimbursements under this agreement. We expect to recover our investment from lot and tract sales and reimbursement of approved infrastructure costs from the SID. We have not recognized income from interest due, but not collected. As these uncertainties are clarified, we will modify our accounting accordingly.
Through year-end 2013, we have submitted and received approval for reimbursement of about $65,465,000 of infrastructure costs and have received reimbursements totaling $23,670,000, of which $600,000 was received in 2013, $550,000 was received in 2012, $1,750,000 was received in 2011, all were accounted for as a reduction of our investment in the mixed-use development. At year-end 2013, we have $41,795,000 in approved and pending reimbursements, excluding interest. At year-end 2013, we have $49,839,000 invested in the mixed-use development.
Accounting Policies
Critical Accounting Estimates
In preparing our financial statements, we follow generally accepted accounting principles, which in many cases require us to make assumptions, estimates, and judgments that affect the amounts reported. Our significant accounting policies are included in Note 1 to the Consolidated Financial Statements. Many of these principles are relatively straightforward. There are, however, a few accounting policies that are critical because they are important in determining our financial condition and results of operations and involve significant assumptions, estimates and judgments that are difficult to determine. We must make these assumptions, estimates and judgments currently about matters that are inherently uncertain, such as future economic conditions, operating results and valuations, as well as our intentions. As the difficulty increases, the level of precision decreases, meaning actual results can, and probably will, differ from those currently estimated. We base our assumptions, estimates and judgments on a combination of historical experiences and other factors that we believe are reasonable. We have reviewed the selection and disclosure of these critical accounting estimates with our Audit Committee.
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Investment in Real Estate and Cost of Real Estate Sales - In allocating costs to real estate owned and real estate sold, we must estimate current and future real estate values. Our estimates of future real estate values sometimes must extend over periods 15 to 20 years from today and are dependent on numerous assumptions including our intentions and future market and economic conditions. In addition, when we sell real estate from projects that are not finished, we must estimate future development costs through completion. Differences between our estimates and actual results will affect future carrying values and operating results.
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Accrued Oil and Gas Revenue - We recognize revenue as oil and gas is produced and sold. There are a significant amount of oil and gas properties which we do not operate and, therefore, revenue is typically recorded in the month of production based on an estimate of our share of volumes produced and prices realized. We obtain the most current available production data from the operators and price indices for each well to estimate the accrual of revenue. Obtaining production data on a timely basis for some wells is not feasible; therefore we utilize past production receipts and estimated sales price information to estimate accrual of working interest revenue on all other non-operated wells each month. Revisions to such estimates are recorded as actual results become known.
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Impairment of Real Estate Long-Lived Assets - Measuring real assets for impairment requires estimating future fair values based on our intentions as to holding periods, future operating cash flows and the residual value of assets under review, primarily undeveloped land. Depending on the asset under review, we use varying methods to determine fair value, such as discounting expected future cash flows, determining resale values by market, or applying a capitalization rate to net operating income using prevailing rates in a given market. Changes in economic conditions, demand for real estate, and the projected net operating income for a specific property will inevitably change our estimates.
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Impairment of Oil and Gas Properties - We review our proved oil and gas properties for impairment whenever events and circumstances indicate that a decline in the recoverability of their carrying value may have occurred. We estimate the expected undiscounted future cash flows of our oil and gas properties and compare such undiscounted future cash flows to the carrying amount of the oil and gas properties to determine if the carrying amount is recoverable. If the carrying amount exceeds the estimated undiscounted future cash flows, we will adjust the carrying amount of the oil and gas properties to fair value. The factors used to determine fair value are subject to our judgment and expertise and include, but are not limited to, recent sales prices of comparable properties, the present value of future cash flows, net of estimated operating and development costs using estimates of proved reserves, future commodity pricing, future production estimates, anticipated capital expenditures, and various discount rates commensurate with the risk and current market conditions associated with realizing the expected cash flows projected. Because of the uncertainty inherent in these factors, we cannot predict when or if future impairment charges for proved properties will be recorded.
The assessment of unproved properties to determine any possible impairment requires significant judgment. We assess our unproved properties periodically for impairment on a property-by-property basis based on remaining lease terms, drilling results or future plans to develop acreage. Due to the uncertainty inherent in these factors, we cannot predict the amount of impairment charges that may be recorded in the future.
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Impairment of Goodwill - Measuring goodwill for impairment annually requires estimation of future cash flows and determination of fair values using many assumptions and inputs, including estimated future selling prices and volumes, estimated future costs to develop and explore, observable market inputs, weighted average cost of capital, estimated operating expenses and various other projected economic factors. Changes in economic and operating conditions can affect these assumptions and could result in additional interim testing and goodwill impairment charges in the future periods.
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Share-Based Compensation - We use the Black-Scholes option pricing model to determine the fair value of stock options. The determination of the fair value of share-based payment awards on the date of grant using an option-pricing model is affected by the stock price as well as assumptions regarding a number of other variables. These variables include expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors (term of option), risk-free interest rate and expected dividends. We have limited historical experience as a stand-alone company so we utilized alternative methods 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. In 2013 and 2012, the expected stock price volatility was based on a blended rate utilizing our historical volatility and 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 and historical trends. We use Monte Carlo simulation pricing model to determine the fair value of market-leveraged stock units (MSU's). A typical Monte Carlo exercise simulates a distribution of stock prices to yield an expected distribution of stock prices at the end of the performance period. The simulations are repeated many times in order to derive a probabilistic assessment of stock performance. The stock-paths are simulated using assumptions which include expected stock price volatility and risk-free interest rate.
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Asset Retirement Obligations - We make estimates of the future costs of the retirement obligations of our producing oil and gas properties. Estimating future costs involves significant assumptions and judgments regarding such factors as estimated costs of plugging and abandonment, timing of settlements, discount rates and inflation rates. Such cost estimates could be subject to significant revisions in subsequent years due to changes in regulatory requirements, technological advances and other factors which may be difficult to predict.
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Income Taxes - In preparing our consolidated financial statements, significant judgment is required to estimate our income taxes. Our estimates are based on our interpretation of federal and state tax laws. We estimate our actual current tax due and assess temporary and permanent differences resulting from differing treatment of items for tax and accounting purposes. The temporary differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheet. If needed, we record a valuation allowance against our deferred tax assets. In addition, when we believe a tax position is supportable but the outcome uncertain, we include the item in our tax return but do not recognize the related benefit in our provision for taxes. Instead, we record a reserve for unrecognized tax benefits, which represents our expectation of the most likely outcome considering the technical merits and specific facts of the position. Changes to liabilities are only made when an event occurs that changes the most likely outcome, such as settlement with the relevant tax authority, expiration of statutes of limitations, changes in tax law, or recent court rulings. Adjustments to temporary differences, permanent differences or uncertain tax positions could materially impact our financial position, cash flow and results of operation.
•
Oil and Gas Reserves - The estimation of oil and gas reserves is a significant estimate which affects the amount of non-cash depletion expense we record as well as impairment analysis we perform. On an annual basis, our consulting petroleum engineering firm, with our assistance, prepares estimates of crude oil and gas reserves based on available geologic and seismic data, reservoir pressure data, core analysis reports, well logs, analogous reservoir performance history, production data and other available sources of engineering, geological and geophysical information. Oil and gas prices are volatile and largely affected by worldwide or domestic production and consumption and are outside our control.
Adopted and Pending Accounting Pronouncements
We adopted several new accounting pronouncements in 2013, the adoption of which did not have a significant effect on our earnings or financial position. There is one pending accounting pronouncement that we will be required to adopt in 2014, which we are currently evaluating its impact on our earnings, financial position and disclosures. Please read Note 2 - New and Pending Accounting Pronouncements to the Consolidated Financial Statements.
Effects of Inflation
Inflation has had minimal effects on operating results the past three years. Our real estate, oil and gas properties, timber, and property and equipment are carried at historical costs. If carried at current replacement costs, the cost of real estate sold, timber cut, and depreciation expense would have been significantly higher than what we reported.
Legal Proceedings
We are involved in various legal proceedings that arise from time to time in the ordinary course of doing business. We believe we have established adequate reserves for any probable losses, and we do not believe that the outcome of any of these proceedings should have a material adverse effect on our financial position, long-term results of operations, or cash flow. It is possible, however, that charges related to these matters could be significant to results of operations or cash flows in any one accounting period.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk.
Interest Rate Risk
Our interest rate risk is principally related to our variable-rate debt. Interest rate changes impact earnings due to the resulting increase or decrease in our variable-rate debt, which was $230,767,000 at year-end 2013 and $290,074,000 at year-end 2012.
The following table illustrates the estimated effect on our pre-tax income of immediate, parallel, and sustained shifts in interest rates for the next 12 months on our variable-rate debt at year-end 2013, with comparative year-end 2012 information. This estimate assumes that debt reductions from contractual payments will be replaced with short-term, variable-rate debt; however, that may not be the financing alternative we choose.
Foreign Currency Risk
We have no exposure to foreign currency fluctuations.
