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FOR > SEC Filings for FOR > Form 10-Q on 8-Aug-2013All Recent SEC Filings

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Quarterly Report

Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations in our 2012 Annual Report on Form 10-K. Unless otherwise indicated, information is presented as of second quarter-end 2013, and references to acreage owned includes all acres owned by ventures regardless of our ownership interest in a venture.
Forward-Looking Statements
This Quarterly Report on Form 10-Q and other materials we have filed or may file with the Securities and Exchange Commission contain "forward-looking statements" within the meaning of the federal securities laws. These forward-looking statements are identified by their use of terms and phrases such as "believe," "anticipate," "could," "estimate," "likely," "intend," "may," "plan," "expect," and similar expressions, including references to assumptions. These statements reflect our current views with respect to future events and are subject to risks and uncertainties. We note that a variety of factors and uncertainties could cause our actual results to differ significantly from the results discussed in the forward-looking statements. Factors and uncertainties that might cause such differences include, but are not limited to:
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 the timing of such payments;

          accuracy of estimates and other assumptions related to investment in
           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, revenue,
           capital expenditure 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;

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 of acquiring CREDO Petroleum
           Corporation (Credo);

risks associated with oil and gas 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 credit facility,
           indenture 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 effecting, 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.

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Other factors, including the risk factors described in Item 1A of our 2012 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.

2012 Strategic Initiatives
In 2012, we announced Triple in FOR, new strategic initiatives designed to
further enhance shareholder value by:
          Accelerating value realization of our real estate and natural
           resources by increasing total residential lot sales, oil and gas
           production, and total segment EBITDA.

          Optimizing transparency and disclosure by expanding reported oil and
           gas resources, providing additional information related to groundwater
           interests, and establishing a progress report on corporate
           responsibility efforts.

          Raising our net asset value through strategic and disciplined
           investments by pursuing growth opportunities which help prove up our
           asset value and meet return expectations, developing a low-capital,
           high-return multifamily business, and accelerating investment in
           lower-risk oil and gas opportunities.

Segment Reporting Change
In first quarter 2013, we strategically changed our reportable segments to better reflect the underlying market fundamentals and operating strategy of our core business operations, real estate and oil and gas. With this change, we aggregated our fiber and water resource operating results in other natural resources. All prior period segment information has been reclassified to conform to the current period presentation.

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Results of Operations
A summary of our consolidated results by business segment follows:
                                                   Second Quarter            First Six Months
                                                  2013         2012         2013          2012
                                                                 (In thousands)
Real estate                                    $ 41,219     $ 26,647     $ 119,908     $ 44,569
Oil and gas                                      15,831        7,148        31,335       16,574
Other natural resources                           3,029        1,517         6,307        2,261
Total revenues                                 $ 60,079     $ 35,312     $ 157,550     $ 63,404
Segment earnings:
Real estate                                    $  8,104     $  7,666     $  27,550     $ 19,243
Oil and gas                                       4,243        5,005         9,370       12,133
Other natural resources                             991         (458 )       2,243       (1,321 )
Total segment earnings                           13,338       12,213        39,163       30,055
Items not allocated to segments:
General and administrative expense               (5,329 )     (7,120 )     (10,287 )    (11,482 )
Share-based compensation expense                 (1,460 )         67       (11,875 )     (5,164 )
Interest expense                                 (5,122 )     (3,664 )      (9,661 )     (7,555 )
Other corporate non-operating income                 25           47            56          111
Income before taxes                               1,452        1,543         7,396        5,965
Income tax expense                                 (911 )       (732 )      (2,904 )     (2,352 )
Net income attributable to Forestar Group Inc. $    541     $    811     $   4,492     $  3,613

Significant aspects of our results of operations follow:
Second Quarter and First Six Months 2013

          Second quarter 2013 real estate segment earnings increased primarily
           due to higher average prices for lots and commercial acres sold offset
           by lower lot sales volume and commercial acres sold in second quarter
           2013 as compared with second quarter 2012. In addition, second quarter
           2013 real estate segment earnings increased primarily due to sale of
           the remaining 440 undeveloped residential acres from a project in
           Florida for $3,536,000, which generated approximately $687,000 in
           segment earnings. First six months 2013 real estate segment earnings
           benefited from sale of Promesa, a 289-unit multifamily property we
           developed and sold in Austin, for $41,000,000, which generated
           approximately $10,881,000 in segment earnings. In addition, first six
           months 2013 segment earnings also benefited from increased residential
           lot sales activity, undeveloped land sales from our retail program and
           commercial tract sales.

