10-Q 1 for-6302014x10q.htm 10-Q FOR-6.30.2014-10Q
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________________________________________ 
FORM 10-Q
_________________________________________________________ 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2014
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number: 001-33662
_________________________________________________________  
FORESTAR GROUP INC.
(Exact Name of Registrant as Specified in Its Charter)
 _________________________________________________________ 
Delaware
 
26-1336998
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
6300 Bee Cave Road, Building Two, Suite 500, Austin, Texas 78746
(Address of Principal Executive Offices, Including Zip Code)
(512) 433-5200
(Registrant’s Telephone Number, Including Area Code)
 _________________________________________________________
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x  Yes    ¨  No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    x  Yes    ¨  No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
¨
 
Accelerated filer
x
 
 
 
 
 
Non-accelerated filer
¨
(Do not check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ¨  Yes    x  No
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Title of Each Class
 
Number of Shares Outstanding as of August 4, 2014
Common Stock, par value $1.00 per share
 
34,915,983
 



FORESTAR GROUP INC.
TABLE OF CONTENTS
 

2


PART I—FINANCIAL INFORMATION
Item 1. Financial Statements
FORESTAR GROUP INC.
Consolidated Balance Sheets
(Unaudited)
 
Second
Quarter-End
 
Year-End
 
2014
 
2013
 
(In thousands, except share data)
ASSETS
 
Cash and cash equivalents
$
184,168

 
$
192,307

Real estate, net
538,493

 
519,464

Oil and gas properties and equipment, net
253,230

 
232,641

Investment in unconsolidated ventures
50,804

 
41,147

Timber
9,053

 
10,947

Receivables, net
46,311

 
39,252

Prepaid expenses
5,062

 
5,136

Income taxes receivable
452

 

Property and equipment, net
10,539

 
6,112

Deferred tax asset, net
34,519

 
40,398

Goodwill and other intangible assets
66,599

 
66,646

Other assets
23,122

 
18,102

TOTAL ASSETS
$
1,222,352

 
$
1,172,152

LIABILITIES AND EQUITY
 
 
 
Accounts payable
$
18,601

 
$
21,409

Accrued employee compensation and benefits
4,568

 
5,814

Accrued property taxes
4,343

 
3,822

Accrued interest
4,501

 
2,343

Income taxes payable

 
3,876

Earnest money deposits
8,460

 
10,854

Other accrued expenses
24,145

 
26,851

Other liabilities
19,530

 
24,379

Debt
400,328

 
357,407

TOTAL LIABILITIES
484,476

 
456,755

COMMITMENTS AND CONTINGENCIES

 

EQUITY
 
 
 
Forestar Group Inc. shareholders’ equity:
 
 
 
Preferred stock, par value $0.01 per share, 25,000,000 authorized shares, none issued

 

Common stock, par value $1.00 per share, 200,000,000 authorized shares, 36,946,603 issued at second quarter-end 2014 and year-end 2013
36,947

 
36,947

Additional paid-in capital
556,395

 
556,676

Retained earnings
173,574

 
150,418

Treasury stock, at cost, 2,037,286 shares at second quarter-end 2014 and 2,199,666 shares at year-end 2013
(31,872
)
 
(34,196
)
Total Forestar Group Inc. shareholders’ equity
735,044

 
709,845

Noncontrolling interests
2,832

 
5,552

TOTAL EQUITY
737,876

 
715,397

TOTAL LIABILITIES AND EQUITY
$
1,222,352

 
$
1,172,152

Please read the notes to consolidated financial statements.

3


FORESTAR GROUP INC.
Consolidated Statements of Income and Comprehensive Income
(Unaudited)
 
Second Quarter
 
First Six Months
 
2014
 
2013
 
2014
 
2013
 
(In thousands, except per share amounts)
REVENUES
 
 
 
 
 
 
 
Real estate sales and other
$
44,124

 
$
23,358

 
$
99,671

 
$
47,876

Commercial and income producing properties
11,049

 
17,861

 
20,982

 
72,032

Real estate
55,173

 
41,219

 
120,653

 
119,908

Oil and gas
24,377

 
15,831

 
41,931

 
31,335

Other natural resources
3,463

 
3,029

 
5,034

 
6,307

 
83,013

 
60,079

 
167,618

 
157,550

COSTS AND EXPENSES
 
 
 
 
 
 
 
Cost of real estate sales and other
(23,419
)
 
(12,414
)
 
(49,483
)
 
(24,509
)
Cost of commercial and income producing properties
(8,606
)
 
(15,848
)
 
(18,726
)
 
(56,799
)
Cost of oil and gas producing activities
(16,926
)
 
(8,838
)
 
(29,546
)
 
(16,672
)
Cost of other natural resources
(801
)
 
(516
)
 
(1,577
)
 
(1,208
)
Other operating
(16,330
)
 
(13,079
)
 
(30,327
)
 
(28,988
)
General and administrative
(6,856
)
 
(5,830
)
 
(12,001
)
 
(16,300
)
 
(72,938
)
 
(56,525
)
 
(141,660
)
 
(144,476
)
GAIN ON ASSET EXCHANGE AND SALES
16,867

 

 
16,867

 

OPERATING INCOME
26,942

 
3,554

 
42,825

 
13,074

Equity in earnings of unconsolidated ventures
958

 
2,566

 
1,949

 
3,479

Interest expense
(7,370
)
 
(5,122
)
 
(12,873
)
 
(9,661
)
Other non-operating income
2,269

 
1,111

 
4,563

 
2,252

INCOME BEFORE TAXES
22,799

 
2,109

 
36,464

 
9,144

Income tax expense
(8,051
)
 
(911
)
 
(12,709
)
 
(2,904
)
CONSOLIDATED NET INCOME
14,748

 
1,198

 
23,755

 
6,240

Less: Net loss (income) attributable to noncontrolling interests
74

 
(657
)
 
(599
)
 
(1,748
)
NET INCOME ATTRIBUTABLE TO FORESTAR GROUP INC.
$
14,822

 
$
541

 
$
23,156

 
$
4,492

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
 
 
 
 
 
 
 
Basic
35,458

 
35,351

 
35,407

 
35,305

Diluted
43,688

 
36,052

 
43,690

 
35,934

NET INCOME PER COMMON SHARE
 
 
 
 
 
 
 
Basic
$
0.34

 
$
0.02

 
$
0.54

 
$
0.13

Diluted
$
0.34

 
$
0.02

 
$
0.53

 
$
0.13

TOTAL COMPREHENSIVE INCOME
$
14,822

 
$
541

 
$
23,156

 
$
4,492

Please read the notes to consolidated financial statements.

