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

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Form 10-Q for FORESTAR GROUP INC.


8-Nov-2013

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 third 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.


Table of Contents

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 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.


Table of Contents

Results of Operations
A summary of our consolidated results by business segment follows:
                                                  Third Quarter            First Nine Months
                                                2013         2012         2013          2012
                                                               (In thousands)
Revenues:
Real estate                                  $ 50,356     $ 27,115     $ 170,264     $  71,684
Oil and gas                                    22,095       10,479        53,430        27,053
Other natural resources                         2,656        3,016         8,963         5,277
Total revenues                               $ 75,107     $ 40,610     $ 232,657     $ 104,014
Segment earnings:
Real estate                                  $ 13,197     $ 12,688     $  40,747     $  31,931
Oil and gas                                     8,499        7,337        17,869        19,470
Other natural resources                           549          552         2,792          (769 )
Total segment earnings                         22,245       20,577        61,408        50,632
Items not allocated to segments:
General and administrative expense             (4,648 )     (8,000 )     (14,935 )     (19,482 )
Share-based compensation expense               (3,492 )     (6,327 )     (15,367 )     (11,491 )
Gain on sale of assets                              -           16             -            16
Interest expense                               (5,231 )     (8,094 )     (14,892 )     (15,649 )
Other corporate non-operating income               24           47            80           158
Income (loss) before taxes                      8,898       (1,781 )      16,294         4,184
Income tax benefit (expense)                    2,932        1,078            28        (1,274 )
Net income (loss) attributable to Forestar
Group Inc.                                   $ 11,830     $   (703 )   $  16,322     $   2,910

Significant aspects of our results of operations follow:
Third Quarter and First Nine Months 2013

          Third quarter and first nine months 2013 real estate segment earnings
           increased due to higher average prices for lots and commercial acres
           sold, higher lot sales volume and higher undeveloped land sales from
           our retail land sales program offset partially by lower commercial
           acres sold as compared with third quarter 2012. First nine months 2013
           real estate segment earnings benefited from 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, first nine 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 for the third quarter and first nine
           months 2013, increased principally due to higher working interest
           production volume and earnings attributable to our exploration and
           production operations on leased mineral interests as result of our
           acquisition of Credo in third quarter 2012 and higher average oil and
           natural gas prices, partially offset by lower oil and gas production
           volumes and reduced lease bonus and delay rental payments received
           related to our owned mineral interests.


          Third quarter 2013 other natural resources segment earnings remained
           flat. Higher average fiber prices were offset by lower volumes
           primarily due to scheduled maintenance outages taken by our customers
           in the quarter. First nine months 2013 other natural resources segment
           earnings benefited from higher levels of timber harvesting activity
           driven by increased customer demand compared to first nine months
           2012.


          Share-based compensation expense fluctuations are primarily driven by
           changes in our stock price. First nine month 2013 share-based
           compensation expense increased principally as result of a 24 percent
           increase in our stock price since year-end 2012, compared with a 10
           percent increase in our stock price in first nine months 2012 since
           year-end 2011, which impacted the value of vested cash-settled awards.


Table of Contents

Third Quarter and First Nine Months 2012
          Third quarter and first nine months 2012 real estate segment earnings
           benefited primarily from a $10,180,000 gain resulting from the sale of
           Broadstone Memorial, a 401 unit multifamily project in Houston, and
           increased residential and commercial sales activity. First nine months
           2012 real estate segment earnings also benefited from a $11,675,000
           gain from the sale of our 25 percent interest in Palisades West LLC, a
           $3,401,000 gain from a consolidated venture's sale of 800 acres near
           Dallas, and increased residential and commercial sales activity.


          Oil and gas segment earnings benefited from $3,543,000 in lease bonus
           revenues as a result of leasing over 3,100 net mineral acres and
           increased oil production volumes. These items were partially offset by
           increased cost of sales due to higher production volumes, lower prices
           and from additional oil and natural gas personnel.


          Third quarter and first nine months 2012 general and administrative
           expense includes $3,248,000 and $5,709,000 in transaction costs to
           outside advisors associated with our acquisition of Credo on September
           28, 2012.


          Share-based compensation expense increased as result of the increase
           in our stock price and the impact on cash-settled vested awards.


          Interest expense includes a $4,448,000 loss on extinguishment of debt
           in connection with amendment and extension of our term loan on
           September 14, 2012.

Current Market Conditions
U.S. single-family residential market conditions continued to improve in first nine 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, and a restrictive mortgage lending environment continue to threaten a robust 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 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 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. 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 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 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.


Table of Contents

Real Estate
We own directly or through ventures 132,000 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 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 third quarter-end 2013, and multifamily properties we may develop and sell as a merchant builder.
A summary of our real estate results follows:

                                                  Third Quarter           First Nine Months
                                                2013         2012         2013          2012
                                                               (In thousands)
Revenues                                     $ 50,356     $ 27,115     $ 170,264     $ 71,684
Cost of sales                                 (31,955 )    (17,539 )    (113,263 )    (43,086 )
Operating expenses                             (8,498 )     (8,421 )     (23,179 )    (24,208 )
                                                9,903        1,155        33,822        4,390
Interest income primarily from loan secured
by real estate                                  1,435        1,066         3,631        2,159
Gain on sale of assets                              -       10,197             -       25,273
Equity in earnings of unconsolidated
ventures                                        2,926          593         6,109        1,787
Less: Net income attributable to
noncontrolling interests                       (1,067 )       (323 )      (2,815 )     (1,678 )
Segment earnings                             $ 13,197     $ 12,688     $  40,747     $ 31,931