          Oil and gas segment earnings decreased principally due to lower oil
           and gas production volumes and lower average oil prices and reduced
           delay rental payments received related to royalties from our owned
           mineral interests. This decrease was partially offset by higher
           working interest production volume and earnings attributable to our
           exploration and production operations as result of our acquisition of
           Credo in third quarter 2012.

          Other natural resources segment earnings benefited from higher levels
           of timber harvesting activity which was driven by increased customer

          Share-based compensation expense increased principally as result of a
           16 percent increase in our stock price since year-end 2012, compared
           to a 15 percent decrease in our stock price in first six months 2012,
           which impacted the value of vested cash-settled awards.

Second Quarter and First Six Months 2012
          Second quarter 2012 real estate segment earnings benefited principally
           from $3,401,000 gain from a consolidated venture's sale of 800 acres
           near Dallas and increased residential lot and commercial sales. First

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months 2012 real estate segment earnings benefited principally from $11,675,000 gain from the sale of our 25 percent interest in Palisades West LLC for $32,095,000 and increased residential lot and commercial sales. These items are partially offset by decreased retail land sales volume.

          Oil and gas segment earnings benefited from increased oil production
           volumes which was partially offset by decreased lease bonus activity
           and increased costs from additional personnel.

          Second quarter and first six months 2012 general and administrative
           expense includes $2,461,000 in transaction costs to outside advisors
           related to entering into a definitive agreement to acquire Credo.

          Second quarter 2012 share-based compensation expense related to
           cash-settled awards decreased as result of a decline in our stock
           price and the impact on vested cash-settled awards. In first six
           months 2012, the decline in our stock price and the impact on vested
           cash-settled awards was offset by expenses related to equity-settled
           awards granted in first quarter 2012.

Current Market Conditions
U.S. single-family residential market conditions continued to improve in first six months 2013, driven by a growing demand for homes and a tightening supply of homes available for sale. Housing demand has been fueled primarily by 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, persistently high unemployment levels, national and global economic weakness and uncertainty, a restrictive mortgage lending environment and the potential for more foreclosures continue to threaten a recovery in the housing market. 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 new construction activity, 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 several months and generally have been stronger over the last two and one-half years. Natural gas prices are up over 50 percent from year ago levels, but are significantly lower than realized prices over the last decade. The prolonged cold weather throughout the 2012 - 2013 heating season has taken working gas in storage below the midpoint of the five year average causing natural 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 natural gas when comparing energy equivalency and due to the U.S. being net importers of crude oil while current estimates of domestic natural gas producing supplies are 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 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 sales 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 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, natural gas, and timber, and the overall strength or weakness of the U.S. economy.
Real Estate
We own directly or through ventures over 133,000 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 approximately 100,000 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

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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 commercial and income producing properties, primarily a hotel at second quarter-end 2013, and multifamily properties we may develop and sell as a merchant builder.
A summary of our real estate results follows:

                                                 Second Quarter            First Six Months
                                                2013         2012         2013          2012
                                                               (In thousands)
Revenues                                     $ 41,219     $ 26,647     $ 119,908     $ 44,569
Cost of sales                                 (28,262 )    (15,216 )     (81,308 )    (25,547 )
Operating expenses                             (7,709 )     (8,243 )     (14,681 )    (15,787 )
                                                5,248        3,188        23,919        3,235
Interest income primarily from loan secured
by real estate                                  1,086        1,093         2,196        1,093
Gain on sale of assets                              -        3,401             -       15,076
Equity in earnings of unconsolidated
ventures                                        2,427          644         3,183        1,194
Less: Net income attributable to
noncontrolling interests                         (657 )       (660 )      (1,748 )     (1,355 )
Segment earnings                             $  8,104     $  7,666     $  27,550     $ 19,243

In first six months 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. In addition, in second quarter and first six months 2013, cost of sales include $11,460,000 and $17,606,000 related to multifamily construction contract costs we incurred as general contractor and paid to subcontractors associated with our development of two multifamily venture properties. Interest income principally represents earnings from a loan we hold which is secured by a mixed-use real estate community in Houston.
In second quarter and first six months 2012, gain on sale of assets includes $3,401,000 from a consolidated venture's sale of 800 acres near Dallas. In addition, in first six months 2012, gain on sale of assets includes $11,675,000 from the sale of our 25 percent interest in Palisades West LLC for $32,095,000. Revenues in our owned and consolidated ventures consist of:

                                              Second Quarter          First Six Months
                                             2013        2012         2013        2012
                                                           (In thousands)
Residential real estate                    $ 18,348    $ 14,830    $  37,450    $ 23,328
Commercial real estate                        2,187       1,765        3,438       1,765
Undeveloped land                              2,578       2,581        5,287       3,314
Commercial and Income producing properties   17,861       7,298       72,032      14,576
Other                                           245         173        1,701       1,586
Total revenues                             $ 41,219    $ 26,647    $ 119,908    $ 44,569

Residential real estate revenues principally consist of the sale of single-family lots to national, regional and local homebuilders. Although lot sales volume decreased in second quarter 2013 compared with second quarter 2012, revenues were up due to higher average price per lot sold. In addition, we sold the remaining 440 undeveloped residential tract acres from a project in Florida for $3,536,000. In first six months 2013, residential real estate revenues increased principally as a result of increased lot sales volume due to demand for finished lot inventory by homebuilders in markets where supply has diminished.
Market conditions for undeveloped land sales under our retail sales program remain challenging due to limited credit availability, and alternate investment options to buyers in the market. However, in first six months 2013, undeveloped land sales increased as compared to first six months 2012. We sold 1,919 acres for $5,287,000 or approximately $2,800 per acre, generating approximately $4,118,000 in segment earnings.
In first six months 2013, commercial and income producing properties revenue increased primarily as result of selling 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 this sale, for $41,000,000. In addition, income producing

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properties revenue increased as a result of construction revenues of $17,606,000 associated with our multifamily guaranteed maximum price construction contracts as general contractor. We are reimbursed for costs paid to subcontractors plus earn a development and construction fee on certain projects, both of which are included in income producing properties revenue. In second quarter 2013, we entered into a $27,900,000 maximum price construction contract with a third-party general contractor for construction of a 354-unit multifamily property near Dallas. Construction on this multifamily development site began in June 2013. Following second quarter-end 2013, we obtained a senior secured construction loan in the amount of $24,357,000 to finance approximately 70 percent of the total development cost. Revenues also increased as a result of higher revenue per available room from our 413 guest room hotel in Austin compared with first six months 2012.
Units sold in our owned and consolidated ventures consist of:

                            Second Quarter          First Six Months
                           2013        2012         2013        2012
Residential real estate:
Lots sold                     259         345          614         482
Revenue per lot sold     $ 57,154    $ 42,725    $  54,440    $ 48,210
Commercial real estate:
Acres sold                     32          38           35          38
Revenue per acre sold    $ 74,166    $ 47,040    $ 100,311    $ 47,040
Undeveloped land:
Acres sold                  1,000         933        1,919       1,253
Revenue per acre sold    $  2,576    $  2,765    $   2,755    $  2,645

Operating expenses consist of:

                                      Second Quarter         First Six Months
                                     2013        2012        2013        2012
                                                  (In thousands)
Employee compensation and benefits $  1,902    $ 1,929    $   3,274    $  4,054
Property taxes                        2,049      2,398        4,045       4,341
Professional services                   956        821        2,126       2,078
Depreciation and amortization           713      1,103        1,742       2,150
Other                                 2,089      1,992        3,494       3,164
Total operating expenses           $  7,709    $ 8,243    $  14,681    $ 15,787

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

                                                                  2013        2012
Owned and consolidated ventures:
Entitled, developed and under development projects
Number of projects                                                    65          65
Residential lots remaining                                        19,681      19,979
Commercial acres remaining                                         2,019       2,085
Undeveloped land and land in the entitlement process
Number of projects                                                    14          16
Acres in entitlement process                                      25,980      27,590
Acres undeveloped                                                 87,714      95,901
Ventures accounted for using the equity method:
Ventures' lot sales (for first six months)
Lots sold                                                            192         230
Average price per lot sold                                     $  54,407    $ 47,568
Ventures' entitled, developed and under development projects
Number of projects                                                     7           7
Residential lots remaining                                         3,495       3,954
Commercial acres sold (for first six months)                           2           -
Average price per acre sold                                    $ 652,886    $      -
Commercial acres remaining                                           306         333
Ventures' undeveloped land and land in the entitlement process
Acres sold (for first six months)                                     42         135
Average price per acre sold                                    $   2,650    $  2,600
Acres undeveloped                                                  5,613       5,655

We underwrite 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 follows:

                                       Developed,                              Commercial
. . .
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