Commodity Price Risk
We have exposure to commodity price fluctuations from our oil and gas production which can materially affect our revenues and cash flows. The prices we receive for our production depend on numerous factors beyond our control. Based on our 2013 production, a 10% decrease in our average realized price received for oil and gas would have reduced our oil and gas production revenues by $6,238,000 and $747,000. To manage our exposure to commodity price risks associated with the sale of oil and gas, we may periodically enter into derivative hedging transactions for a portion of our estimated production. We do not have any commodity derivative positions outstanding at year-end 2013.
Item 8.
Item 8.
Financial Statements and Supplementary Data.
Page
Management’s Annual Report on Internal Control over Financial Reporting
Report of Independent Registered Public Accounting Firm
Report of Independent Registered Public Accounting Firm
Audited Financial Statements
Consolidated Balance Sheets
Consolidated Statements of Income and Comprehensive Income
Consolidated Statements of Equity
Consolidated Statements of Cash Flows
Notes to the Consolidated Financial Statements
Financial Statement Schedule
Schedule III - Consolidated Real Estate and Accumulated Depreciation
MANAGEMENT’S ANNUAL REPORT ON
INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of Forestar is responsible for establishing and maintaining adequate internal control over financial reporting. Management has designed our internal control over financial reporting to provide reasonable assurance that our published financial statements are fairly presented, in all material respects, in conformity with generally accepted accounting principles.
Management is required by paragraph (c) of Rule 13a-15 of the Securities Exchange Act of 1934, as amended, to assess the effectiveness of our internal control over financial reporting as of each year end. In making this assessment, management used the Internal Control - Integrated Framework (1992) by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Management conducted the required assessment of the effectiveness of our internal control over financial reporting as of year-end. Based upon this assessment, management believes that our internal control over financial reporting is effective as of year-end 2013.
Ernst & Young LLP, the independent registered public accounting firm that audited our financial statements included in this Form 10-K, has also audited our internal control over financial reporting. Their attestation report follows this report of management.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders of Forestar Group Inc.
We have audited Forestar Group Inc.’s internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 framework) (the COSO criteria). Forestar Group Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Forestar Group Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Forestar Group Inc. as of December 31, 2013 and December 31, 2012, and the related consolidated statements of income and comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2013 of Forestar Group Inc. and our report dated March 11, 2014 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Austin, Texas
March 11, 2014
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders of Forestar Group Inc.
We have audited the accompanying consolidated balance sheets of Forestar Group Inc. as of December 31, 2013 and 2012, and the related consolidated statements of income and comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2013. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Forestar Group Inc. at December 31, 2013 and 2012, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2013, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all materials respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Forestar Group Inc.’s internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 framework) and our report dated March 11, 2014 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Austin, Texas
March 11, 2014
FORESTAR GROUP INC.
CONSOLIDATED BALANCE SHEETS
Please read the notes to the consolidated financial statements.
FORESTAR GROUP INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
Please read the notes to the consolidated financial statements.
FORESTAR GROUP INC.
CONSOLIDATED STATEMENTS OF EQUITY
Please read the notes to the consolidated financial statements.
FORESTAR GROUP INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Please read the notes to the consolidated financial statements.
FORESTAR GROUP INC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Summary of Significant Accounting Policies
Basis of Presentation
Our consolidated financial statements include the accounts of Forestar Group Inc., 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. Noncontrolling interests in consolidated pass-through entities are recognized before income taxes. We account for our investment in other entities in which we have significant influence over operations and financial policies using the equity method (we recognize our share of the entities’ income or loss and any preferential returns and treat distributions as a reduction of our investment). We account for our investment in other entities in which we do not have significant influence over operations and financial policies using the cost method (we recognize as income only distribution of accumulated earnings).
We prepare our financial statements in accordance with generally accepted accounting principles in the United States, which require us to make estimates and assumptions about future events. Actual results can, and probably will, differ from those we currently estimate. Examples of significant estimates include those related to allocating costs to real estate, measuring assets for impairment, oil and gas revenue accrual and depletion of our oil and gas properties.
Cash and Cash Equivalents
Cash and cash equivalents include cash and other short-term instruments with original maturities of three months or less. At year-end 2013 and 2012, restricted cash was $3,954,000 and $1,160,000 and is included in other assets.
Cash Flows
Expenditures for the acquisition and development of single-family and multifamily real estate are classified as operating activities. Expenditures for the acquisition of stabilized income producing properties, investment in oil and gas properties and equipment, and business acquisitions are classified as investing activities. Our accrued capital expenditures for leasehold acquisitions and drilling and completion costs at year-end 2013 and 2012 were $12,976,000 and $5,440,000 and are included in other accrued expenses in our consolidated balance sheets. These oil and gas property additions will be reflected as cash used for investing activities in the period the accrued payables are settled.
Capitalized Software
We capitalize purchased software costs as well as the direct internal and external costs associated with software we develop for our own use. We amortize these capitalized costs using the straight-line method over estimated useful lives generally ranging from three to five years. The carrying value of capitalized software was $1,544,000 at year-end 2013 and $1,797,000 at year-end 2012 and is included in other assets. The amortization of these capitalized costs was $1,593,000 in 2013, $1,320,000 in 2012 and $1,493,000 in 2011 and is included in general and administrative and operating expenses.
Environmental and Asset Retirement Obligations
We recognize environmental remediation liabilities on an undiscounted basis when environmental assessments or remediation are probable and we can reasonably estimate the cost. We adjust these liabilities as further information is obtained or circumstances change. Our asset retirement obligations are related to the abandonment and site restoration requirements that result from the acquisition, construction and development of our oil and gas properties. We record the fair value of a liability for an asset retirement obligation in the period in which it is incurred and a corresponding increase in the carrying amount of the related long-lived asset. Accretion expense related to the asset retirement obligation and depletion expense related to capitalized asset retirement cost is included in cost of oil and gas producing activities on our consolidated statements of income.
The following summarizes the changes in asset retirement obligations:
Fair Value Measurements
Financial instruments for which we did not elect the fair value option include cash and cash equivalents, accounts and notes receivables, other assets, long-term debt, accounts payable and other liabilities. With the exception of long-term notes receivable and debt, the carrying amounts of these financial instruments approximate their fair values due to their short-term nature or variable interest rates.
Goodwill and Other Intangible Assets
We record goodwill when the purchase price of a business acquisition exceeds the estimated fair value of net identified tangible and intangible assets acquired. We do not amortize goodwill or other indefinite lived intangible assets. Instead, we measure these assets for impairment based on the estimated fair values at least annually or more frequently if impairment indicators exist. We perform the annual impairment measurement in the fourth quarter of each year. Intangible assets with finite useful lives are amortized over their estimated useful lives.
Impairment of Real Estate Long-Lived Assets
We review real estate long-lived assets held for use for impairment when events or circumstances indicate that their carrying value may not be recoverable. Impairment exists if the carrying amount of the long-lived asset is not recoverable from the undiscounted cash flows expected from its use and eventual disposition. We determine the amount of the impairment loss by comparing the carrying value of the long-lived asset to its estimated fair value. In the absence of quoted market prices, we determine estimated fair value generally based on the present value of future probability weighted cash flows expected from the sale of the long-lived asset. Non-cash impairment charges related to our owned and consolidated real estate assets are included in cost of real estate sales and other.
Impairment of Oil and Gas Properties
We evaluate our oil and gas properties, including facilities and equipment, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. We estimate the expected undiscounted future cash flows of our oil and gas properties and compare such undiscounted future cash flows to the carrying amount of the oil and gas properties to determine if the carrying amount is recoverable. If the carrying amount exceeds the estimated undiscounted future cash flows, we will adjust the carrying amount of the oil and gas properties to fair value. The factors used to determine fair value are subject to our judgment and expertise and include, but are not limited to, recent sales prices of comparable properties, the present value of future cash flows, net of estimated operating and development costs using estimates of proved reserves, future commodity pricing, future production estimates, anticipated capital expenditures, and various discount rates commensurate with the risk and current market conditions associated with realizing the expected cash flows projected. Because of the uncertainty inherent in these factors, we cannot predict when or if future impairment charges for proved properties will be recorded.
The assessment of unproved properties to determine any possible impairment requires significant judgment. We assess our unproved properties periodically for impairment on a property-by-property basis based on remaining lease terms, drilling results or future plans to develop acreage. Impairment expense for proved and unproved oil and gas properties are included in costs of oil and gas producing activities.
Income Taxes
We provide deferred income taxes using current tax rates for temporary differences between the financial accounting carrying value of assets and liabilities and their tax accounting carrying values. We recognize and value income tax exposures for the various taxing jurisdictions where we operate based on laws, elections, commonly accepted tax positions, and management estimates. We include tax penalties and interest in income tax expense. We provide a valuation allowance for any deferred tax asset that is not likely to be recoverable in future periods.
When we believe a tax position is supportable but the outcome uncertain, we include the item in our tax return but do not recognize the related benefit in our provision for taxes. Instead, we record a reserve for unrecognized tax benefits, which represents our expectation of the most likely outcome considering the technical merits and specific facts of the position. Changes to liabilities are only made when an event occurs that changes the most likely outcome, such as settlement with the relevant tax authority, expiration of statutes of limitations, changes in tax law, or recent court rulings.
