10-Q 1 for-9302014x10q.htm 10-Q FOR-9.30.2014-10Q
 
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 September 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 November 3, 2014
Common Stock, par value $1.00 per share
 
34,958,270
 



FORESTAR GROUP INC.
TABLE OF CONTENTS
 

2


PART I—FINANCIAL INFORMATION
Item 1. Financial Statements
FORESTAR GROUP INC.
Consolidated Balance Sheets
(Unaudited)
 
Third
Quarter-End
 
Year-End
 
2014
 
2013
 
(In thousands, except share data)
ASSETS
 
Cash and cash equivalents
$
170,606

 
$
192,307

Real estate, net
591,805

 
519,464

Oil and gas properties and equipment, net
259,755

 
232,641

Investment in unconsolidated ventures
53,709

 
41,147

Timber
9,216

 
10,947

Receivables, net
46,301

 
39,252

Prepaid expenses
4,613

 
5,136

Income taxes receivable
2,837

 

Property and equipment, net
11,547

 
6,112

Deferred tax asset, net
30,932

 
40,398

Goodwill and other intangible assets
67,440

 
66,646

Other assets
19,478

 
18,102

TOTAL ASSETS
$
1,268,239

 
$
1,172,152

LIABILITIES AND EQUITY
 
 
 
Accounts payable
$
17,667

 
$
21,409

Accrued employee compensation and benefits
6,852

 
5,814

Accrued property taxes
7,044

 
3,822

Accrued interest
8,695

 
2,343

Income taxes payable

 
3,876

Earnest money deposits
8,466

 
10,854

Other accrued expenses
27,371

 
26,851

Other liabilities
17,418

 
24,379

Debt
429,295

 
357,407

TOTAL LIABILITIES
522,808

 
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 third quarter-end 2014 and year-end 2013
36,947

 
36,947

Additional paid-in capital
558,165

 
556,676

Retained earnings
178,801

 
150,418

Treasury stock, at cost, 1,988,333 shares at third quarter-end 2014 and 2,199,666 shares at year-end 2013
(31,154
)
 
(34,196
)
Total Forestar Group Inc. shareholders’ equity
742,759

 
709,845

Noncontrolling interests
2,672

 
5,552

TOTAL EQUITY
745,431

 
715,397

TOTAL LIABILITIES AND EQUITY
$
1,268,239

 
$
1,172,152

Please read the notes to consolidated financial statements.

3


FORESTAR GROUP INC.
Consolidated Statements of Income and Comprehensive Income
(Unaudited)
 
Third Quarter
 
First Nine Months
 
2014
 
2013
 
2014
 
2013
 
(In thousands, except per share amounts)
REVENUES
 
 
 
 
 
 
 
Real estate sales and other
$
23,067

 
$
37,001

 
$
122,738

 
$
84,877

Commercial and income producing properties
9,378

 
13,355

 
30,360

 
85,387

Real estate
32,445

 
50,356

 
153,098

 
170,264

Oil and gas
24,145

 
22,095

 
66,076

 
53,430

Other natural resources
2,250

 
2,656

 
7,284

 
8,963

 
58,840

 
75,107

 
226,458

 
232,657

COSTS AND EXPENSES
 
 
 
 
 
 
 
Cost of real estate sales and other
(10,662
)
 
(18,603
)
 
(60,145
)
 
(43,112
)
Cost of commercial and income producing properties
(9,391
)
 
(13,352
)
 
(28,117
)
 
(70,151
)
Cost of oil and gas producing activities
(18,470
)
 
(10,090
)
 
(48,016
)
 
(26,762
)
Cost of other natural resources
(711
)
 
(454
)
 
(2,288
)
 
(1,662
)
Other operating
(12,860
)
 
(16,051
)
 
(43,187
)
 
(45,039
)
General and administrative
(5,140
)
 
(5,945
)
 
(17,141
)
 
(22,245
)
 
(57,234
)
 
(64,495
)
 
(198,894
)
 
(208,971
)
GAIN ON ASSET PURCHASE, EXCHANGE AND SALES
11,110

 

 
27,977

 

OPERATING INCOME
12,716

 
10,612

 
55,541

 
23,686

Equity in earnings of unconsolidated ventures
2,016

 
3,125

 
3,965

 
6,604

Interest expense
(8,634
)
 
(5,231
)
 
(21,507
)
 
(14,892
)
Other non-operating income
1,896

 
1,459

 
6,459

 
3,711

INCOME BEFORE TAXES
7,994

 
9,965

 
44,458

 
19,109

Income tax (expense) benefit
(2,755
)
 
2,932

 
(15,464
)
 
28

CONSOLIDATED NET INCOME
5,239

 
12,897

 
28,994

 
19,137

Less: Net (income) attributable to noncontrolling interests
(12
)
 
(1,067
)
 
(611
)
 
(2,815
)
NET INCOME ATTRIBUTABLE TO FORESTAR GROUP INC.
$
5,227

 
$
11,830

 
$
28,383

 
$
16,322

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
 
 
 
 
 
 
 
Basic
35,498

 
35,410

 
35,437

 
35,341

Diluted
43,868

 
36,072

 
43,750

 
35,949

NET INCOME PER COMMON SHARE
 
 
 
 
 
 
 
Basic
$
0.12

 
$
0.33

 
$
0.66

 
$
0.46

Diluted
$
0.12

 
$
0.33

 
$
0.65

 
$
0.45

TOTAL COMPREHENSIVE INCOME
$
5,227

 
$
11,830

 
$
28,383

 
$
16,322

Please read the notes to consolidated financial statements.