4


FORESTAR GROUP INC.
Consolidated Statements of Cash Flows
(Unaudited) 
 
First Six Months
 
2014
 
2013
 
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Consolidated net income
$
23,755

 
$
6,240

Adjustments:
 
 
 
Depreciation, depletion and amortization
17,927

 
13,577

Change in deferred income taxes
7,668

 
1,492

Change in unrecognized tax benefits

 
75

Equity in earnings of unconsolidated ventures
(1,949
)
 
(3,479
)
Distributions of earnings of unconsolidated ventures
1,768

 
210

Share-based compensation
3,532

 
11,875

Real estate cost of sales
47,976

 
53,208

Dry hole exploration costs
5,665

 
1,296

Real estate development and acquisition expenditures, net
(66,558
)
 
(34,772
)
Reimbursements from utility and improvement districts
6,618

 
2,881

Other changes in real estate
2,341

 
144

Changes in deferred income
1,141

 
(1,329
)
Gain on asset exchange and sales
(16,867
)
 

Other
2,483

 
212

Changes in:
 
 
 
Notes and accounts receivable
(6,809
)
 
(1,452
)
Prepaid expenses and other
3,751

 
1,136

Accounts payable and other accrued liabilities
(9,156
)
 
(15,854
)
Income taxes
(4,291
)
 
(587
)
Net cash provided by operating activities
18,995

 
34,873

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Property, equipment, software, reforestation and other
(9,823
)
 
(3,357
)
Oil and gas properties and equipment
(44,632
)
 
(32,286
)
Investment in unconsolidated ventures
(4,430
)
 
(782
)
Proceeds from sales of oil and gas properties
11,022

 

Return of investment in unconsolidated ventures
155

 
1,370

Other

 
(10
)
Net cash used for investing activities
(47,708
)
 
(35,065
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Proceeds from issuance of convertible senior notes, net

 
120,795

Proceeds from issuance of senior secured notes, net
241,947

 

Payments of debt
(219,653
)
 
(93,390
)
Additions to debt
10,383

 
32,621

Deferred financing fees
(3,068
)
 
(193
)
Distributions to noncontrolling interests, net
(898
)
 
(1,401
)
Purchase of noncontrolling interests
(7,971
)
 

Exercise of stock options
754

 
1,645

Payroll taxes on issuance of stock-based awards
(972
)
 
(1,027
)
Excess income tax benefit from share-based compensation
52

 
(81
)
Net cash provided by financing activities
20,574

 
58,969

 
 
 
 
Net increase (decrease) in cash and cash equivalents
(8,139
)
 
58,777

Cash and cash equivalents at beginning of period
192,307

 
10,361

Cash and cash equivalents at end of period
$
184,168

 
$
69,138

Please read the notes to consolidated financial statements.

5


FORESTAR GROUP INC.
Notes to Consolidated Financial Statements
(Unaudited)
Note 1—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. We eliminate all material intercompany accounts and transactions. Noncontrolling interests in consolidated pass-through entities are recognized before income taxes. In our consolidated balance sheets we have reclassified prior year's earnest money deposits that were included in other accrued expenses and other liabilities as a separate line item to conform to the current year presentation. 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 distributions of accumulated earnings).
We prepare our unaudited interim financial statements in accordance with U.S. generally accepted accounting principles and Securities and Exchange Commission requirements for interim financial statements. As a result, they do not include all the information and disclosures required for complete financial statements. However, in our opinion, all adjustments considered necessary for a fair presentation have been included. Such adjustments consist only of normal recurring items unless otherwise noted. We make estimates and assumptions about future events. Actual results can, and probably will, differ from those we currently estimate including those principally related to allocating costs to real estate, measuring long-lived assets for impairment, oil and gas revenue accruals, capital expenditure and lease operating expense accruals associated with our oil and gas production activities, oil and gas reserves and depletion of our oil and gas properties. These interim operating results are not necessarily indicative of the results that may be expected for the entire year. For further information, please read the financial statements included in our 2013 Annual Report on Form 10-K.
Note 2—New and Pending Accounting Pronouncements
Accounting Standards Adopted in 2014
In second quarter 2014, we adopted ASU 2014-12 — Compensation-Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period and ASU 2014-08 — Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360), Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. Adoption did not materially affect our earnings, financial position or disclosures.
Pending Accounting Standards
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), requiring an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The updated standard will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective and permits the use of either the retrospective or cumulative effect transition method. Early adoption is not permitted. The updated standard becomes effective for annual and interim periods beginning after December 15, 2016. We have not yet selected a transition method and we are currently evaluating the effect that the updated standard will have on our earnings, financial position and disclosures.


6


Note 3—Real Estate
Real estate consists of:
 
Second
Quarter-End
 
Year-End
 
2014
 
2013
 
(In thousands)
Entitled, developed and under development projects
$
345,311

 
$
361,687

Undeveloped land (includes land in entitlement)
94,314

 
86,367

Commercial and income producing properties
 
 
 
Carrying value
128,167

 
99,476

Less: accumulated depreciation
(29,299
)
 