Owned Mineral Interests
We acquire real estate that may include the subsurface rights associated with the property, including minerals. We capitalize the costs of acquiring these mineral interests. We amortize the cost assigned to unproved interests, principally acquisition costs, using the straight-line method over appropriate periods based on our experience, generally no longer than ten years. Costs assigned to individual unproven interests are minimal and amortized on an aggregate basis. When we lease these interests to third-party oil and gas exploration and production entities, any related unamortized costs are accounted for using the cost recovery method from the cash proceeds received from lease bonus payments.
When we lease our mineral interests to third-party exploration and production entities, we retain a royalty interest and may take an additional participation in production, including a working interest. Mineral interests and working interests related to our owned mineral interests are included in oil and gas properties and equipment on our balance sheet, net of accumulated depletion.
Oil and Gas Properties
We use the successful efforts method of accounting for our oil and gas producing activities. Costs to acquire mineral interests leased, costs to drill and complete development of oil and gas wells and related asset retirement costs are capitalized. Costs to drill exploratory wells are capitalized pending determination of whether the wells have proved reserves and if determined incapable of producing commercial quantities of oil and gas these costs are expensed as dry hole costs. Exploration costs include dry hole costs, geological and geophysical costs, and seismic studies, and are expensed as incurred. We generally capitalize interest on expenditures for exploration and development projects that last more than six months while activities are in progress to bring the assets to their intended use. Production costs incurred to maintain wells and related equipment are charged to expense as incurred.
Depreciation and depletion of producing oil and gas properties is calculated using the units-of-production method. Proved developed reserves are used to compute unit rates for unamortized tangible and intangible drilling and completion costs. Proved reserves are used to compute unit rates for unamortized acquisition of proved leasehold costs. Unit-of-production amortization rates are revised whenever there is an indication of the need for revision but at least once a year and those revisions are accounted for prospectively as changes in accounting estimates.
Net capitalized costs related to our oil and gas producing activities are as follows:
Operating Leases
We occupy office space in various locations under operating leases. The lease agreements may contain rent escalation clauses, construction allowances and/or contingent rent provisions. We expense operating leases ratably over the shorter of the useful life or the lease term. For scheduled rent escalation clauses, we recognize the base rent expense on a straight-line basis and record the difference between the recognized rent expense and the amounts payable under the lease as deferred lease credits included in other liabilities in the consolidated balance sheets. Deferred lease credits are amortized over the lease term. For construction allowances, we record leasehold improvement assets included in property and equipment in the consolidated balance sheets amortized over the shorter of their economic lives or the lease term. The related deferred lease credits are amortized as a reduction of rent expense over the lease term.
Property and Equipment
We carry property and equipment at cost less accumulated depreciation. We capitalize the cost of significant additions and improvements, and we expense the cost of repairs and maintenance. We capitalize interest costs incurred on major construction projects. We depreciate these assets using the straight-line method over their estimated useful lives as follows:
Depreciation expense of property and equipment was $1,028,000 in 2013, $962,000 in 2012 and $893,000 in 2011.
Real Estate
We carry real estate at the lower of cost or fair value less cost to sell. We capitalize interest costs once development begins, and we continue to capitalize throughout the development period. We also capitalize infrastructure, improvements, amenities, and other development costs incurred during the development period. We determine the cost of real estate sold using the relative sales value method. When we sell real estate from projects that are not finished, we include in the cost of real estate sold estimates of future development costs through completion, allocated based on relative sales values. These estimates of future development costs are reevaluated at least annually, with any adjustments being allocated prospectively to the remaining units available for sale. We receive cash deposits from builders for purchases of real estate community development projects. These deposits are released to the builders as lots are developed and sold. Our escrow deposits at year-end 2013 and 2012 were $6,805,000 and $4,598,000 and are included in other accrued expenses in our consolidated balance sheets.
Income producing properties are carried at cost less accumulated depreciation computed using the straight-line method over their estimated useful lives.
We have agreements with utility or improvement districts, principally in Texas, whereby we agree to convey to the district's water, sewer and other infrastructure-related assets we have constructed in connection with projects within their jurisdiction. The reimbursement for these assets ranges from 70 to 100 percent of allowable cost as defined by the district. The transfer is consummated and we receive payment when the districts have a sufficient tax base to support funding of their bonds. The cost we incur in constructing these assets is included in capitalized development costs, and upon collection, we remove the assets from capitalized development costs. We provide an allowance to reflect our past experiences related to claimed allowable development costs.
Reclassifications
In 2013, we have reclassified prior years' other accrued expenses that were included in accounts payable on the balance sheet to conform to the current year presentation. In 2012, we reclassified non-cash cost of timber cut for 2011 on the statement of cash flows to depreciation, depletion and amortization.
Revenue
Real Estate
We recognize revenue from sales of real estate when a sale is consummated, the buyer’s initial investment is adequate, any receivables are probable of collection, the usual risks and rewards of ownership have been transferred to the buyer, and we do not have significant continuing involvement with the real estate sold. If we determine that the earnings process is not complete, we defer recognition of any gain until earned. We recognize revenue from hotel room sales and other guest services when rooms are occupied and other guest services have been rendered. We recognize revenue from our multifamily properties when payments are due from residents, generally on a monthly basis.
We exclude from revenue amounts we collect from utility or improvement districts related to the conveyance of water, sewer and other infrastructure related assets. We also exclude from revenue amounts we collect for timber sold on land being developed. These proceeds reduce capitalized development costs. We exclude from revenue amounts we collect from customers that represent sales tax or other taxes that are based on the sale. These amounts are included in other accrued expenses until paid.
Oil and Gas
We recognize revenue as oil and gas is produced and sold. There are a significant amount of oil and gas properties which we do not operate and, therefore, revenue is typically recorded in the month of production based on an estimate of our share of volumes produced and prices realized. We obtain the most current available production data from the operators and price indices for each well to estimate the accrual of revenue. Obtaining production data on a timely basis for some wells is not feasible; therefore we utilize past production receipts and estimated sales price information to estimate accrual of working interest revenue on all other non-operated wells each month. Revisions to such estimates are recorded as actual results become known. We review accounts receivable periodically and reduce the carrying amount by a valuation allowance that reflects our best estimate of the amount that may not be collectible. No such allowance was considered necessary at December 31, 2013 or 2012.
A majority of our sales are made under contractual arrangements with terms that are considered to be usual and customary in the oil and gas industry. The contracts are for periods of up to five years with prices determined upon a percentage of pre-determined and published monthly index price. The terms of these contracts have not had an effect on how we recognize revenue.
We recognize revenue from mineral bonus payments received as a result of leasing our owned mineral interests to others when we have received an executed agreement with the exploration company transferring the rights to any oil or gas it may find and requiring drilling be done within a specified period, the payment has been collected, and we have no obligation to refund the payment. We recognize revenue from delay rentals received if drilling has not started within the specified period and when the payment has been collected. We recognize revenue from mineral royalties when the minerals have been delivered to the buyer, the value is determinable, and we are reasonably sure of collection.
Other Natural Resources
We recognize revenue from timber sales upon passage of title, which occurs at delivery; when the price is fixed and determinable; and we are reasonably sure of collection. We recognize revenue from recreational leases on the straight-line basis over the lease term.
Share-Based Compensation
We use the Black-Scholes option pricing model for stock options, Monte Carlo simulation pricing model for market-leveraged stock units, grant date fair value for equity-settled awards and period-end fair value for cash-settled awards. We expense share-based awards ratably over the vesting period or earlier based on retirement eligibility.
Timber
We carry timber at cost less the cost of timber cut. We expense the cost of timber cut based on the relationship of the timber carrying value to the estimated volume of recoverable timber multiplied by the amount of timber cut. We include the cost of timber cut in cost of fiber resources and other in the income statement. We determine the estimated volume of recoverable timber using statistical information and other data related to growth rates and yields gathered from physical observations, models and other information gathering techniques. Changes in yields are generally due to adjustments in growth rates and similar matters and are accounted for prospectively as changes in estimates. We capitalize reforestation costs incurred in developing viable seedling plantations (up to two years from planting), such as site preparation, seedlings, planting, fertilization, insect and wildlife control, and herbicide application. We expense all other costs, such as property taxes and costs of forest management personnel, as incurred. Once the seedling plantation is viable, we expense all costs to maintain the viable plantations, such as fertilization, herbicide application, insect and wildlife control, and thinning, as incurred.
We own directly or through ventures about 117,000 acres of timber, primarily in Georgia, and about 14,000 acres of timber under lease. The non-cash cost of timber cut and sold is $609,000 in 2013, $1,220,000 in 2012 and $990,000 in 2011 and is included in depreciation, depletion and amortization in our statement of cash flows.
Note 2 - New and Pending Accounting Pronouncements
Accounting Standards Adopted in 2013
In 2013, we adopted Accounting Standards Update (ASU) ASU 2013-11- Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists, ASU 2011-10 - Property, Plant, and Equipment (Topic 360): Derecognition of in Substance Real Estate, ASU 2012-02 - Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment and ASU No. 2013-01 - Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. Adoption of these pronouncements did not materially affect our earnings or financial position.