4


FORESTAR GROUP INC.
Consolidated Statements of Cash Flows
(Unaudited) 
 
First Nine Months
 
2014
 
2013
 
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Consolidated net income
$
28,994

 
$
19,137

Adjustments:
 
 
 
Depreciation, depletion and amortization
29,109

 
21,698

Change in deferred income taxes
10,649

 
3,535

Change in unrecognized tax benefits

 
(6,251
)
Equity in earnings of unconsolidated ventures
(3,965
)
 
(6,604
)
Distributions of earnings of unconsolidated ventures
2,817

 
869

Share-based compensation
4,523

 
15,367

Real estate cost of sales
59,251

 
71,324

Dry hole and leasehold abandonment costs
11,541

 
2,206

Real estate development and acquisition expenditures, net
(82,864
)
 
(65,762
)
Reimbursements from utility and improvement districts
8,554

 
4,540

Other changes in real estate
3,148

 
1,440

Changes in deferred income
102

 
(2,229
)
Gain on asset purchase, exchange and sales
(27,977
)
 

Other
1,697

 
154

Changes in:
 
 
 
Notes and accounts receivable
(6,300
)
 
(544
)
Prepaid expenses and other
4,232

 
(373
)
Accounts payable and other accrued liabilities
(3,249
)
 
(11,268
)
Income taxes
(3,876
)
 
(2,156
)
Net cash provided by operating activities
36,386

 
45,083

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Property, equipment, software, reforestation and other
(13,583
)
 
(6,241
)
Oil and gas properties and equipment
(65,661
)
 
(56,482
)
Acquisition of partner's interest in unconsolidated multifamily venture, net of cash
(20,155
)
 

Investment in unconsolidated ventures
(5,016
)
 
(819
)
Proceeds from sales of oil and gas properties, net
17,017

 

Proceeds from sales of other assets, net
2,868

 

Return of investment in unconsolidated ventures
1,601

 
1,271

Other

 
(45
)
Net cash used for investing activities
(82,929
)
 
(62,316
)
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
(222,468
)
 
(96,915
)
Additions to debt
17,169

 
38,901

Deferred financing fees
(3,114
)
 
(353
)
Distributions to noncontrolling interests, net
(1,070
)
 
(1,561
)
Purchase of noncontrolling interests
(7,971
)
 

Exercise of stock options
1,197

 
1,812

Payroll taxes on issuance of stock-based awards
(1,024
)
 
(1,128
)
Excess income tax benefit from share-based compensation
176

 
90

Net cash provided by financing activities
24,842

 
61,641

 
 
 
 
Net increase (decrease) in cash and cash equivalents
(21,701
)
 
44,408

Cash and cash equivalents at beginning of period
192,307

 
10,361

Cash and cash equivalents at end of period
$
170,606

 
$
54,769

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 account for our investment in other entities in which we have significant influence over operations and financial policies using the equity method. 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 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 first nine months 2014, we adopted ASU 2013-04 — Liabilities (Topic 405): Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date, 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:
 
Third
Quarter-End
 
Year-End
 
2014
 
2013
 
(In thousands)
Entitled, developed and under development projects
$
342,553

 
$
361,687

Undeveloped land (includes land in entitlement)
94,241

 
86,367

Commercial and income producing properties
 
 
 
Carrying value
184,977

 
99,476

Less: accumulated depreciation
(29,966
)
 