(28,066
)
Net carrying value
98,868

 
71,410

 
$
538,493

 
$
519,464

Included in entitled, developed and under development projects are the estimated costs of assets we expect to convey to utility and improvement districts of $62,812,000 at second quarter-end 2014 and $62,183,000 at year-end 2013, including $40,045,000 at second quarter-end 2014 and $41,795,000 at year-end 2013 related to our Cibolo Canyons project near San Antonio, Texas. These costs relate to water, sewer and other infrastructure assets we have submitted to utility or improvement districts for approval and reimbursement. We submitted for reimbursement to these districts $7,118,000 and $1,966,000 in first six months 2014 and 2013. We collected reimbursements from these districts of $3,468,000 and $1,081,000 in first six months 2014 and 2013. We expect to collect the remaining amounts billed when these districts achieve adequate tax basis or otherwise have funds available 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. We received $3,150,000 and $1,800,000 from the special improvement district in first six months 2014 and 2013. At second quarter-end 2014, we have $24,967,000 invested in the resort development.
In first six months 2014, commercial and income producing properties increased principally due to acquisition of two multifamily development sites in Austin for $19,479,000. At second quarter-end 2014, commercial and income producing properties primarily represents our investment in a 413 guest room hotel in Austin with a carrying value of $27,453,000 and our investment in multifamily development sites located in Charlotte, Denver, Austin and Dallas with a combined carrying value of $70,840,000.
In second quarter and first six months 2014, we recorded a $10,476,000 gain associated with a non-monetary exchange of leasehold timber rights on approximately 10,300 acres for 5,400 acres of undeveloped land with a partner in a consolidated venture.
Note 4—Oil and Gas Properties and Equipment, net
Net capitalized costs, utilizing the successful efforts method of accounting, related to our oil and gas producing activities follows:
 
Second
Quarter-End
 
Year-End
 
2014
 
2013
 
(In thousands)
Unproved oil and gas properties
$
97,058

 
$
100,320

Proved oil and gas properties
188,220

 
155,262

Total capitalized costs
285,278

 
255,582

Less: accumulated depreciation, depletion and amortization
(32,048
)
 
(22,941
)
 
$
253,230

 
$
232,641

In second quarter 2014, we recorded a gain of $5,706,000 which is related to the sale of 97 gross (6 net) producing oil and gas wells in Oklahoma for a gain of $4,488,000 and the sale of 223 net mineral acres leased from others in North Dakota for a gain of $1,218,000.

7


Note 5—Goodwill and Other Intangible Assets
Carrying value of goodwill and other intangible assets follows:
 
Second
Quarter-End
 
Year-End
 
2014
 
2013
 
(In thousands)
Goodwill
$
64,493

 
$
64,493

Identified intangibles, net
2,106

 
2,153

 
$
66,599

 
$
66,646

Goodwill of $60,619,000 represents the excess of the purchase price over the fair value of the tangible and intangible assets associated with acquisition of CREDO Petroleum Corporation (Credo) in 2012 and $3,874,000 associated with a water resources company acquired in 2010.
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 associated with our acquisition of Credo and is being amortized over the average remaining useful life of the patents. The net carrying value at second quarter-end 2014 is $425,000.
Note 6—Equity
A reconciliation of changes in equity at second quarter-end 2014 follows:
 
Forestar
Group Inc.
 
Noncontrolling
Interests
 
Total
 
(In thousands)
Balance at year-end 2013
$
709,845

 
$
5,552

 
$
715,397

Net income
23,156

 
599

 
23,755

Distributions to noncontrolling interests

 
(1,921
)
 
(1,921
)
Contributions from noncontrolling interests

 
533

 
533

Dissolution of noncontrolling interests

 
1,342

 
1,342

Purchase of noncontrolling interests, net of deferred taxes of $1,750,000
(2,948
)
 
(3,273
)
 
(6,221
)
Other (primarily share-based compensation)
4,991

 

 
4,991


$
735,044

 
$
2,832

 
$
737,876

In first quarter 2014, we acquired our partner's noncontrolling interests in the Lantana partnerships for $7,971,000. Prior to acquisition of the noncontrolling interests, we were the primary beneficiary of all but one of the Lantana partnerships which were variable interest entities (VIEs) and consolidated in our financial statements. We adjusted the carrying amount of noncontrolling interests to reflect the change in our ownership interest in the partnerships. The difference between the consideration paid and the carrying amount of the noncontrolling interests acquired is recognized as an adjustment to additional paid in capital attributable to Forestar, net of deferred taxes.
Note 7—Investment in Unconsolidated Ventures
At second quarter-end 2014, we had ownership interests in 13 ventures that we account for using the equity method. We have no ventures that are accounted for using the cost method.
In first quarter 2014, we entered into the CREA FMF Nashville LLC venture with Massachusetts Mutual Life Insurance Co. to develop a 320-unit multifamily property in Nashville, Tennessee. We contributed $5,897,000 of land and pre-development costs to the venture, net of $7,191,000 of reimbursements received from the venture for pre-development costs we previously incurred. The venture obtained a senior secured construction loan in the amount of $51,950,000 that bears interest at 30-day LIBOR plus 2.50% per annum, of which $14,227,000 was outstanding at second quarter-end 2014. We provided the lender a construction completion guaranty; a guaranty of repayment of 25 percent of the principal balance and unpaid accrued interest; and a nonrecourse carve-out guaranty. The principal guaranty will reduce from 25 percent of principal to zero upon achievement of certain conditions. At second quarter-end 2014, our investment in this venture is $5,655,000.

8


Combined summarized balance sheet information for our ventures accounted for using the equity method follows:
 
Venture Assets
 
Venture Borrowings(a)
 
Venture Equity
 
Our Investment
 
Second
Quarter-End
 
Year-End
 
Second
Quarter-End
 
Year-End
 
Second
Quarter-End
 
Year-End
 
Second
Quarter-End
 
Year-End
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
242, LLC (b)
$
23,139

 
$
23,751

 
$
910

 
$
921

 
$
19,318

 
$
19,838

 
$
8,835

 
$
9,084

CJUF III, RH Holdings
40,148

 
36,320

 
23,022

 
18,492

 
14,764

 
15,415

 
2,584

 
3,235

CL Ashton Woods (c)
10,940

 
10,473

 

 

 
10,001

 
9,704

 
3,997

 
3,544

CL Realty
8,348

 
8,298

 

 

 
8,220

 
8,070

 
4,110

 
4,035

CREA FMF Nashville (b)
22,289

 

 
14,227

 

 
6,125

 

 
5,655

 

FMF Peakview
36,406

 
30,673

 
16,544

 
12,533

 
16,915

 
16,620

 
3,465

 
3,406

HM Stonewall Estates (c)
3,489

 
3,781

 

 
63

 
3,489

 
3,718

 
1,963

 
2,128

LM Land Holdings (c)
33,362

 
33,298

 
10,533

 
9,768

 
18,051

 
13,347

 
9,430

 
8,283

PSW Communities
10,100

 

 
5,064

 

 
4,281

 

 
3,805

 

Temco
13,313

 
13,320

 