Pending Accounting Standards
ASU 2013-04 - Liabilities (Topic 405): Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date will be effective in first quarter 2014. This ASU requires an entity that is jointly and severally liable to measure the obligation as the sum of the amount the entity has agreed with co-obligors to pay and any additional amount it expects to pay on behalf of one or more co-obligors. We are evaluating the impact of adopting ASU 2013-04 on our earnings, financial position and disclosures.
Note 3 - Goodwill and Other Intangible Assets
Carrying value of goodwill and other intangible assets follows:
Goodwill represents the excess of the purchase price over the fair value of the tangible and identifiable intangible assets of $60,619,000 associated with our acquisition of Credo in third quarter 2012 and $3,874,000 associated with a water resources company acquired in 2010.
On September 28, 2012, we acquired 100 percent of the outstanding common stock of CREDO Petroleum Corporation (Credo) in an all cash transaction for $14.50 per share, representing an equity purchase price of approximately $146,445,000. In addition, we paid in full $8,770,000 of Credo’s outstanding debt.
The following unaudited pro forma information for the year 2012 and 2011 represents the results of our consolidated operations as if the acquisition of Credo had occurred on January 1, 2011. This information is based on historical results of operations, adjusted for certain estimated accounting adjustments and does not purport to represent our actual results of operations if the transaction would have occurred on January 1, 2011, nor is it necessarily indicative of future results.
The final purchase price allocation related to the Credo acquisition based on additional information obtained during the acquisition measurement period, in particular, allocation of the estimated values assigned to oil and gas properties and equipment, goodwill and deferred tax liability, is as follows:
_____________________
(a)
Primarily related to unrecorded seismic and leasehold costs due from partners.
(b)
Fair value adjustments allocated to near-term expiring leasehold acreage.
(c)
Goodwill adjustments associated with fair value adjustments for oil and gas properties, net of deferred taxes and working capital adjustments.
(d)
Primarily related to current income taxes payable.
(e)
Primarily related to deferred taxes on fair value adjustments of near-term expiring leasehold acreage.
Identified intangibles include $1,681,000 in indefinite lived groundwater leases associated with a water resources company acquired in 2010. In addition, identified intangibles includes $590,000 related to patents with definite lives associated with the Calliope Gas Recovery System acquired as part of our acquisition of Credo and is being amortized over the average remaining useful life of the patents. The net carrying value at year-end 2013 is $472,000.
Note 4 - Real Estate
Real estate consists of:
Included in entitled, developed and under development projects are the estimated costs of assets we expect to convey to utility and improvement districts of $62,183,000 in 2013 and $50,476,000 in 2012, including about $41,795,000 at year-end 2013 and about $34,252,000 at year-end 2012 related to our Cibolo Canyons project near San Antonio. These costs relate to water, sewer and other infrastructure assets we have submitted to utility or improvement districts for approval and reimbursement. In 2013, these costs increased by $11,707,000 as result of development costs exceeding reimbursements by the utility or improvement districts. We submitted for reimbursement to these districts $17,923,000 in 2013 and $6,432,000 in 2012. We collected $5,545,000 from these districts in 2013, of which $600,000 related to our Cibolo Canyons project and was accounted for as a reduction of our investment in the mixed-use development. We collected $5,674,000 from these districts in 2012, of which $550,000 related to our Cibolo Canyons project. We expect to collect the remaining amounts billed when these districts achieve adequate tax bases to support payment.
Also included in entitled, developed and under development projects is our investment in the resort development owned by third parties at our Cibolo Canyons project. In 2013 and 2012, we received $4,400,000 and $2,850,000 from the Special Improvement District (SID) from hotel occupancy and sales revenues collected as taxes by the SID. We currently account for these receipts as a reduction of our investment in the resort development. At year-end 2013, we have $28,118,000 invested in the resort development.
We recognized non-cash asset impairment charges of $1,790,000 in 2013 associated with a master-planned community and golf club near Dallas. We had no non-cash impairment charges in 2012. We recognized non-cash asset impairment charges of $11,525,000 in 2011 principally associated with owned and consolidated residential real estate projects located near Denver and the Texas gulf coast.
Depreciation expense related to income producing properties was $2,507,000 in 2013, $3,640,000 in 2012 and $3,547,000 in 2011 and is included in other operating expense.
Note 5 - Investment in Unconsolidated Ventures
At year-end 2013, we had ownership interests in 13 ventures that we account for using the equity method. We have no real estate ventures that are accounted for using the cost method.
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:
_____________________
(a)
Total includes current maturities of $37,966,000 at year-end 2013, of which $37,822,000 is non-recourse to us, and $32,323,000 at year-end 2012, of which $32,083,000 is non-recourse to us.
(b)
Includes unamortized deferred gains on real estate contributed by us to ventures. We recognize deferred gains as income as real estate is sold to third parties. Deferred gains of $835,000 are reflected as a reduction to our investment in unconsolidated ventures at year-end 2013.
(c)
We acquired these equity investments from CL Realty in 2012 at estimated fair values. The difference between estimated fair value of the equity investment and our capital account within the respective ventures at closing (basis difference) will be accreted as income or expense over the life of the investment and included in our share of earnings (loss) from the respective ventures. Unrecognized basis difference of $1,601,000 is reflected as a reduction of our investment in unconsolidated ventures at year-end 2013.
(d)
Our investment in other ventures reflects our ownership interests generally ranging from 25 to 50 percent, excluding venture losses that exceed our investment where we are not obligated to fund those losses. Please read Note 15 - Variable Interest Entities for additional information.
(e)
In 2011, CL Realty’s loss includes non-cash impairment charges of $25,750,000, of which, $23,255,000 relates to additional non-cash impairments associated with real estate assets sold in 2012.
(f)
In 2011, Temco’s loss includes non-cash impairment charges of $41,226,000, of which, $21,426,000 principally relates to additional non-cash impairments associated with real estate assets sold in 2012.
(g)
In 2012, other ventures earnings include $5,307,000 related to a consolidated venture’s share of the gain associated with Round Rock Luxury Apartments sale of Las Brisas. Our share of these earnings was $2,541,000 and we allocated $2,766,000 to net income attributable to noncontrolling interests. In 2011, our share of other ventures earnings (loss) includes $2,164,000 in earnings related to a deferred gain recognized as a result of entering into an agreement to acquire certain of CL Realty’s real estate assets and $4,869,000 in deferred gains for year 2010 related to CL Realty’s sale of 625 acres to a third party for $20,250,000.
In 2013, we invested $857,000 in these ventures and received $9,854,000 in distributions; in 2012, we invested $2,318,000 in these ventures and received $15,905,000 in distributions; in 2011, we invested $2,007,000 in these ventures and received $9,664,000 in distributions. Distributions include both return of investments and distributions of earnings.
We provide construction and development services for some of these ventures for which we receive fees. Fees for these services were $1,068,000 in 2013, $935,000 in 2012 and $804,000 in 2011 and are included in real estate revenues.
Note 6 - Receivables
Receivables consist of:
At year-end 2013, we have $7,610,000 invested in a loan secured by real estate. The loan was acquired from a financial institution in 2011 when it was non-performing and is secured by a lien on developed and undeveloped real estate located near Houston designated for single-family residential and commercial development. In 2012, an approved bankruptcy plan of reorganization of the borrower became effective establishing a principal amount of $33,900,000 maturing in April 2017. Interest accrues at nine percent the first three years escalating to ten percent in year four and 12 percent in year five, with interest above 6.25 percent to be forgiven if the loan is prepaid by certain dates. Commencing with the reorganization, we estimated future cash flows and calculated accretable yield to be recognized over the term of the loan, which is included in other non-operating income. In 2013 and 2012, we received principal payments of $14,315,000 and $3,887,000 and interest payments of $1,872,000 and $1,635,000. At year-end 2013, the outstanding principal balance was $15,698,000.
Estimated accretable yield is as follows:
Other loans secured by real estate generally are secured by a deed of trust and due within three years. The increase in 2013 is principally associated with the sale of 33 commercial tract acres from our Cibolo Canyons project in San Antonio, Texas for $7,700,000 in which we seller-financed $6,160,000 at an interest rate of prime plus one percent. Principal and accrued interest are due in June 2014, with a possible extension of three months. The remaining loans secured by real estate at year-end 2013 principally consist of $959,000 related to the 2012 sale of the remaining 109 residential lots from a project in Florida and $550,000 related to a real estate contract for a project in Los Angeles. The original principal balance of the Florida project loan was $1,501,000, and in 2013 we received principal payments of $542,000 and interest payments of $67,000. The
loan matures July 1, 2014 and bears interest at five percent per annum. The $550,000 loan is due and payable in full on April 30, 2016 at an interest rate of zero percent per annum prior to maturity and, subject to conditions specified in the Los Angeles real estate contract, 3.5 percent per annum thereafter.
Note 7 - Debt
Debt consists of:
Our debt agreements contain financial covenants customary for such agreements including minimum levels of interest coverage and limitations on leverage. At year-end 2013, we were in compliance with the financial covenants of these agreements. In addition, we may elect to make distributions so long as the total leverage ratio is less than 30%, the interest coverage is greater than 3.0:1.0, the revenues / capital expenditures ratio exceeds 1.5:1.0, and available liquidity is not less than $125,000,000. At year-end 2013, our total leverage ratio exceeded 30 percent and as a result we are prohibited from making distributions until the above conditions are satisfied.