(28,066
)
Net carrying value
155,011

 
71,410

 
$
591,805

 
$
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 $66,198,000 at third quarter-end 2014 and $62,183,000 at year-end 2013, including $40,045,000 at third 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 $15,713,000 in first nine months 2014 and 2013. We collected reimbursements from these districts of $4,504,000 and $1,840,000 in first nine 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 $4,050,000 and $2,700,000 from the special improvement district in first nine months 2014 and 2013. At third quarter-end 2014, we have $24,067,000 invested in the resort development.
In third quarter 2014, we acquired full ownership in CJUF III, RH Holdings partnership (the Eleven venture), owner of a 257-unit multifamily project in Austin in which we previously held a 25 percent interest, for $21,500,000. The acquisition-date fair value was $55,275,000, including debt of $23,936,000. Our investment in the Eleven venture prior to acquiring our partner’s interest was $2,229,000. We accounted for this transaction as a business combination achieved in stages and as a result, we remeasured our equity method investment in the Eleven venture to its acquisition-date fair value of $9,839,000 and recognized the resulting gain of $7,610,000 in real estate segment earnings. The purchase price allocation related to the acquisition of our partner’s interest in the Eleven venture is preliminary as it is subject to final valuation adjustments. At third quarter-end 2014, we recorded additions to real estate commercial and income producing properties of $53,917,000 and other assets of $992,000 primarily consisting of in-place tenant leases of $865,000. In addition, we recorded a working capital deficit of $979,000 and debt of $23,936,000. In first nine months 2014, we also 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 nine months 2014, the increase in commercial and income producing properties was principally due to $53,917,000 related to the Eleven multifamily project which is now wholly-owned after acquisition of our partner's interest in the Eleven venture, and $26,110,000 from acquisition of three multifamily development sites. At third quarter-end 2014, commercial and income producing properties principally represents our investment in a 413 guest room hotel in Austin with a carrying value of $29,002,000, our $53,917,000 investment in our 257-unit multifamily property in Austin and our investment in multifamily development sites located in Austin, Charlotte, Dallas and Nashville with a combined carrying value of $58,727,000.

7


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:
 
Third
Quarter-End
 
Year-End
 
2014
 
2013
 
(In thousands)
Unproved oil and gas properties
$
97,824

 
$
100,320

Proved oil and gas properties
201,905

 
155,262

Total capitalized costs
299,729

 
255,582

Less: accumulated depreciation, depletion and amortization
(39,974
)
 
(22,941
)
 
$
259,755

 
$
232,641

In first nine months 2014, we recorded gains of $9,041,000 principally related to the sale of 102 gross (7 net) producing oil and gas wells in Oklahoma for a gain of $4,758,000 and the sale of 571 net mineral acres leased from others in North Dakota for a gain of $4,283,000.
Note 5—Goodwill and Other Intangible Assets
Carrying value of goodwill and other intangible assets follows:
 
Third
Quarter-End
 
Year-End
 
2014
 
2013
 
(In thousands)
Goodwill
$
64,493

 
$
64,493

Identified intangibles, net
2,947

 
2,153

 
$
67,440

 
$
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, $865,000 related to in-place tenant leases with definite lives associated with the purchase of our partner's interest in the Eleven venture and $401,000 related to patents with definite lives associated with the Calliope Gas Recovery System, a process to increase natural gas production.
Note 6—Equity
A reconciliation of changes in equity at third 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
28,383

 
611

 
28,994

Distributions to noncontrolling interests

 
(2,093
)
 
(2,093
)
Contributions from noncontrolling interests

 
533

 
533

Dissolution of noncontrolling interests

 
1,342

 
1,342

Purchase of noncontrolling interests, net of deferred taxes of $1,723,000
(2,975
)
 
(3,273
)
 
(6,248
)
Other (primarily share-based compensation)
7,506

 

 
7,506


$
742,759

 
$
2,672

 
$
745,431

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

8


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 third quarter-end 2014, we have ownership interests in 14 ventures that we account for using the equity method.
In third quarter 2014, we acquired full ownership in the Eleven venture for $21,500,000. The acquisition-date fair value was $55,275,000, including debt of $23,936,000. Our investment in the Eleven venture prior to acquiring our partner’s interest was $2,229,000. At third quarter-end 2014, we no longer have an equity method investment in the Eleven venture.
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. The venture obtained a senior secured construction loan in the amount of $46,384,000 that bears interest at 30-day LIBOR plus 1.90% payable monthly, of which none was outstanding at third 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 ten percent upon achievement of certain conditions. At third quarter-end 2014, our investment in this venture is $5,465,000.
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 $20,289,000 was outstanding at third 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 third quarter-end 2014, our investment in this venture is $5,655,000.
Combined summarized balance sheet information for our ventures accounted for using the equity method follows:
 
Venture Assets
 
Venture Borrowings(a)
 
Venture Equity
 
Our Investment
 
Third
Quarter-End
 
Year-End
 
Third
Quarter-End
 
Year-End
 
Third
Quarter-End
 
Year-End
 
Third
Quarter-End
 
Year-End
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
242, LLC (b)
$
26,139

 
$
23,751

 
$
2,934

 
$
921

 
$
19,286

 
$
19,838

 
$
8,819

 
$
9,084

CJUF III, RH Holdings

 
36,320

 

 
18,492

 

 
15,415

 

 
3,235

CL Ashton Woods (c)
11,671

 
10,473

 

 

 
10,277

 
9,704

 
4,370

 
3,544

CL Realty
8,085

 
8,298

 

 

 
7,916

 
8,070

 
3,958

 
4,035

CREA FMF Nashville (b)
28,962

 

 
20,289

 

 
6,126

 

 
5,655

 

FMF Littleton
21,599

 

 

 

 
21,148

 