 

 
13,074

 
13,160

 
6,537

 
6,580

Other ventures (3) (d)
12,535

 
12,723

 
29,756

 
29,699

 
(31,634
)
 
(31,357
)
 
423

 
852

 
$
214,069

 
$
172,637

 
$
100,056

 
$
71,476

 
$
82,604

 
$
68,515

 
$
50,804

 
$
41,147

Combined summarized income statement information for our ventures accounted for using the equity method follows:
 
 Venture Revenues
 
 Venture Earnings (Loss)
 
Our Share of Earnings (Loss)
 
Second Quarter
 
First Six Months
 
Second Quarter
 
First Six Months
 
Second Quarter
 
First Six Months
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
242, LLC
$

 
$
1,497

 
$
1,475

 
$
3,131

 
$
(53
)
 
$
354

 
$
480

 
$
837

 
$
(26
)
 
$
190

 
$
251

 
$
448

CJUF III, RH Holdings
707

 
3

 
1,070

 
3

 
(438
)
 
(108
)
 
(651
)
 
(224
)
 
(438
)
 
(108
)
 
(651
)
 
(224
)
CL Ashton Woods (c)
361

 
1,419

 
1,069

 
2,891

 
76

 
293

 
296

 
550

 
135

 
563

 
453

 
1,140

CL Realty
459

 
373

 
827

 
801

 
322

 
216

 
552

 
452

 
161

 
108

 
276

 
226

CREA FMF Nashville

 

 

 

 

 

 
(25
)
 

 

 

 
(25
)
 

FMF Peakview

 

 

 

 
(79
)
 
(7
)
 
(152
)
 
(39
)
 
(16
)
 
(2
)
 
(31
)
 
(8
)
HM Stonewall Estates (c) 
434

 
1,098

 
1,435

 
1,098

 
170

 
425

 
522

 
400

 
68

 
182

 
209

 
176

LM Land Holdings (c)
4,395

 
3,953

 
9,293

 
5,264

 
4,044

 
3,160

 
6,971

 
3,759

 
1,220

 
1,486

 
1,897

 
1,654

PSW Communities

 

 

 

 
(4
)
 

 
(220
)
 

 
(6
)
 

 
(195
)
 

Temco
654

 
206

 
714

 
275

 
134

 
18

 
116

 
6

 
67

 
9

 
58

 
3

Other ventures (3)
27

 
788

 
49

 
5,150

 
(141
)
 
109

 
(189
)
 
(522
)
 
(207
)
 
138

 
(293
)
 
64

 
$
7,037

 
$
9,337

 
$
15,932

 
$
18,613

 
$
4,031

 
$
4,460

 
$
7,700

 
$
5,219

 
$
958

 
$
2,566

 
$
1,949

 
$
3,479

 _____________________
(a) 
Total includes current maturities of $77,510,000 at second quarter-end 2014, of which $37,795,000 is non-recourse to us, and $37,966,000 at year-end 2013, of which $37,822,000 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 $1,648,000 are reflected as a reduction to our investment in unconsolidated ventures at second quarter-end 2014.
(c) 
Includes unrecognized basis difference of $2,089,000 which is reflected as a reduction of our investment in unconsolidated ventures at second quarter-end 2014. The 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.
(d) 
Our investment in other ventures reflects our ownership interests, excluding venture losses that exceed our investment where we are not obligated to fund those losses. Please read Note 16—Variable Interest Entities for additional information.
In first six months 2014, we contributed cash of $4,430,000 to these ventures and received $1,923,000 in cash distributions, and in first six months 2013, we contributed cash of $782,000 to these ventures and received $1,580,000 in cash distributions. Distributions include both return of investments and distribution of earnings.

9


We have provided performance bonds and letters of credit on behalf of certain ventures that could 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. At second quarter-end 2014, we have $26,906,000 outstanding, of which $26,577,000 is related to development and construction of a 257-unit multifamily property in Austin which is substantially complete.
Note 8—Receivables
Receivables consist of:
 
Second
Quarter-End
 
Year-End
 
2014
 
2013
 
(In thousands)
Loan secured by real estate
$
6,240

 
$
7,610

Other loans secured by real estate, average interest rates of 4.41% at second quarter-end 2014 and 5.00% at year-end 2013
9,803

 
7,987

Oil and gas joint interest billing receivables
11,086

 
3,896

Oil and gas revenue accruals
13,108

 
8,137

Other receivables and accrued interest
6,100

 
11,648

 
46,337

 
39,278

Allowance for bad debts
(26
)
 
(26
)
 
$
46,311

 
$
39,252

At second quarter-end 2014, we have $6,240,000 invested in a loan which was acquired from a financial institution in second quarter 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. Interest accrues at nine percent the first three years escalating to ten percent in April 2015 and 12 percent in April 2016, with interest above 6.25 percent to be forgiven if the loan is prepaid by certain dates. In first six months 2014, we received principal payments of $5,293,000 and cash interest payments of $388,000. At second quarter-end 2014, the outstanding principal balance was $10,406,000.
Estimated accretable yield follows:
 
Second
Quarter-End
 
2014
 
(In thousands)
Beginning of period (year-end 2013)
$
8,908

Change in accretable yield due to change in timing of estimated cash flows
(427
)
Interest income recognized (in first six months 2014)
(4,311
)
End of period
$
4,170

Other loans secured by real estate generally are secured by a deed of trust and generally due within three years.
Note 9—Debt
Debt consists of:
 
Second
Quarter-End
 
Year-End
 
2014
 
2013
 
(In thousands)
Senior secured credit facility
 
 
 
Term loan facility — average interest rate of 4.17% at year-end 2013
$

 
$
200,000

8.50% senior secured notes due 2022
250,000

 

3.75% convertible senior notes due 2020, net of discount
101,542

 
99,890

6.00% tangible equity units, net of discount
21,208

 
25,619

Secured promissory notes — average interest rates of 3.15% at second quarter-end 2014 and 3.17% at year-end 2013
15,400

 
15,400

Other indebtedness — interest rates ranging from 2.44% to 5.00% at second quarter-end 2014
12,178