At year-end 2013, our senior secured credit facility provides for a $200,000,000 term loan maturing September 14, 2017, and a $200,000,000 revolving line of credit maturing September 14, 2015. The term loan and revolving line of credit may be prepaid at any time without penalty. The revolving line of credit includes a $100,000,000 sublimit for letters of credit, of which $3,653,000 is outstanding at year-end 2013. Total borrowings under our senior secured credit facility (including the face amount of letters of credit) may not exceed a borrowing base formula. At year-end 2013, we had $164,685,000 in net unused borrowing capacity under our senior credit facility.
Under the terms of our senior secured credit facility, at our option, we can borrow at LIBOR plus 4.0 percent or at the alternate base rate plus 3.0 percent. The alternate base rate is the highest of (i) KeyBank National Association’s base rate, (ii) the federal funds effective rate plus 0.5 percent or (iii) 30 day LIBOR plus 1 percent. Borrowings under the senior secured credit facility are or may be secured by (a) mortgages on the timberland, high value timberland and portions of raw entitled land, as well as pledges of other rights including certain oil and gas operating properties, (b) assignments of current and future leases, rents and contracts, (c) a security interest in our primary operating account, (d) a pledge of the equity interests in current and future material operating subsidiaries or majority-owned joint venture interest, or if such pledge is not permitted, a pledge of the right to distributions from such entities, (e) a pledge of certain reimbursements and other revenues payable to us from special improvement district tax collections in connection with our Cibolo Canyons project, and (f) a negative pledge (without a mortgage) on other assets. The senior secured credit facility provides for releases of real estate provided that borrowing base compliance is maintained.
On February 26, 2013, we issued $125,000,000 aggregate principal amount of 3.75% convertible senior notes due 2020 (Convertible Notes). Interest on the Convertible Notes is payable semiannually at a rate of 3.75 percent per annum and they mature on March 1, 2020. The Convertible Notes have an initial conversion rate of 40.8351 per $1,000 principal amount. The initial conversion rate is subject to adjustment upon the occurrence of certain events. Prior to November 1, 2019, the Convertible Notes are convertible only upon certain circumstances, and thereafter are convertible at any time prior to the close of business on the second scheduled trading day prior to maturity. If converted, holders will receive cash, shares of our common stock or a combination thereof at our election. We intend to settle the principal amount of the Convertible Notes in cash upon conversion, with any excess conversion value to be settled in shares of our common stock. Net proceeds from the offering were used to repay $68,000,000 under our revolving line of credit, the balance to be used for general corporate purposes, including investments in oil and gas exploration and drilling and real estate acquisition and development.
We separately account for the liability and equity conversion components of the Convertible Notes due to our option to settle the conversion obligation in cash, shares or a combination thereof at our election. The fair value of the Convertible Notes excluding the conversion feature at the date of issuance was estimated to be approximately $97,309,000 and was calculated based on the fair value of similar non-convertible debt instruments. The resulting value of the conversion option of $27,691,000
was recognized as debt discount and recorded as additional paid-in capital on our consolidated balance sheet. The effective interest rate to calculate the accretion of the bond discount is eight percent and is based on our estimated (non-convertible) borrowing rate on long-term debt with a similar maturity at the time the Convertible Notes were issued. Interest expense includes the cash coupon rate on the Convertible Notes plus the non-cash accretion of the debt discount, which is based on the difference between the effective interest rate and the cash coupon rate. Amortization of debt discount was $2,581,000 in 2013 and is included in interest expense. At year-end 2013, unamortized debt discount of our Convertible Notes was $25,110,000. Total debt issuance costs were $4,205,000 (including underwriters discount of $3,750,000), of which $3,273,000 was allocated to the liability component and $932,000 to the equity component of the Convertible Notes. The portion of the issuance costs allocated to the debt component of the Convertible Notes is being amortized over the term of the Convertible Notes.
On November 27, 2013, we issued $150,000,000 aggregate principal amount of 6.00% tangible equity units (Units). The total offering was 6,000,000 Units, including 600,000 exercised by the underwriters, each with a stated amount of $25.00. Each Unit is comprised of (i) a prepaid stock purchase contract to be settled by delivery of a number of shares of our common stock, par value $1.00 per share to be determined pursuant to a purchase contract agreement, and (ii) a senior amortizing note due December 15, 2016 that has an initial principal amount of $4.2522, bears interest at a rate of 4.50% per annum and has a final installment payment date of December 15, 2016.
We separately account for the purchase contracts and amortizing notes. The purchase contract component of the Units is recorded in equity as additional paid in capital. The amortizing note component of the Units is recorded as debt. The fair value of the amortizing notes was based on the fair value of similar debt instruments and was estimated to be approximately $25,514,000. The resulting value of the purchase contracts of $124,486,000 was recorded as additional paid-in capital on our consolidated balance sheet. Total issuance costs associated with the Units were $5,002,000 (including the underwriters discount of $4,500,000), of which $851,000 was allocated to the liability component and $4,151,000 was allocated to the equity component of the Units. Net proceeds of $144,998,000 from the issuance of the Units are designated for general corporate purposes, including investments in strategic growth opportunities. The portion of the issuance costs allocated to the debt component of the Units is being amortized over the term of the amortizing note.
At year-end 2013, secured promissory notes include a $15,400,000 loan collateralized by a 413 guest room hotel located in Austin with a carrying value of $24,391,000. In 2013, secured promissory notes decreased by $18,902,000 as result of selling of Promesa, a 289-unit multifamily property we developed in Austin, for $41,000,000. We received $21,522,000 in net proceeds and we recognized $10,881,000 in segment earnings.
At year-end 2013, other indebtedness, principally non-recourse, is collateralized by entitled, developed and under development projects with a carrying value of $60,553,000.
At year-end 2013 and 2012, we have $7,896,000 and $6,508,000 in unamortized deferred fees which are included in other assets. Amortization of deferred financing fees, excluding loss on extinguishment of debt, was $3,050,000 in 2013, $2,922,000 in 2012 and $2,881,000 in 2011 and is included in interest expense.
Debt maturities during the next five years are: 2014 - $28,247,000; 2015 - $12,699,000; 2016 - $15,484,000; 2017 - $201,087,000; 2018 - $0 and thereafter - $99,890,000.
Note 8 - Fair Value
Fair value is the exchange price that would be the amount received for an asset or paid to transfer a liability in an orderly transaction between market participants. In arriving at a fair value measurement, we use a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable. The three levels of inputs used to establish fair value are the following:
•
Level 1 - Quoted prices in active markets for identical assets or liabilities;
•
Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and
•
Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
Non-financial assets measured at fair value on a non-recurring basis principally include real estate assets, goodwill and intangible assets, which are measured for impairment. In 2013, certain real estate assets were remeasured and reported at fair value due to events or circumstances that indicated the carrying value may not be recoverable. We determined estimated fair value based on the present value of future probability weighted cash flows expected from the sale of the long-lived asset or based on a third party appraisal of current value. As a result, we recognized non-cash asset impairment charges of $1,790,000 in 2013 associated with a master-planned community and golf club near Dallas. We had no non-cash impairment charges in 2012.
We elected not to use the fair value option for cash and cash equivalents, accounts receivable, other current assets, variable debt, accounts payable and other current liabilities. The carrying amounts of these financial instruments approximate their fair values due to their short-term nature or variable interest rates. We determine the fair value of fixed rate financial instruments using quoted prices for similar instruments in active markets.
Information about our fixed rate financial instruments not measured at fair value follows:
_____________________
(a)
Year-end 2013 includes our 3.75% convertible senior notes due 2020, issued February 26, 2013 and our amortizing notes associated with 6.00% tangible equity units, issued November 27, 2013.
Note 9 - Capital Stock
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 10th business day following public announcement that a 20 percent position has been acquired. The Rights will expire on December 11, 2017.
Please read Note 7 - Debt and Note 10 - Net Income per Share for information about shares of common stock that could be issued under our 3.75% convertible senior notes due 2020 and our 6.00% tangible equity units.
Please read Note 16 - Share-Based Compensation for information about additional shares of common stock that could be issued under terms of our share-based compensation plans.
At year-end 2013, personnel of former affiliates held options to purchase 779,000 shares of our common stock. The options have a weighted average exercise price of $25.11 and a weighted average remaining contractual term of two years. At year-end 2013, the options have an aggregate intrinsic value of $711,000.
In 2013, we did not repurchase shares of our common stock. In 2012, we repurchased 94,450 shares of our common stock for $1,409,000. We have repurchased 2,002,145 shares of our common stock for $29,564,000 since we announced our 2009 strategic initiative of repurchasing up to 20 percent or 7,000,000 shares of our common stock.
Note 10 - Net Income per Share
Basic and diluted earnings per share is computed using the two-class method. The two-class method is an earnings allocation formula that determines net income per share for each class of common stock and participating security. We have determined that our 6.00% tangible equity units are participating securities. Per share amounts are computed by dividing earnings available to common shareholders by the weighted average shares outstanding during each period.