 
5,465

 

FMF Peakview
40,137

 
30,673

 
21,088

 
12,533

 
17,617

 
16,620

 
3,605

 
3,406

HM Stonewall Estates (c)
3,367

 
3,781

 
286

 
63

 
3,081

 
3,718

 
1,751

 
2,128

LM Land Holdings (c)
32,824

 
33,298

 
9,502

 
9,768

 
19,349

 
13,347

 
9,843

 
8,283

PSW Communities
12,604

 

 
7,377

 

 
4,270

 

 
3,795

 

Temco
12,756

 
13,320

 

 

 
12,518

 
13,160

 
6,259

 
6,580

Other ventures (d)
12,383

 
12,723

 
29,730

 
29,699

 
(32,022
)
 
(31,357
)
 
189

 
852

 
$
210,527

 
$
172,637

 
$
91,206

 
$
71,476

 
$
89,566

 
$
68,515

 
$
53,709

 
$
41,147


9


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)
 
Third Quarter
 
First Nine Months
 
Third Quarter
 
First Nine Months
 
Third Quarter
 
First Nine Months
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
242, LLC
$
88

 
$
37

 
$
1,563

 
$
3,168

 
$
(32
)
 
$
(20
)
 
$
448

 
$
817

 
$
(15
)
 
$
(10
)
 
$
236

 
$
438

CJUF III, RH Holdings
1,098

 
4

 
2,168

 
7

 
(305
)
 
(133
)
 
(956
)
 
(357
)
 
(305
)
 
(133
)
 
(956
)
 
(357
)
CL Ashton Woods (c)
790

 
1,355

 
1,859

 
4,246

 
277

 
477

 
573

 
1,027

 
373

 
677

 
826

 
1,817

CL Realty
413

 
445

 
1,240

 
1,246

 
294

 
350

 
846

 
802

 
147

 
175

 
423

 
401

CREA FMF Nashville

 

 

 

 

 

 
(25
)
 

 

 

 
(25
)
 

FMF Peakview
3

 
200

 
3

 
200

 
(109
)
 
(98
)
 
(261
)
 
(137
)
 
(21
)
 
(19
)
 
(52
)
 
(27
)
HM Stonewall Estates (c) 
292

 
696

 
1,727

 
1,794

 
91

 
255

 
613

 
655

 
36

 
100

 
245

 
276

LM Land Holdings (c)
4,604

 
9,387

 
13,897

 
14,651

 
3,397

 
5,515

 
10,368

 
9,274

 
1,200

 
2,344

 
3,097

 
3,998

PSW Communities

 

 

 

 
(11
)
 

 
(231
)
 

 
(9
)
 

 
(204
)
 

Temco
79

 
162

 
793

 
437

 
42

 
42

 
158

 
48

 
21

 
21

 
79

 
24

Other ventures
1,329

 
21

 
1,378

 
5,171

 
691

 
(120
)
 
502

 
(642
)
 
589

 
(30
)
 
296

 
34

 
$
8,696

 
$
12,307

 
$
24,628

 
$
30,920

 
$
4,335

 
$
6,268

 
$
12,035

 
$
11,487

 
$
2,016

 
$
3,125

 
$
3,965

 
$
6,604

 _____________________
(a) 
Total includes current maturities of $61,936,000 at third quarter-end 2014, of which $40,697,000 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 third quarter-end 2014.
(c) 
Includes unrecognized basis difference of $2,011,000 which is reflected as a reduction of our investment in unconsolidated ventures at third 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 nine months 2014, we contributed cash of $5,016,000 to these ventures and received $4,418,000 in cash distributions, and in first nine months 2013, we contributed cash of $819,000 to these ventures and received $2,140,000 in cash distributions. Distributions include both return of investments and distribution of earnings.
From time to time, we provide 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 third quarter-end 2014, we have no outstanding performance bonds or letters of credit.
Note 8—Receivables
Receivables consist of:
 
Third
Quarter-End
 
Year-End
 
2014
 
2013
 
(In thousands)
Loan secured by real estate
$
4,236

 
$
7,610

Other loans secured by real estate, average interest rates of 4.40% at third quarter-end 2014 and 5.00% at year-end 2013
8,234

 
7,987

Oil and gas joint interest billing receivables
11,220

 
3,896

Oil and gas revenue accruals
18,753

 
8,137

Other receivables and accrued interest
3,884

 
11,648

 
46,327

 
39,278

Allowance for bad debts
(26
)
 
(26
)
 
$
46,301

 
$
39,252


10


At third quarter-end 2014, we have $4,236,000 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 nine months 2014, we received principal payments of $8,912,000 and interest payments of $530,000. At third quarter-end 2014, the outstanding principal balance was $6,787,000.
Estimated accretable yield follows:
 
Third
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
(347
)
Interest income recognized (in first nine months 2014)
(6,068
)
End of period
$
2,493