 
16,498

 
$
400,328

 
$
357,407


10


Our debt agreements contain financial covenants customary for such agreements including minimum levels of interest coverage and limitations on leverage. At second quarter-end 2014, we were in compliance with the financial covenants of these agreements.
In second quarter 2014, we amended our senior secured credit facility in order to consolidate previous amendments and to effect the following:
increase the revolving loan commitment from $200,000,000 to $300,000,000;
extend the maturity date to May 15, 2017 (with two one-year extension options);
increase the minimum interest coverage ratio from 1.50x to 2.50x;
eliminate the collateral value to loan commitment ratio covenant; and
increase the maximum total leverage ratio from 40% to 50%.
At second quarter-end 2014, our senior secured credit facility provides for a $300,000,000 revolving line of credit maturing May 15, 2017. The 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 $8,198,000 is outstanding at second quarter-end 2014. Total borrowings under our senior secured credit facility (including the face amount of letters of credit) may not exceed a borrowing base formula. We incurred fees of $3,068,000 related to this amendment. At second quarter-end 2014, we had $291,802,000 in net unused borrowing capacity under our senior secured 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 and most of our majority-owned joint venture interests, or if such pledge is not permitted, a pledge of the right to distributions from such entities, and (e) a pledge of reimbursements, hotel occupancy and other revenues payable to us from special improvement district tax collections in connection with our Cibolo Canyons project. The senior secured credit facility provides for releases of real estate and other collateral provided that borrowing base compliance is maintained.
On May 12, 2014, we issued $250,000,000 aggregate principal of 8.5% Senior Secured Notes due 2022 (Notes). The Notes will mature on June 1, 2022 and interest on the Notes is payable semiannually at a rate of 8.5 percent per annum in arrears. We incurred debt issuance costs of approximately $8,053,000, including the underwriters discount of $6,250,000. Net proceeds from issuance of the Notes were used to repay our $200,000,000 senior secured term loan. We intend to use the remaining amount for general corporate purposes, which may include investments in strategic growth opportunities.
At second quarter-end 2014, secured promissory notes represent a $15,400,000 loan collateralized by a 413 guest room hotel located in Austin with a carrying value of $27,453,000. Other indebtedness is collateralized by entitled, developed and under development projects with a carrying value of $40,956,000.
At second quarter-end 2014 and year-end 2013, we have $16,909,000 and $7,896,000 in unamortized deferred financing fees which are included in other assets. Amortization of deferred financing fees was $2,107,000 and $1,534,000 in first six months 2014 and 2013 and is included in interest expense.
Note 10—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.

11


Non-financial assets measured at fair value on a non-recurring basis principally include real estate assets, oil and gas properties, assets held for sale, goodwill and other intangible assets, which are measured for impairment. In second quarter 2014 and 2013, no non-financial assets were remeasured at fair value.
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:
 
Second Quarter-End 2014
 
Year-End 2013
 
 
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
 
Valuation
Technique
 
(In thousands)
 
 
Loan secured by real estate
$
6,240

 
$
11,695

 
$
7,610

 
$
18,025

 
Level 2
Fixed rate debt (a)
(372,750
)
 
(395,230
)
 
(126,640
)
 
(118,634
)
 
Level 2
_____________________
(a) 
Second quarter-end 2014 includes our 8.50% senior secured notes due 2022, issued May 12, 2014.

Note 11—Capital Stock
Pursuant to our stockholder rights plan, each share of common stock outstanding is coupled with one-quarter of a preferred stock purchase right (Right). Each Right entitles our stockholders 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 17—Share-Based Compensation for information about additional shares of common stock that could be issued under terms of our share-based compensation plans.
At second quarter-end 2014, personnel of former affiliates held options to purchase 713,000 shares of our common stock. The options have a weighted average exercise price of $26.02 and a weighted average remaining contractual term of two years. At second quarter-end 2014, the options have an aggregate intrinsic value of $75,300.
Note 12—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 (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.

12


The computations of basic and diluted earnings per share are as follows:
 
Second Quarter
 
First Six Months
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
Numerator:
 
 
 
 
 
 
 
Consolidated net income
$
14,748

 
$
1,198

 
$
23,755

 
$
6,240

Less: Net loss (income) attributable to noncontrolling interest
74

 
(657
)
 
(599
)
 
(1,748
)
Earnings available for diluted earnings per share
$
14,822

 
$
541

 
$
23,156

 
$
4,492

Less: Undistributed net income allocated to participating securities
(2,689
)
 

 
(4,205
)
 

Earnings available to common shareholders for basic earnings per share
$
12,133

 
$
541

 
$
18,951

 
$
4,492

 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
Weighted average common shares outstanding — basic
35,458

 
35,351

 
35,407

 
35,305

Weighted average common shares upon conversion of participating securities (a)
7,857

 

 
7,857

 

Dilutive effect of stock options, restricted stock and equity-settled awards
373

 
701

 
426

 
629

Total weighted average shares outstanding — diluted
43,688

 
36,052

 
43,690

 
35,934

Anti-dilutive awards excluded from diluted weighted average shares
2,503

 
1,854

 
2,277

 
1,837

_____________________
(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 6,547,800 shares (the minimum settlement rate) and 7,857,000 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 our convertible senior notes (Convertible Notes) in cash upon conversion with only the amount in excess of par value of the Convertible Notes to be settled in shares of our common stock. Therefore, our calculation of diluted net income per share using the treasury stock method includes only the amount, if any, in excess of par value of the Convertible Notes. As such, the Convertible Notes have no impact on diluted net income per share until the price of our common stock exceeds the $24.49 conversion price of the Convertible Notes. The average price of our common stock in second quarter 2014 did not exceed the conversion price which resulted in no additional diluted outstanding shares.
Note 13—Income Taxes
Our effective tax rate was 35 percent in second quarter and first six months 2014, which includes a one percent benefit for noncontrolling interests. Our effective tax rate was 43 percent in second quarter 2013 and 32 percent in first six months 2013, which included a four percent benefit for noncontrolling interests. In addition, 2014 and 2013 effective tax rates include the effect of state income taxes, nondeductible items and benefits of percentage depletion.
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.
Note 14—Commitments and 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. However, it is possible 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 $869,000, which is included in other accrued expenses.