The computations of basic and diluted earnings per share are as follows:
_____________________
(a)
Our earnings per share calculation reflects the weighted average shares issuable upon settlement of the prepaid stock purchase contract component of our 6.00% tangible equity units, issued November 27, 2013.
The actual number of shares we may issue upon settlement of the stock purchase contract will be between 6,547,900 shares (the minimum settlement rate) and 7,857,500 shares (the maximum settlement rate) based on the applicable market value, as defined in the purchase contract agreement associated with issuance of the Units.
We intend to settle the principal amount of the Convertible Notes in cash upon conversion, with any excess conversion value to be settled in shares of our common stock. Therefore, only the amount in excess of the par value of the Convertible Notes will be included in our calculation of diluted net income per share using the treasury stock method. As such, the Convertible Notes have no impact on diluted net income per share until the price of our common stock exceeds the conversion price of the Convertible Notes of $24.49. The average price of our common stock in 2013 did not exceed the conversion price which resulted in no additional diluted outstanding shares.
Note 11 - Income Taxes
Income tax expense consists of:
A reconciliation of the federal statutory rate to the effective income tax rate on continuing operations follows:
Our 2013 effective tax rate includes a 15 percent benefit from recognition of $6,326,000 of previously unrecognized tax benefits upon lapse of the statute of limitations for a previously reserved tax position. Our 2012 effective tax rate includes a two percent non-cash benefit associated with state deferred tax rate changes due to our acquisition of Credo and operating in additional states.
Significant components of deferred taxes are:
At year-end 2013, we had federal and state net operating loss carryforwards of approximately $7,500,000 primarily as a result of our acquisition of Credo in third quarter 2012. These are subject to certain limitations. If not utilized, these carryforwards will expire in 2031 for federal purposes and 2015 to 2032 for state purposes. We had approximately $9,200,000 of oil and gas percentage depletion carryforwards that also were a result of our acquisition of Credo. These carryforwards are subject to certain limitations but do not expire.
At year-end 2012, we disclosed federal and state net operating loss carryforwards of approximately $31,000,000. We subsequently made a tax return election to capitalize approximately $26,000,000 of intangible drilling costs thereby increasing our tax basis in depletable oil and gas properties and decreasing our net operating loss carryforwards. These capitalized intangible drilling costs are amortizable over 60 months for tax purposes.
At year-end 2013 and 2012, we have not provided a valuation allowance for our federal deferred tax asset because we believe it is likely it will be recoverable in future periods. We have provided a valuation allowance for some of our state net operating loss carryforwards. The change in our state valuation allowance for the year was $268,000. Our deferred tax liability on oil and gas properties includes purchase accounting amounts for the excess of fair value allocated to Credo oil and gas properties over the carryover tax basis received. Goodwill associated with our acquisition of Credo is not deductible for income tax purposes.
We file income tax returns in the U.S. federal jurisdiction and in various state jurisdictions. We are no longer subject to U.S. federal income tax examinations for years before 2010 and state examinations for years before 2009.
Prior to our 2007 spin-off, we were included in Temple-Inland’s consolidated income tax returns. In conjunction with our spin-off, we entered into an agreement with Temple-Inland whereby we agreed to indemnify Temple-Inland for any adjustments related to our tax positions reported in their pre-spin income tax returns. All federal and state examinations for pre-spin years have been finalized resulting in no adjustments to us.
A reconciliation of the beginning and ending amount of tax benefits not recognized for book purposes is as follows:
We recognize interest accrued related to unrecognized tax benefits in income tax expense. In 2013, 2012 and 2011, we recognized approximately $75,000, $152,000 and $41,000 in interest expense. At year-end 2013, we have no accrued interest or penalties. At year-end 2012 and 2011, we have $420,000 and $269,000 of accrued interest and no penalties.
Note 12 - Litigation and Environmental Contingencies
Litigation
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.
Environmental
Environmental remediation liabilities arise from time to time in the ordinary course of doing business, and we believe we have established adequate reserves for any probable losses that we can reasonably estimate. We own 288 acres near Antioch, California, portions of which were sites of a former paper manufacturing operation that are in remediation. We have received certificates of completion on all but one 80 acre tract, a portion of which includes subsurface contamination. We estimate the remaining cost to complete remediation activities will be approximately $1,000,000, which is included in other accrued expenses. It is possible that remediation or monitoring activities could be required in addition to those included within our estimate, but we are unable to determine the scope, timing or extent of such activities.
We have asset retirement obligations related to the abandonment and site restoration requirements that result from the acquisition, construction and development of oil and gas properties. We record the fair value of a liability for an asset retirement obligation in the period in which it is incurred and a corresponding increase in the carrying amount of the related long-lived asset. Accretion expense related to the asset retirement obligation and depletion expense related to capitalized asset retirement cost is included in cost of oil and gas producing activities on our consolidated statements of income and comprehensive income. At year-end 2013, our asset retirement obligation was $1,483,000, which is included in other liabilities.
Note 13 - Commitments and Other Contingencies
We lease timberland, facilities and equipment under non-cancelable long-term operating lease agreements. In addition, we have various obligations under other office space and equipment leases of less than one year. Lease expense on timberland was $311,000 in 2013, $382,000 in 2012 and $349,000 in 2011. Rent expense on facilities and equipment was $2,374,000 in 2013, $2,115,000 in 2012 and $2,000,000 in 2011. Future minimum rental commitments under non-cancelable operating leases having a remaining term in excess of one year are: 2014 - $3,283,000; 2015 - $3,161,000; 2016 - $2,841,000; 2017 - $2,792,000; 2018 - $1,851,000 and thereafter -$2,383,000.
We have 12 years remaining on a 65-year timber lease associated with about 14,000 acres. At year-end 2013, the remaining contractual obligation for this lease is $3,857,000. In addition, we have five years remaining on groundwater leases of about 20,000 acres. At year-end 2013, the remaining contractual obligation for these groundwater leases is $2,019,000.
In 2008, we entered into a 10-year operating lease for approximately 32,000 square feet in Austin, Texas, which we occupy as our corporate headquarters. This lease contains predetermined fixed increases of the minimum rental rate during the initial lease term and a construction allowance for leasehold improvements. The remaining contractual obligation for this lease is $6,853,000. In addition, we maintain offices in Ft. Worth, Texas and Denver, Colorado with approximately 8,000 and 10,000 square feet. The total remaining contractual obligations for these leases is $1,921,000.
We may provide performance bonds and letters of credit on behalf of certain ventures that would be drawn on due to failure to satisfy construction obligations as general contractor or for failure to timely deliver streets and utilities in accordance with local codes and ordinances. In connection with our unconsolidated venture operations, we have provided performance bonds and letters of credit aggregating $26,587,000 at year-end 2013.
Note 14 - Segment Information
We manage our operations through three business segments: real estate, oil and gas and other natural 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 income producing properties, primarily a hotel and our multifamily properties. Oil and gas manages our owned mineral interests and interests leased from others and is an independent oil and gas exploration, development and production operation. Other natural resources manages our timber, recreational leases and water resource initiatives.
We evaluate performance based on segment earnings (loss) before unallocated items and income taxes. Segment earnings (loss) consist of operating income, equity in earnings (loss) of unconsolidated ventures, gain on sale of assets, interest income on loans secured by real estate and net (income) loss attributable to noncontrolling interests. Items not allocated to our business segments consist of general and administrative expense, share-based compensation, gain on sale of strategic timberland, interest expense and other corporate non-operating income and expense. The accounting policies of the segments are the same as those described in Note 1 - Summary of Significant Accounting Policies. Our revenues are derived from our U.S. operations and all of our assets are located in the U.S. In 2013 and 2012, no single customer accounted for more than 10 percent of our total revenues. In 2011, revenues of $17,980,000 from one customer of our real estate segment exceeded 10 percent of our total revenues as result of selling about 9,700 acres of undeveloped land.
_____________________
(a)
Items not allocated to segments consist of:
(b)
Consists of expenditures for oil and gas properties and equipment, property, plant and equipment and reforestation of timber.
Note 15 - Variable Interest Entities
We participate in real estate ventures for the purpose of acquiring and developing residential, multifamily and mixed-use communities in which we may or may not have a controlling financial interest. Generally accepted accounting principles require consolidation of variable interest entities (VIE) in which an enterprise has a controlling financial interest and is the primary beneficiary. A controlling financial interest will have both of the following characteristics: (a) the power to direct the VIE activities that most significantly impact economic performance and (b) the obligation to absorb the VIE losses and right to receive benefits that are significant to the VIE. We examine specific criteria and use judgment when determining whether we are the primary beneficiary and must consolidate a VIE. We perform this review initially at the time we enter into venture agreements and subsequently when reconsideration events occur.
At year-end 2013, we are the primary beneficiary of 23 VIEs, primarily Lantana partnerships, that we consolidate. We have the power to unilaterally control development activities that are significant to the economic success of these partnerships and therefore, we are the primary beneficiary. At year-end 2013 and 2012, these VIEs had assets totaling $29,900,000 and $33,212,000, liabilities of $10,478,000 and $11,585,000 and net working capital (deficit) of $189,000 and $(746,000). In 2013 and 2012, we contributed $8,317,000 and $4,985,000 to these VIEs.