Other loans secured by real estate generally are secured by a deed of trust and due within three years.
Note 9—Debt
Debt consists of:
 
Third
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
102,368

 
99,890

6.00% tangible equity unit notes, net of discount
19,192

 
25,619

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

 
15,400

Other indebtedness — interest rates ranging from 2.19% to 5.50% at third quarter-end 2014
42,335

 
16,498

 
$
429,295

 
$
357,407

Our debt agreements contain financial covenants customary for such agreements including minimum levels of interest coverage and limitations on leverage. At third 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%.
We incurred fees of $3,068,000 related to this amendment. At third 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 $10,118,000 is outstanding at third 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. At third quarter-end 2014, we had $289,882,000 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

11


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 third 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 $29,002,000. Other indebtedness principally represents $38,033,000 of senior secured construction loans for two multifamily properties, of which $23,936,000 is related to the third quarter 2014 acquisition of our partner's interest in the 257-unit multifamily project in Austin. The combined carrying value of these two multifamily properties is $82,715,000 at third quarter-end 2014. The remaining other indebtedness is collateralized by entitled, developed and under development projects with a carrying value of $19,239,000.
At third quarter-end 2014 and year-end 2013, we have $16,072,000 and $7,896,000 in unamortized deferred financing fees which are included in other assets. Amortization of deferred financing fees was $3,089,000 and $2,282,000 in first nine 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.
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 third quarter 2014, we recognized non-cash asset impairment charges of $94,000 associated with a real estate project in Austin. We had no non-cash impairment charges in third quarter 2013.
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:
 
Third Quarter-End 2014
 
Year-End 2013
 
 
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
 
Valuation
Technique
 
(In thousands)
 
 
Loan secured by real estate
$
4,236

 
$
7,524

 
$
7,610

 
$
18,025

 
Level 2
Fixed rate debt (a)
(371,560
)
 
(381,619
)
 
(126,640
)
 
(118,634
)
 
Level 2
_____________________
(a) 
Third quarter-end 2014 includes our $250,000,000 of 8.50% senior secured notes due 2022, issued May 12, 2014.


12


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 third quarter-end 2014, personnel of former affiliates held options to purchase 706,000 shares of our common stock. The options have a weighted average exercise price of $26.11 and a weighted average remaining contractual term of one year. At third quarter-end 2014, the options have an aggregate intrinsic value of $54,300.
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.
The computations of basic and diluted earnings per share are as follows:
 
Third Quarter
 
First Nine Months
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
Numerator:
 
 
 
 
 
 
 
Consolidated net income
$
5,239

 
$
12,897

 
$
28,994

 
$
19,137

Less: Net loss (income) attributable to noncontrolling interest
(12
)
 
(1,067
)
 
(611
)
 
(2,815
)
Earnings available for diluted earnings per share
$
5,227

 
$
11,830

 
$
28,383

 
$
16,322

Less: Undistributed net income allocated to participating securities
(947
)
 

 
(5,151
)
 

Earnings available to common shareholders for basic earnings per share
$
4,280

 
$
11,830

 
$
23,232

 
$
16,322

 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
Weighted average common shares outstanding — basic
35,498

 
35,410

 
35,437

 
35,341

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
513

 
662

 
456

 
608

Total weighted average shares outstanding — diluted
43,868

 
36,072

 
43,750

 
35,949

Anti-dilutive awards excluded from diluted weighted average shares
1,959

 
1,764

 
2,171

 
2,022

_____________________
(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 third 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 third quarter and first nine months 2014, which includes a one percent benefit for noncontrolling interests. Our effective tax rate was a 29 percent benefit in third quarter 2013 and less than a one percent benefit in first nine months 2013, which included a four percent benefit for noncontrolling interests. Our third quarter and first nine months 2013 effective tax rates include a benefit from recognition of $6,326,000 of previously unrecognized tax benefits upon lapse of the statute of limitations for a previously reserved tax position. Our effective tax rates in third quarter and first nine months 2013 would have been 33 percent excluding the impact of the foregoing tax benefits.
Our 2014 and 2013 effective tax rates also 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 $810,000, which is included in other accrued expenses. It is possible that remediation or monitoring activities could be required in addition to those included within our estimate, but we are unable to determine the scope, timing or extent of such activities.
We have asset retirement obligations related to the abandonment and site restoration requirements that result from the acquisition, construction and development of oil and gas properties. We record the fair value of a liability for an asset retirement obligation in the period in which it is incurred and a corresponding increase in the carrying amount of the related long-lived asset. Accretion expense related to the asset retirement obligation and depletion expense related to capitalized asset retirement cost is included in cost of oil and gas producing activities on our consolidated statements of income and comprehensive income. At third quarter-end 2014, our asset retirement obligation was $1,667,000, 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:
 