13


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 second quarter-end 2014, our asset retirement obligation was $1,616,000, which is included in other liabilities.
Note 15—Segment Information
We manage our operations through three 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, commercial and income producing properties, primarily a hotel and our multifamily investments. Oil and gas is an independent oil and gas exploration, development and production operation and manages our owned and leased mineral interests. Other natural resources manages our timber, recreational leases and water resource initiatives.
Total assets allocated by segment are as follows:
 
Second
Quarter-End
 
Year-End
 
2014
 
2013
 
(In thousands)
Real estate
$
612,076

 
$
582,802

Oil and gas
343,164

 
312,553

Other natural resources
26,103

 
23,478

Assets not allocated to segments (a)
241,009

 
253,319

 
$
1,222,352

 
$
1,172,152

  _________________________
(a) 
Assets not allocated to segments at second quarter-end 2014 principally consist of cash and cash equivalents of $184,168,000 and a net deferred tax asset of $34,519,000. Assets not allocated to segments at year-end 2013 principally consist of cash and cash equivalents of $192,307,000 and a net deferred tax asset of $40,398,000.
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 Note 1—Basis of Presentation. Our revenues are derived from U.S. operations and all of our assets are located in the U.S. In second quarter and first six months 2014, no single customer accounted for more than ten percent of our total revenues.

14


Segment revenues and earnings are as follows:
 
Second Quarter
 
First Six Months
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
Revenues:
 
 
 
 
 
 
 
Real estate
$
55,173

 
$
41,219

 
$
120,653

 
$
119,908

Oil and gas
24,377

 
15,831

 
41,931

 
31,335

Other natural resources
3,463

 
3,029

 
5,034

 
6,307

Total revenues
$
83,013

 
$
60,079

 
$
167,618

 
$
157,550

Segment earnings:
 
 
 
 
 
 
 
Real estate
$
27,297

 
$
8,104

 
$
50,872

 
$
27,550

Oil and gas
9,522

 
4,243

 
10,329

 
9,370

Other natural resources
2,079

 
991

 
1,551

 
2,243

Total segment earnings
38,898

 
13,338

 
62,752

 
39,163

Items not allocated to segments (a)
(16,025
)
 
(11,886
)
 
(26,887
)
 
(31,767
)
Income before taxes attributable to Forestar Group Inc.
$
22,873

 
$
1,452

 
$
35,865

 
$
7,396

  _________________________
(a) 
Items not allocated to segments consist of:
 
Second Quarter
 
First Six Months
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
General and administrative expense
$
(5,566
)
 
$
(5,329
)
 
$
(10,734
)
 
$
(10,287
)
Shared-based compensation expense
(3,219
)
 
(1,460
)
 
(3,532
)
 
(11,875
)
Interest expense
(7,370
)
 
(5,122
)
 
(12,873
)
 
(9,661
)
Other corporate non-operating income
130

 
25

 
252

 
56

 
$
(16,025
)
 
$
(11,886
)
 
$
(26,887
)
 
$
(31,767
)
Note 16—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 VIEs 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 continuously reassess to see if we are the primary beneficiary of a VIE.
At second quarter-end 2014, we have four VIEs. We account for these VIEs using the equity method and we are not the primary beneficiary. Although we have certain rights regarding major decisions, we do not have the power to direct the activities that are most significant to the economic performance of these VIEs. At second quarter-end 2014, these VIEs have total assets of $44,002,000, substantially all of which represent developed and undeveloped real estate, and total liabilities of $66,153,000, which includes $27,410,000 of borrowings classified as current maturities. These amounts are included in the summarized balance sheet information for ventures accounted for using the equity method in Note 7—Investment in Unconsolidated Ventures. At second quarter-end 2014, our investment in these VIEs is $9,513,000 and is included in investment in unconsolidated ventures. In first six months 2014, we contributed $4,341,000 to these VIEs. Our maximum exposure to loss related to one of these VIEs is estimated at $3,659,000, which exceeds our investment as we have a nominal general partner interest and could be held responsible for its 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.

15


Note 17—Share-Based Compensation
Share-based compensation expense consists of:
 
Second Quarter
 
First Six Months
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
Cash-settled awards
$
1,488

 
$
(972
)
 
$
(1,195
)
 
$
5,675

Equity-settled awards
1,241

 
947

 
3,590

 
2,666

Restricted stock
33

 
61

 
79

 
456

Stock options
457

 
1,424

 
1,058

 
3,078

 
$
3,219

 
$
1,460

 
$
3,532

 
$
11,875

Share-based compensation expense is included in:
 
Second Quarter
 
First Six Months
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
General and administrative expense
$
1,290

 
$
501

 
$
1,267

 
$
6,013

Other operating expense
1,929

 
959

 
2,265

 
5,862

 
$
3,219

 
$
1,460

 
$
3,532

 
$
11,875

In first six months 2014, we granted 92,800 cash-settled awards and 467,200 equity-settled awards. Equity-settled awards granted to employees in the first six months 2014 include restricted stock units (RSUs), market-leveraged stock units (MSUs) and performance stock units (PSUs). Both cash-settled and equity-settled RSUs vest ratably over three years from the date of grant. Equity-settled MSUs and PSUs vest after three years from the date of grant upon achievement of market condition for MSUs and upon achievement of performance goals for PSUs. Equity-settled awards in the form of RSUs granted to our directors are fully vested at the time of grant and are issued upon retirement. There were no restricted stock awards or stock options granted in first six months 2014.
The fair value of awards granted to retirement eligible employees and expensed at the date of grant was $760,000 and $590,000 in first six months 2014 and 2013. Unrecognized share-based compensation expense related to non-vested equity-settled awards, restricted stock and stock options is $12,762,000 at second quarter-end 2014.
In first six months 2014 and 2013, we issued 162,380 and 87,154 shares out of our treasury stock associated with vesting of stock-based awards or exercise of stock options, net of 51,681 and 54,497 shares withheld having a value of $972,000 and $1,027,000 for payroll taxes in connection with vesting of stock-based awards or exercise of stock options.
Note 18—Subsequent Event
On July 15, 2014, we entered into the FMF Littleton LLC venture with AIGGRE Littleton Common Investor LLC (AIGGRE), to develop a 385-unit multifamily property in Littleton, Colorado. We own a 25 percent interest and AIGGRE owns remaining 75 percent interest. We contributed $4,900,000 of land and pre-development costs to the venture, net of $9,852,000 of reimbursements received from the venture for land and pre-development costs we previously incurred. On July 15, 2014, FMF Littleton LLC obtained a senior secured construction loan in the amount of $46,384,000 that bears interest at LIBOR rate plus 1.90% payable monthly and has an initial term (Initial Loan Term) of 36 months and may be extended for two additional 12-month periods following the Initial Loan Term, subject to payment of extension fees and fulfillment of specified conditions. 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 for repayment of 25 percent of the principal balance and unpaid accrued interest; and a standard nonrecourse carve-out guaranty. The principal guaranty will reduce from 25 percent of principal to ten percent upon achievement of certain conditions.