Also at year-end 2013, we are not the primary beneficiary of three VIEs that we account for using the equity method. The unrelated managing partners oversee the day-to-day operations and guarantee some of the debt of the VIEs while we have the authority to approve project budgets and the issuance of additional debt. Although some of the debt is guaranteed by the managing partners, we may under certain circumstances elect or be required to provide additional funds to these VIEs. At year-end 2013, these VIEs have total assets of $11,304,000, substantially all of which represent developed and undeveloped real estate and total liabilities of $43,910,000, which includes $27,277,000 of borrowings classified as current maturities. These amounts are included in other ventures in the combined summarized balance sheet information for ventures accounted for using the equity method in Note 5 - Investment in Unconsolidated Ventures. At year-end 2013, our investment is $17,000 and is included in investment in unconsolidated ventures. In 2013, we contributed $149,000 to these VIEs. Our maximum exposure to loss related to these VIEs is estimated at $3,698,000, which exceeds our investment as we have a nominal general partner interest in these VIEs and could be held responsible for their liabilities. The maximum exposure to loss represents the maximum loss that we could be required to recognize assuming all the ventures’ assets (principally real estate) are worthless, without consideration of the probability of a loss or of any actions we may take to mitigate any such loss.
Note 16 - Share-Based Compensation
Share-based compensation expense consists of:
Share-based compensation expense is included in:
In 2013, share-based compensation expense increased principally as a result of increase in our stock price and its impact on cash-settled awards.
The fair value of awards granted to retirement-eligible employees and expensed at the date of grant was $590,000 in 2013, $595,000 in 2012 and $654,000 in 2011. Unrecognized share-based compensation expense related to non-vested equity-settled awards, restricted stock and stock options is $8,033,000 at year-end 2013. The weighted average period over which this amount will be recognized is estimated to be two years. We did not capitalize any share-based compensation in 2013, 2012 or 2011.
In 2013, we withheld 59,219 shares in connection with vesting of restricted stock awards and exercises of stock options, which are accounted for as treasury stock. In 2013, $1,137,000 was withheld for payroll taxes and is reflected in financing activities in our consolidated statements of cash flows.
A summary of awards granted under our 2007 Stock Incentive Plan follows:
Cash-settled awards
Cash-settled awards granted to our employees in the form of restricted stock units or stock appreciation rights generally vest over three to four years from the date of grant and generally provide for accelerated vesting upon death, disability or if there is a change in control. Vesting for some restricted stock unit awards is also conditioned upon achievement of a minimum one percent annualized return on assets over a three-year period. Cash-settled stock appreciation rights 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. Stock appreciation rights were granted with an exercise price equal to the market value of our stock on the date of grant.
Cash-settled awards granted to our directors in the form of restricted stock units are fully vested at the time of grant and payable upon retirement.
The following table summarizes the activity of cash-settled restricted stock unit awards in 2013:
The weighted average grant date fair value of our non-vested cash-settled restricted stock unit awards at year-end 2012 was $17.03 for 350,000 equivalent units and at year-end 2011 was $13.13 for 449,000 equivalent units.
The following table summarizes the activity of cash-settled stock appreciation rights in 2013:
The weighted average exercise price of our cash-settled stock appreciation rights at year-end 2012 was $11.38 for 866,000 awards and at year-end 2011 was $11.31 for 895,000 awards.
The fair value of awards settled in cash was $7,237,000 in 2013, $5,299,000 in 2012 and $197,000 in 2011. At year-end 2013, the fair value of accrued cash-settled awards is $16,737,000 and is included in other liabilities. The aggregate current value of non-vested awards is $5,112,000 at year-end 2013 based on a year-end stock price of $21.27.
Equity-settled awards
Equity-settled awards granted to our employees include restricted stock units (RSU), which vest ratably over three years from the date of grant, market-leveraged stock units (MSU), which vest after three years from date of grant and performance stock units (PSU), which generally vest after three years from the date of grant if certain performance goals are met. Equity settled awards in the form of restricted stock units granted to our directors are fully vested at time of grant and settled upon retirement. The following table summarizes the activity of equity-settled awards in 2013:
In 2013, we granted 136,000 MSU awards. These awards will be settled in common stock based upon our stock price performance over three years from the date of grant. The number of shares to be issued could range from a high of 204,000 shares if our stock price increases by 50 percent or more, to 68,000 shares if our stock price decreases by 50 percent, or could be zero if our stock price decreases by more than 50 percent, the minimum threshold performance. MSU awards are valued using a Monte Carlo simulation pricing model, which includes expected stock price volatility and risk-free interest rate assumptions. Compensation expense is recognized regardless of achievement of performance conditions, provided the requisite service period is satisfied.
The weighted average grant date fair value of our non-vested equity-settled awards at year-end 2012 was $18.99 for 409,000 non-vested restricted shares and at year-end 2011 was $20.74 for 159,000 non-vested restricted shares.
Unrecognized share-based compensation expense related to non-vested equity-settled awards is $4,182,000 at year-end 2013. The weighted average period over which this amount will be recognized is estimated to be two years.
Restricted stock
Restricted stock awards generally vest over three years, typically if we achieve a minimum one percent annualized return on assets over such three-year period. The following table summarizes the activity of restricted stock awards in 2013:
The weighted average grant date fair value of our non-vested restricted stock awards at year-end 2012 was $16.95 for 211,000 non-vested restricted shares and at year-end 2011 was $15.02 for 399,000 non-vested restricted shares.
Unrecognized share-based compensation expense related to non-vested restricted stock awards is $255,000 at year-end 2013. The weighted average period over which this amount will be recognized is estimated to be two years.
Stock options
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 our stock on the date of grant. The following table summarizes the activity of stock option awards in 2013:
We estimate the fair value of stock options using the Black-Scholes option pricing model and the following assumptions:
We have limited historical experience as a stand-alone company so we utilized alternative methods 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 is based on a blended rate utilizing our historical volatility and historical prices of our peers’ common stock for a period corresponding to the expected life of the options.
Unrecognized share-based compensation expense related to non-vested stock options is $3,596,000 at year-end 2013. The weighted average period over which this amount will be recognized is estimated to be two years.
Pre-Spin Awards
Certain of our employees participated in Temple-Inland’s share-based compensation plans. In conjunction with our 2007 spin-off, these awards were equitably adjusted into separate awards of the common stock of Temple-Inland and the spin-off
entities. As a result of Temple-Inland’s merger with International Paper in first quarter 2012, all outstanding awards on Temple-Inland stock were settled with an intrinsic value of $1,132,000.
Pre-spin stock option awards to our employees to purchase our common stock 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. At year-end 2013, there were 57,000 pre-spin awards outstanding and exercisable on our stock with a weighted average exercise price of $26.68, weighted average remaining term of two years and aggregate intrinsic value of $23,000.
The intrinsic value of options exercised was $51,000 in 2013, $64,000 in 2012 and $766,000 in 2011.
Note 17 - Retirement Plans
Our defined contribution retirement plans include a 401(k) plan, which is funded, and a supplemental plan for certain employees, which is unfunded. The expense of our defined contribution retirement plans was $1,456,000 in 2013, $1,393,000 in 2012 and $924,000 in 2011. The unfunded liability for our supplemental plan was $586,000 at year-end 2013 and $449,000 at year-end 2012 and is included in other liabilities.
Note 18 - Supplemental Oil and Gas Disclosures (Unaudited)
The following unaudited information regarding our oil and gas reserves has been prepared and is presented pursuant to requirements of the Securities and Exchange Commission (SEC) and the Financial Accounting Standards Board (FASB).
We lease our mineral interests, principally in Texas and Louisiana, to third-party entities for the exploration and production of oil and gas. When we lease our mineral interests, we may negotiate a lease bonus payment and we retain a royalty interest and may take an additional participation in production, including a working interest in which we pay a share of the costs to drill, complete and operate a well and receive a proportionate share of the production revenues.
On September 28, 2012, we acquired 100 percent of the outstanding common stock of Credo in an all cash transaction for $14.50 per share, representing an equity purchase price of approximately $146,445,000. In addition, we paid in full $8,770,000 of Credo’s outstanding debt. Credo was an independent oil and gas exploration, development and production company based in Denver, Colorado. The acquired assets included leasehold interests in the Bakken and Three Forks formations of North Dakota, the Lansing - Kansas City formation in Kansas and Nebraska, and the Tonkawa and Cleveland formations in Texas.
We engaged independent petroleum engineers, Netherland, Sewell & Associates, Inc., to prepare estimates of our proved oil and gas reserves, all of which are located in the U.S., and future net cash flows as of year-end 2013, 2012 and 2011.
These estimates were based on the economic and operating conditions existing at year-end 2013, 2012 and 2011. Proved developed reserves are those quantities of petroleum from existing wells and facilities, which by analysis of geosciences and engineering data, can be estimated with reasonable certainty to be commercially recoverable, from a given date forward for known reservoirs and under defined economic conditions, operating methods and government regulations.
SEC rules require disclosure of proved reserves using the twelve-month average beginning-of-month price (which we refer to as the average price) for the year. These same average prices also are used in calculating the amount of (and changes in) future net cash inflows related to the standardized measure of discounted future net cash flows.