Third
Quarter-End
 
Year-End
 
2014
 
2013
 
(In thousands)
Real estate
$
664,642

 
$
582,802

Oil and gas
355,501

 
312,553

Other natural resources
23,502

 
23,478

Assets not allocated to segments (a)
224,594

 
253,319

 
$
1,268,239

 
$
1,172,152

  _________________________

13


(a) 
Assets not allocated to segments at third quarter-end 2014 principally consist of cash and cash equivalents of $170,606,000 and a net deferred tax asset of $30,932,000. 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 third quarter and first nine months 2014, no single customer accounted for more than ten percent of our total revenues.
Segment revenues and earnings are as follows:
 
Third Quarter
 
First Nine Months
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
Revenues:
 
 
 
 
 
 
 
Real estate
$
32,445

 
$
50,356

 
$
153,098

 
$
170,264

Oil and gas
24,145

 
22,095

 
66,076

 
53,430

Other natural resources
2,250

 
2,656

 
7,284

 
8,963

Total revenues
$
58,840

 
$
75,107

 
$
226,458

 
$
232,657

Segment earnings:
 
 
 
 
 
 
 
Real estate
$
15,987

 
$
13,197

 
$
66,859

 
$
40,747

Oil and gas
6,002

 
8,499

 
16,331

 
17,869

Other natural resources
669

 
549

 
2,220

 
2,792

Total segment earnings
22,658

 
22,245

 
85,410

 
61,408

Items not allocated to segments (a)
(14,676
)
 
(13,347
)
 
(41,563
)
 
(45,114
)
Income before taxes attributable to Forestar Group Inc.
$
7,982

 
$
8,898

 
$
43,847

 
$
16,294

  _________________________
(a) 
Items not allocated to segments consist of:
 
Third Quarter
 
First Nine Months
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
General and administrative expense
$
(5,190
)
 
$
(4,648
)
 
$
(15,924
)
 
$
(14,935
)
Shared-based compensation expense
(991
)
 
(3,492
)
 
(4,523
)
 
(15,367
)
Interest expense
(8,634
)
 
(5,231
)
 
(21,507
)
 
(14,892
)
Other corporate non-operating income
139

 
24

 
391

 
80

 
$
(14,676
)
 
$
(13,347
)
 
$
(41,563
)
 
$
(45,114
)
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 third 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 third quarter-end 2014, these VIEs have total assets of $53,747,000, substantially all of which represent developed and undeveloped real estate, and total liabilities of $75,575,000, which includes $31,060,000 of borrowings classified as current maturities. These amounts are included in the

14


summarized balance sheet information for ventures accounted for using the equity method in Note 7—Investment in Unconsolidated Ventures. At third quarter-end 2014, our investment in these VIEs is $9,507,000 and is included in investment in unconsolidated ventures. In first nine months 2014, we contributed $4,378,000 to these VIEs. Our maximum exposure to loss related to one of these VIEs is estimated at $3,627,000, 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.
Note 17—Share-Based Compensation
Share-based compensation expense consists of:
 
Third Quarter
 
First Nine Months
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
Cash-settled awards
$
(801
)
 
$
1,823

 
$
(1,996
)
 
$
7,498

Equity-settled awards
1,307

 
899

 
4,897

 
3,565

Restricted stock
22

 
85

 
101

 
541

Stock options
463

 
685

 
1,521

 
3,763

 
$
991

 
$
3,492

 
$
4,523

 
$
15,367

Share-based compensation expense is included in:
 
Third Quarter
 
First Nine Months
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
General and administrative expense
$
(50
)
 
$
1,297

 
$
1,217

 
$
7,310

Other operating expense
1,041

 
2,195

 
3,306

 
8,057

 
$
991

 
$
3,492

 
$
4,523

 
$
15,367

In first nine months 2014, we granted 92,800 cash-settled awards and 467,200 equity-settled awards. Equity-settled awards granted to employees in the first nine months 2014 include restricted stock units (RSUs), market-leveraged stock units (MSUs) and performance stock units (PSUs). Cash-settled RSUs vest ratably over three years from the date of grant. Equity-settled RSUs, MSUs and PSUs vest after three years from the date of grant upon achievement of market conditions 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 nine 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 nine months 2014 and 2013. Unrecognized share-based compensation expense related to non-vested equity-settled awards, restricted stock and stock options is $10,950,000 at third quarter-end 2014.
In first nine months 2014 and 2013, we issued 211,333 and 118,472 shares out of our treasury stock associated with vesting of stock-based awards or exercise of stock options, net of 54,272 and 59,172 shares withheld having a value of $1,024,000 and $1,128,000 for payroll taxes in connection with vesting of stock-based awards or exercise of stock options.
Note 18—Subsequent Event
Cibolo Canyons—San Antonio, Texas
On October 24, 2014, we received $46,500,000 from the Cibolo Canyons Special Improvement District (CCSID) under 2007 economic development agreements in connection with development of the JW Marriott Hill Country Resort & Spa at our Cibolo Canyons project near San Antonio. CCSID funded payment to us from its issuance of $48,900,000 Hotel Occupancy Tax (HOT) and Sales and Use Tax Revenue Bonds. These bonds are obligations solely of CCSID and are payable from HOT and sales and use taxes levied by CCSID.
The resort hotel owner, SA Real Estate, LLLP (SARE), previously had senior rights to certain payments from CCSID to be funded by HOT and sales and use taxes. To facilitate issuance of the bonds by CCSID, SARE assigned these rights to us so that we could subordinate the rights to the rights of bondholders. In return, we provided SARE a $10,000,000 surety bond