16


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 2013 Annual Report on Form 10-K. Unless otherwise indicated, information is presented as of second quarter-end 2014, 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 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;
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 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.

17



Other factors, including the risk factors described in Item 1A of our 2013 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
A summary of our consolidated results by business segment follows:
 
Second Quarter
 
First Six Months
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
Revenues:
 
 
 
 
 
 
 
Real estate
$
55,173

 
$
41,219

 
$
120,653

 
$
119,908

Oil and gas
24,377

 
15,831

 
41,931

 
31,335

Other natural resources
3,463

 
3,029

 
5,034

 
6,307

Total revenues
$
83,013

 
$
60,079

 
$
167,618

 
$
157,550

Segment earnings:
 
 
 
 
 
 
 
Real estate
$
27,297

 
$
8,104

 
$
50,872

 
$
27,550

Oil and gas
9,522

 
4,243

 
10,329

 
9,370

Other natural resources
2,079

 
991

 
1,551

 
2,243

Total segment earnings
38,898

 
13,338

 
62,752

 
39,163

Items not allocated to segments:
 
 
 
 
 
 
 
General and administrative expense
(5,566
)
 
(5,329
)
 
(10,734
)
 
(10,287
)
Share-based compensation expense
(3,219
)
 
(1,460
)
 
(3,532
)
 
(11,875
)
Interest expense
(7,370
)
 
(5,122
)
 
(12,873
)
 
(9,661
)
Other corporate non-operating income
130

 
25

 
252

 
56

Income before taxes
22,873

 
1,452

 
35,865

 
7,396

Income tax expense
(8,051
)
 
(911
)
 
(12,709
)
 
(2,904
)
Net income attributable to Forestar Group Inc.
$
14,822

 
$
541

 
$
23,156

 
$
4,492


18


Significant aspects of our results of operations follow:
Second Quarter and First Six Months 2014
Second quarter and first six months 2014 real estate segment earnings benefited from increased undeveloped land sales and residential lot sales activity. In addition, second quarter 2014 real estate segment earnings included a $10,476,000 gain associated with a non-monetary exchange of leasehold timber rights for 5,400 acres of undeveloped land with a partner in a consolidated venture.
Oil and gas segment earnings increased principally due to gain of $5,706,000 related to the sale of oil and gas properties in Oklahoma and North Dakota. Segment earnings also benefited from higher working interest production volumes compared with second quarter and first six months 2013, offset partially by higher exploration, production and operating expenses. In addition, segment earnings were negatively impacted by lower production volumes and delay rental revenues associated with our owned mineral interests.
Second quarter 2014 other natural resources segment earnings increased compared with second quarter 2013 principally due to a groundwater reservation agreement which generated $698,000 in segment earnings and a $685,000 gain from a partial termination of a timber lease. Second quarter and first six months 2014 segment earnings were impacted by lower fiber volumes compared with second quarter and first six months 2013.
Share-based compensation expense decreased principally as result of a ten percent decrease in our stock price since year-end 2013, compared with a 16 percent increase in our stock price in first six months 2013 since year-end 2012, which impacted the value of vested cash-settled awards.
Second quarter and first six months 2014 interest expense increased primarily due to higher average borrowing rates and debt outstanding.
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 demand.
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.
Current Market Conditions
U.S. single-family residential market conditions continued to improve in first six months 2014, driven by a growing demand for homes and a tightening supply of homes available for sale. Housing demand has been fueled primarily by improved housing affordability, largely due to relatively low mortgage rates, and increased consumer confidence. Inventories of new homes are at historically low levels in many areas. In addition, declining finished lot inventories and supply of economically developable raw land is increasing demand for our developed lots. However, 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 remained strong over the last several months and generally have been stronger over the last two years. Gas prices are up nearly 40 percent from year ago levels, but are significantly lower than realized prices over the last decade. 

19


Prolonged cold weather throughout the 2013 - 2014 heating season has taken working gas in storage below the previous five year average (2009 - 2013) 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 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 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, gas and timber, and the overall strength or weakness of the U.S. economy.
Real Estate
We own directly or through ventures approximately 121,000 acres of real estate located in ten states and 13 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 98,000 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:
 
Second Quarter
 
First Six Months
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
Revenues
$
55,173

 
$
41,219

 
$
120,653

 
$
119,908

Cost of sales
(32,025
)
 
(28,262
)
 
(68,209
)
 
(81,308
)
Operating expenses
(9,315
)
 
(7,709
)
 
(17,390
)
 
(14,681
)
 
13,833

 
5,248

 
35,054

 
23,919

Interest income on loan secured by real estate
2,139

 
1,086

 
4,311

 
2,196

Gain on non-monetary exchange
10,476

 

 
10,476

 

Equity in earnings of unconsolidated ventures
775

 
2,427

 
1,630

 
3,183

Less: Net income attributable to noncontrolling interests
74

 
(657
)
 
(599
)
 
(1,748
)
Segment earnings
$
27,297

 
$
8,104

 
$
50,872

 
$
27,550

In first six months 2014, revenues were principally driven by increased residential real estate and undeveloped land sales.
In second quarter and first six months 2014, cost of sales includes $3,539,000 and $9,041,000 related to multifamily construction contract costs we incurred as general contractor and paid to subcontractors associated with our development of two multifamily venture properties, which includes a $2,269,000 charge absorbed by us in first quarter 2014 and $78,000 charge in second quarter 2014 reflecting estimated cost increases associated with our fixed fee contract as a general contractor for these two multifamily venture properties. Cost of sales associated with multifamily construction contracts for second quarter and first six months 2013 were $11,460,000 and $17,606,000. First six months 2013 cost of sales also included