Third quarter and first nine months 2013 revenues include construction revenues of $9,029,000 and $26,635,000 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 commercial and income producing properties revenue. Revenues associated with multifamily construction contracts for third quarter and first nine months 2012 were $2,099,000 and $2,158,000. Third quarter and first nine months 2013, cost of sales include $9,583,000 and $27,189,000 related to multifamily construction contract costs we incurred as general contractor and paid to subcontractors associated with our development of two multifamily venture properties, as well as an estimated loss of $554,000 associated with our fixed fee contract as a general contractor related to one of our venture multifamily properties. Cost of sales associated with multifamily construction contracts for third quarter and first nine months 2012 were $2,099,000 and $2,158,000.
In addition, first nine 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.
Third quarter and first nine months 2013 interest income principally represents earnings from a loan we hold which is secured by a mixed-use real estate community in Houston.
In third quarter and first nine months 2012, gain on sale of assets includes $10,180,000 resulting from the sale of Broadstone Memorial, a 401-unit multifamily project in Houston. In addition, first nine months 2012 includes a $11,675,000 gain from the sale of our 25 percent interest in Palisades West LLC for $32,095,000 and a $3,401,000 gain from a consolidated venture's sale of 800 acres in Dallas.
In third quarter and first nine months 2013, the increase in equity earnings of unconsolidated ventures compared to third quarter 2012 is primarily due to higher average residential lot prices and lot sales volume and increase in commercial tract sales.


Table of Contents

Revenues in our owned and consolidated ventures consist of:

                                               Third Quarter          First Nine Months
                                             2013        2012         2013         2012
                                                           (In thousands)
Residential real estate                    $ 28,298    $ 13,564    $   65,748    $ 36,892
Commercial real estate                        1,083       2,405         4,521       4,170
Undeveloped land                              6,571       1,604        11,858       4,918
Commercial and income producing properties   13,355       8,805        85,387      23,381
Other                                         1,049         737         2,750       2,323
Total revenues                             $ 50,356    $ 27,115    $  170,264    $ 71,684

Residential real estate revenues principally consist of the sale of single-family lots to national, regional and local homebuilders. Revenues increased in third quarter 2013 compared with third quarter 2012 due to both higher average price per lot sold and increased lot sales volume. In addition, in third quarter 2013, we sold about 46 undeveloped residential tract acres for $4,964,000 which generated segment earnings of $2,214,000. In first nine 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. In addition, in first nine months 2013, we sold 486 undeveloped residential tract acres of which 440 were the remaining undeveloped residential tract acres from a project in Florida for $3,536,000.
Undeveloped land sales increased in third quarter 2013 as compared with third quarter 2012 due to sale of 1,314 undeveloped acres for $6,571,000 which generated segment earnings of $3,769,000. In first nine months 2013, undeveloped land sales increased as compared to first nine months 2012 due to sale of 3,233 acres for $11,858,000, or approximately $3,700 per acre, generating approximately $7,887,000 in segment earnings.
In first nine 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 its sale, for $41,000,000. In addition, income producing properties revenue increased in third quarter and first nine months 2013 as a result of construction revenues of $9,029,000 and $26,635,000 associated with our multifamily guaranteed maximum price construction contracts as general contractor.
In first nine months 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. In third quarter 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, with no loan balance outstanding at third quarter-end 2013.
Third quarter 2013 revenues related to our 413 guest room hotel in Austin were down $893,000 when compared with third quarter 2012, primarily due to lower occupancy from increased renovation activity. In addition, third quarter 2013 real estate segment operating expenses includes a $776,000 loss on retirement of assets associated with the capital improvement project at the hotel. Units sold in our owned and consolidated ventures consist of:

                              Third Quarter           First Nine Months
                            2013         2012         2013         2012
Residential real estate:
Lots sold                      414          193         1,028         675
Revenue per lot sold     $  56,866    $  54,206    $   55,417    $ 49,925
Commercial real estate:
Acres sold                       2           18            37          56
Revenue per acre sold    $ 426,554    $ 133,882    $  115,892    $ 75,147
Undeveloped land:
Acres sold                   1,314          564         3,233       1,817
Revenue per acre sold    $   5,001    $   2,846    $    3,668    $  2,707


Table of Contents

Operating expenses consist of:

                                      Third Quarter         First Nine Months
                                     2013       2012        2013         2012
                                                  (In thousands)
Employee compensation and benefits $ 2,434    $ 2,530    $    5,708    $  6,584
Property taxes                       1,669      1,964         5,714       6,305
Professional services                  871        992         2,997       3,070
Depreciation and amortization          721      1,101         2,463       3,251
Other                                2,803      1,834         6,297       4,998
Total operating expenses           $ 8,498    $ 8,421    $   23,179    $ 24,208

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

                                                                       Third
                                                                    Quarter-End
                                                                  2013        2012
Owned and consolidated ventures:
Entitled, developed and under development projects
Number of projects                                                    65          65
Residential lots remaining                                        19,378      20,019
Commercial acres remaining                                         2,020       2,067
Undeveloped land and land in the entitlement process
. . .
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