15


securing the entire obligation. The surety bond will decrease as CCSID satisfies it payment obligation to SARE, which is scheduled to be retired in full by 2020.
In addition, we provided a $6,846,000 letter of credit to the bond trustee as security for certain debt service fund obligations in the event CCSID tax collections are not sufficient to support payment of the bonds in accordance with their terms. The letter of credit must be maintained until the earlier of redemption of the bonds or scheduled bond maturity in 2034. If the letter of credit is drawn upon in part or in full, we are not required to replenish the letter of credit.
At third quarter-end 2014, we had $24,067,000 invested in the resort development against which we expect to apply proceeds resulting in a recovery of our full investment in fourth quarter 2014.

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 third 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, including impacts from shortages in materials or labor;
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:
 
Third Quarter
 
First Nine Months
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
Revenues:
 
 
 
 
 
 
 
Real estate
$
32,445

 
$
50,356

 
$
153,098

 
$
170,264

Oil and gas
24,145

 
22,095

 
66,076

 
53,430

Other natural resources
2,250

 
2,656

 
7,284

 
8,963

Total revenues
$
58,840

 
$
75,107

 
$
226,458

 
$
232,657

Segment earnings:
 
 
 
 
 
 
 
Real estate
$
15,987

 
$
13,197

 
$
66,859

 
$
40,747

Oil and gas
6,002

 
8,499

 
16,331

 
17,869

Other natural resources
669

 
549

 
2,220

 
2,792

Total segment earnings
22,658

 
22,245

 
85,410

 
61,408

Items not allocated to segments:
 
 
 
 
 
 
 
General and administrative expense
(5,190
)
 
(4,648
)
 
(15,924
)
 
(14,935
)
Share-based compensation expense
(991
)
 
(3,492
)
 
(4,523
)
 
(15,367
)
Interest expense
(8,634
)
 
(5,231
)
 
(21,507
)
 
(14,892
)
Other corporate non-operating income
139

 
24

 
391

 
80

Income before taxes
7,982

 
8,898

 
43,847

 
16,294

Income tax (expense) benefit
(2,755
)
 
2,932

 
(15,464
)
 
28

Net income attributable to Forestar Group Inc.
$
5,227

 
$
11,830

 
$
28,383

 
$
16,322


18


Significant aspects of our results of operations follow:
Third Quarter and First Nine Months 2014
Third quarter 2014 real estate segment earnings were up compared with third quarter 2013 due principally to a gain of $7,610,000 associated with the acquisition of our partner's interest in the Eleven multifamily venture, which more than offset lower undeveloped land sales, commercial acre tract sales, and residential lot sales activity. First nine months 2014 real estate segment earnings were up compared with first nine months 2013 principally due to increased undeveloped land sales, 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 and higher residential lot sales activity. 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.
Third quarter 2014 oil and gas segment earnings were down compared with third quarter 2013 principally due to higher exploration costs and lower production volumes, lease bonus and delay rental revenues associated with our owned mineral interests, which were partially offset by a gain of $3,335,000 related to the sale of oil and gas properties in North Dakota and Oklahoma and higher working interest oil production volume. First nine months 2014 oil and gas segment earnings were down compared with first nine months 2013 principally due to higher exploration costs, lower production volumes, lease bonus and delay rental revenues associated with our owned mineral interests and higher operating expenses, which were partially offset by gains of $9,041,000 related to sale of oil and gas properties in North Dakota and Oklahoma and higher working interest production volumes.
Third quarter 2014 other natural resources segment earnings benefited from lower operating costs, a groundwater reservation agreement which generated $250,000 in segment revenues and a $165,000 gain associated with sale of water rights associated with a real estate project in Colorado, partially offset by lower fiber volumes compared with third quarter 2013. First nine months 2014 other natural resources segment earnings declined compared to first nine months 2013 principally due to lower fiber volumes, partially offset principally due to a groundwater reservation agreement which generated $1,000,000 in segment revenues, lower operating costs and a $685,000 gain from a partial termination of a timber lease.
Share-based compensation expense decreased principally as result of a 17 percent decrease in our stock price since year-end 2013, compared with a 24 percent increase in our stock price in first nine months 2013 since year-end 2012, which impacted the value of vested cash-settled awards.
Third quarter and first nine months 2014 interest expense increased primarily due to higher average borrowing rates and increased debt outstanding.
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.