For 2013, 2012 and 2011, the average spot price per barrel of oil based on the West Texas Intermediate Crude price is $96.91, $94.71 and $92.71 and the average price per MMBTU of gas based on the Henry Hub spot market is $3.67, $2.76 and $4.12. All prices were adjusted for quality, transportation fees and regional price differentials.
The process of estimating proved reserves and future net cash flows is complex involving decisions and assumptions in evaluating the available engineering and geologic data and prices for oil and gas and the cost to produce these reserves and other factors, many of which are beyond our control. As a result, these estimates are imprecise and should be expected to change as future information becomes available. These changes could be significant. In addition, this information should not be construed as being the current fair market value of our proved reserves.
Estimated Quantities of Proved Oil and Gas Reserves
Estimated quantities of proved oil and gas reserves are summarized as follows:
_____________________
(a)
In 2011, consolidated entities and equity method ventures did not include any proved undeveloped reserves. In 2013 and 2012, proved undeveloped reserves are a result of our acquisition of Credo.
We do not have any estimated reserves of synthetic oil, synthetic gas or products of other non-renewable natural resources that are intended to be upgraded into synthetic oil and gas.
In 2013, increase in gas prices accounted for about 1,243,000 Mcf of upward revisions in gas reserves for our consolidated entities.
In 2012, decreases in gas prices accounted for about 800,000 Mcf of downward revisions in gas reserves for our consolidated entities and about 330,000 Mcf of downward revisions for our equity method ventures. The remaining downward revisions in gas reserves for our consolidated entities were attributable to adverse performance from reducing the total fluid withdrawal rate in a natural water drive reservoir, adverse performance from increasing total fluid withdrawal rate in another natural water drive reservoir, from unfavorable performance from newer wells in over-pressured reservoirs that are exhibiting pressure-dependent permeability reductions, and generally due to higher operating pressures adversely affecting gas well performances in a higher back-pressure environment.
In 2011, increases in oil prices accounted for about 28,000 barrels of the upward revisions in oil reserves for our consolidated entities. The remaining upward revisions to oil reserves were attributable to continued improved response from a steam injection program, improved operational efficiencies from water drive reservoirs, improved performance of recently completed oil wells and generally from improved production performances as a result of more efficient operations driven by higher oil prices.
In 2013, 2012 and 2011, reserve additions from new wells drilled and completed during the year are shown for both consolidated entities and ventures accounted for using the equity method under extensions and discoveries for the royalty interest wells and in 2012 with the acquisition of Credo, working interest wells apply industry practices for new well classifications. There were 88 new well additions in 2013, 27 new well additions in 2012 and 36 new well additions in 2011.
Capitalized Costs Relating to Oil and Gas Producing Activities
Capitalized costs related to our oil and gas producing activities are as follows:
We have not capitalized any costs for our share in ventures accounted for using the equity method.
Costs Incurred in Oil and Gas Property Acquisition, Exploration and Development
Costs incurred in oil and gas property acquisition, exploration and development activities, whether capitalized or expensed, follows:
We have not incurred any costs for our share in ventures accounted for using the equity method. In 2013 and 2012, acquisition of leasehold interests, exploration expenses, and development costs have increased as a result of our increased focus on these activities to increase production, reserves, and add net asset value, and also to explore and develop the assets acquired from Credo.
Standardized Measure of Discounted Future Net Cash Flows
Estimates of future cash flows from proved oil and gas reserves are shown in the following table. Estimated income taxes are calculated by applying the appropriate tax rates to the estimated future pre-tax net cash flows less depreciation of the tax basis of properties and the statutory depletion allowance.
Future net cash flows were computed using prices used in estimating proved oil and gas reserves, year-end costs, and statutory tax rates (adjusted for tax deductions) that relate to proved oil and gas reserves.
Changes in the standardized measure of discounted future net cash flow follows:
Results of Operations for Oil and Gas Producing Activities
Our royalty interests are contractually defined and based on a percentage of production at prevailing market prices. We receive our percentage of production in cash. Similarly, our working interests and the associated net revenue interests are contractually defined and we pay our proportionate share of the capital and operating costs to develop and operate the well and we market our share of the production. Our revenues fluctuate based on changes in the market prices for oil and gas, the inevitable decline in production in existing wells, and other factors affecting oil and gas exploration and production activities, including the cost of development and production.
Information about the results of operations of our oil and gas interests follows:
_____________________
(a)
2012 includes only three months of operations from Credo due to our third quarter 2012 acquisition.
Production costs represent our share of oil and gas production severance taxes, and lease operating expenses. Exploration costs principally represent exploratory dry hole costs, geological and geophysical and seismic study costs.
Note 19 - Summary of Quarterly Results of Operations (Unaudited)
Summarized quarterly financial results for 2013 and 2012 follows:
Note 20 - Subsequent Event
On January 17, 2014, a venture in which we own a 30 percent interest obtained a senior secured construction loan in the amount of $51,950,000 to develop a 320-unit multifamily project located in Nashville, Tennessee. The loan is secured by a lien on the project land and improvements to be constructed, and by a collateral assignment of present and future leases and rents. We provided the lender with a guaranty of completion of the improvements; a guaranty of repayment of 25 percent, repayment of all accrued and unpaid interest, and payment of all operating expenses of the project (except for certain expenses); and a standard nonrecourse carve-out guaranty. The principal guaranty will reduce from 25 percent to zero percent of the principal upon achievement of certain conditions.
Forestar Group Inc.
Schedule III - Consolidated Real Estate and Accumulated Depreciation
Year-End 2013
(In thousands)
Forestar Group Inc.
Schedule III - Consolidated Real Estate and Accumulated Depreciation
Year-End 2013
(In thousands)
Forestar Group Inc.
Schedule III - Consolidated Real Estate and Accumulated Depreciation
Year-End 2013
(In thousands)
Forestar Group Inc.
Schedule III - Consolidated Real Estate and Accumulated Depreciation
Year-End 2013
(In thousands)
_____________________
(a)
We do not capitalize carrying costs until development begins.
(b)
The acquisition date for this land is not available.
Reconciliation of real estate:
Reconciliation of accumulated depreciation:
Item 9.
Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A.
Controls and Procedures.
(a) Disclosure controls and procedures
Our management, with the participation of the Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (or the Exchange Act)) as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or submit under the Exchange Act and are effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
(b) Internal control over financial reporting
Management’s report on internal control over financial reporting is included in Part II, Item 8 of this Annual Report on Form 10-K.
(c) Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fourth quarter 2013 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B.
Other Information.
None.
PART III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance.
Set forth below is certain information about the members of our Board of Directors:
The remaining information required by this item is incorporated herein by reference from our definitive proxy statement, involving the election of directors, to be filed pursuant to Regulation 14A with the SEC not later than 120 days after the end of the fiscal year covered by this Form 10-K (or Definitive Proxy Statement). Certain information required by this item concerning executive officers is included in Part I of this report.
The information required by this item is incorporated by reference from our Definitive Proxy Statement.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Equity Compensation Plan Information
We have only one equity compensation plan, the Forestar 2007 Stock Incentive Plan. It was approved by our sole stockholder prior to spin-off and material terms and amendments thereto were subsequently approved by our stockholders. Information at year-end 2013 about our equity compensation plan under which our common stock may be issued follows:
_____________________
(1)
Includes approximately 779,000 issuable to personnel of Temple-Inland and the other spin-off entity resulting from the equitable adjustment of Temple-Inland equity awards in connection with our spin-off.
(2)
Includes approximately 387,000 equity-settled restricted stock units, 416,000 market-leveraged stock units and 41,000 performance stock units, which are excluded from the calculation of weighted-average exercise price. The market-leveraged stock unit awards will be settled in common stock based upon our stock price performance over three years from the date of grant. The number of shares to be issued could range from a high of 624,000 shares if our stock price increases
by 50 percent or more, to 208,000 shares if our stock price decreases by 50 percent, or could be zero if our stock price decreases by more than 50 percent, the minimum threshold performance.
The remaining information required by this item is incorporated by reference from our Definitive Proxy Statement.
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence.
The information required by this item is incorporated by reference from our Definitive Proxy Statement.
Item 14.
Item 14.
Principal Accountant Fees and Services.
The information required by this item is incorporated by reference from our Definitive Proxy Statement.
PART IV
Item 15.
Item 15.
Exhibits and Financial Statement Schedules.
(a)
Documents filed as part of this report.
(1)
Financial Statements
Our Consolidated Financial Statements are included in Part II, Item 8 of this Annual Report on Form 10-K.
(2)
Financial Statement Schedules
Schedule III - Consolidated Real Estate and Accumulated Depreciation is included in Part II, Item 8 of this Annual Report on Form 10-K.
Schedules other than those listed above are omitted as the required information is either inapplicable or the information is presented in our Consolidated Financial Statements and notes thereto.
(3)
Exhibits
The exhibits listed in the Exhibit Index in (b) below are filed or incorporated by reference as part of this Annual Report on Form 10-K.
(b)
Exhibits
_____________________
*
Filed herewith.
†
Management contract or compensatory plan or arrangement.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
FORESTAR GROUP INC.
By:
/s/ James M. DeCosmo
James M. DeCosmo
President and Chief Executive Officer
Date: March 11, 2014
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.