20


$29,707,000 in carrying value related to Promesa, a 289-unit multifamily property we developed as a merchant builder and sold.
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 2014, we recorded a $10,476,000 gain associated with a non-monetary exchange of leasehold timber rights on approximately 10,300 acres for 5,400 acres of undeveloped land with a partner in a consolidated venture.
In first six months 2014, the decrease in net income attributable to noncontrolling interests compared with first six months 2013 is principally due to the purchase of noncontrolling interests in the Lantana ventures for $7,971,000 in March 2014.
Revenues in our owned and consolidated ventures consist of:
 
Second Quarter
 
First Six Months
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
Residential real estate
$
33,901

 
$
18,348

 
$
69,162

 
$
37,450

Commercial real estate
609

 
2,187

 
780

 
3,438

Undeveloped land
7,297

 
2,578

 
27,010

 
5,287

Commercial and income producing properties
11,050

 
17,861

 
20,983

 
72,032

Other
2,316

 
245

 
2,718

 
1,701

 
$
55,173

 
$
41,219

 
$
120,653

 
$
119,908

Residential real estate revenues principally consist of the sale of single-family lots to national, regional and local homebuilders. Revenues increased in second quarter and first six months 2014 compared with second quarter and first six months 2013 due to increased lot sales volume offset by lower average price per lot sold and higher undeveloped land sales. In addition, in first six months 2014, we sold 910 undeveloped residential tract acres for $6,567,000 which generated segment earnings of $2,698,000, compared with 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 in first six months 2013.
In first six months 2014, undeveloped land sales increased as compared with first six months 2013 principally due to first quarter sale of 9,329 acres for $19,713,000, or approximately $2,100 per acre, generating approximately $16,233,000 in segment earnings.
In addition, second quarter and first six months 2014 commercial and income producing properties revenues include construction revenues of $3,461,000 and $6,694,000 associated with our multifamily guaranteed maximum price construction contracts as general contractor. We are reimbursed for costs paid to subcontractors plus we may 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 second quarter and first six months 2013 were $11,460,000 and $17,606,000.
In first six months 2014, commercial and income producing properties revenue decreased compared with first six months 2013 as a result of the first quarter 2013 sale of Promesa, a 289-unit multifamily property in Austin which we developed and sold as a merchant builder for $41,000,000 generating segment earnings of $10,881,000.
In first six months 2014, revenues related to our 413 guest room hotel in Austin were up $1,187,000 when compared with first six months 2013, primarily due to higher average room rates and food and beverage sales.

21


Units sold in our owned and consolidated ventures consist of:
 
Second Quarter
 
First Six Months
 
2014
 
2013
 
2014
 
2013
Residential real estate:
 
 
 
 
 
 
 
Lots sold
481

 
259

 
1,317

 
614

Revenue per lot sold
$
60,651

 
$
57,154

 
$
47,644

 
$
54,440

Commercial real estate:
 
 
 
 
 
 
 
Acres sold
3

 
32

 
3

 
35

Revenue per acre sold
$
96,774

 
$
74,166

 
$
96,774

 
$
100,311

Undeveloped land:
 
 
 
 
 
 
 
Acres sold
2,950

 
1,000

 
12,279

 
1,919

Revenue per acre sold
$
2,473

 
$
2,576

 
$
2,200

 
$
2,755

Operating expenses consist of:
 
Second Quarter
 
First Six Months
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
Employee compensation and benefits
$
2,655

 
$
1,902

 
$
5,513

 
$
3,274

Property taxes
1,899

 
2,049

 
3,485

 
4,045

Professional services
2,272

 
956

 
3,411

 
2,126

Depreciation and amortization
695

 
713

 
1,343

 
1,742

Other
1,794

 
2,089

 
3,638

 
3,494

 
$
9,315

 
$
7,709

 
$
17,390

 
$
14,681

The increase in employee compensation and benefits in second quarter and first six months 2014 is principally related to increase in staffing and incentive compensation. The increase in professional services in second quarter and first six months 2014 is primarily associated with conveyance of land in payment of management fees in a consolidated venture associated with non-monetary exchange of leasehold timber rights for undeveloped land.
Information about our real estate projects and our real estate ventures follows:
 
Second
Quarter-End
 
2014
 
2013
Owned and consolidated ventures:
 
 
 
Entitled, developed and under development projects
 
 
 
Number of projects
65

 
65

Residential lots remaining
15,077

 
19,681

Commercial acres remaining
1,718

 
2,019

Undeveloped land and land in the entitlement process
 
 
 
Number of projects
11

 
14

Acres in entitlement process
24,430

 
25,980

Acres undeveloped
79,563

 
87,714

Ventures accounted for using the equity method:
 
 
 
Ventures’ lot sales (for first six months)
 
 
 
Lots sold
194

 
192

Average price per lot sold
$
67,772

 
$
54,407

Ventures’ entitled, developed and under development projects
 
 
 
Number of projects
8

 
7

Residential lots remaining
3,021

 
3,495

Commercial acres sold (for first six months)

 
2

Average price per acre sold
$

 
$
652,886

Commercial acres remaining
240

 
306

Ventures’ undeveloped land and land in the entitlement process
 
 
 
Acres sold (for first six months)
258

 
42

Average price per acre sold
$
2,306

 
$
2,650

Acres undeveloped
5,073

 
5,613


22


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:
State
Entitled,
Developed,
and Under
Development
Projects
 
Undeveloped
Land and Land
in Entitlement Process
 
Commercial
and Income
Producing
Properties
 
Total
 
(In thousands)
Texas
$
277,924

 
$
5,851

 
$
70,159

 
$
353,934

Georgia
18,483

 
64,737

 

 
83,220

Colorado
23,967

 

 
14,837

 
38,804

California
8,915

 
22,374

 

 
31,289

North Carolina

 
28

 
13,872

 
13,900

Tennessee
8,687

 
1,019

 

 
9,706

Other
7,335

 
305

 

 
7,640

 
$
345,311

 
$
94,314

 
$
98,868

 
$
538,493

Oil and Gas
Our oil and gas segment is focused on the exploration, development and production of oil and gas on our mineral and leasehold interests.
We are an independent oil and gas exploration, development and production company. We have approximately 345,000 net mineral acres leased f