19


Current Market Conditions
Sales of new U.S. single-family homes rose to a six-year high in September 2014, on a seasonally adjusted basis, but a sharp downward revision to August's sales pace indicates the housing recovery remains tentative.  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, national and global economic weakness and uncertainty, and a restrictive mortgage lending environment continue to threaten a robust recovery in the housing market, despite low interest rates. 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 posted their biggest one-day drop in nearly two years on October 14, 2014 due to weakening global demand and the strength of U.S. domestic oil production. The International Energy Agency cut its full-year oil-demand growth forecast to the lowest level in five years. 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. However, the inpact of lower oil prices on well economics could impact future exploration and development activity.
Gas prices are up nearly 12 percent from year ago levels, but are significantly lower than realized prices over the last decade.  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. 
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 120,000 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.

20


A summary of our real estate results follows:
 
Third Quarter
 
First Nine Months
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
Revenues
$
32,445

 
$
50,356

 
$
153,098

 
$
170,264

Cost of sales
(20,053
)
 
(31,955
)
 
(88,262
)
 
(113,263
)
Operating expenses
(7,604
)
 
(8,498
)
 
(24,994
)
 
(23,179
)
 
4,788

 
9,903

 
39,842

 
33,822

Interest income on loan secured by real estate
1,757

 
1,435

 
6,068

 
3,631

Gain on asset purchase and non-monetary exchange
7,610

 

 
18,086

 

Equity in earnings of unconsolidated ventures
1,844

 
2,926

 
3,474

 
6,109

Less: Net income attributable to noncontrolling interests
(12
)
 
(1,067
)
 
(611
)
 
(2,815
)
Segment earnings
$
15,987

 
$
13,197

 
$
66,859

 
$
40,747

In first nine months 2014, revenues were principally driven by increased residential real estate and undeveloped land sales. First nine months 2013 revenues include $41,000,000 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.
In third quarter and first nine months 2014, cost of sales includes $4,649,000 and $13,690,000 related to multifamily construction contract costs we incurred as general contractor and paid to subcontractors associated with our development of two multifamily venture properties. We incurred charges of $1,784,000 and $4,131,000 in third quarter and first nine months 2014 reflecting estimated cost increases associated with our fixed fee contracts as general contractor for these two multifamily venture properties. Cost of sales associated with multifamily construction contracts for third quarter and first nine months 2013 were $9,583,000 and $27,189,000. First nine months 2013 cost of sales also included $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 third quarter 2014, we acquired full ownership in CJUF III, RH Holdings partnership (the Eleven venture), owner of a 257-unit multifamily project in Austin in which we previously held a 25 percent interest, for $21,500,000. The acquisition-date fair value was $55,275,000, including debt of $23,936,000. Our investment in the Eleven venture prior to acquiring our partner’s interest was $2,229,000. We accounted for this transaction as a business combination achieved in stages and as a result, we remeasured our equity method investment in the Eleven venture to its acquisition-date fair value of $9,839,000 and recognized the resulting gain of $7,610,000 in real estate segment earnings. Also in first nine 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 nine months 2014, the decrease in net income attributable to noncontrolling interests compared with first nine 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:
 
Third Quarter
 
First Nine Months
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
Residential real estate
$
20,714

 
$
28,298

 
$
89,876

 
$
65,748

Commercial real estate
166

 
1,083

 
946

 
4,521

Undeveloped land
2,021

 
6,571

 
29,031

 
11,858

Commercial and income producing properties
9,378

 
13,355

 
30,361

 
85,387

Other
166

 
1,049

 
2,884

 
2,750

 
$
32,445

 
$
50,356

 
$
153,098

 
$
170,264

Residential real estate revenues principally consist of the sale of single-family lots to national, regional and local homebuilders. Revenues decreased in third quarter 2014 compared with third quarter 2013 primarily due to lower residential lot and undeveloped land sales activity, which was somewhat offset by higher average price per lot sold. Revenues increased in first nine months 2014 compared with first nine months 2013 due to increased lot sales volume offset by lower average price

21


per lot sold and higher undeveloped land sales. In addition, in first nine months 2014, we sold 918 undeveloped residential tract acres for $6,617,000 which generated segment earnings of $2,689,000, compared with the sale of 486 undeveloped residential acres of which 440 were the remaining undeveloped residential tract acres from a project in Florida for $3,536,000, which generated approximately $687,000 in segment earnings in first nine months 2013.
In first nine months 2014, undeveloped land sales increased as compared with first nine 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, third quarter and first nine months 2014 commercial and income producing properties revenues include construction revenues of $2,865,000 and $9,559,000 associated with our multifamily fixed fee 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 third quarter and first nine months 2013 were $9,029,000 and $26,635,000.
In first nine months 2014, commercial and income producing properties revenue decreased compared with first nine 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 nine months 2014, revenues related to our 413 guest room hotel in Austin were up $3,007,000 when compared with first nine months 2013, primarily due to a higher average room rates and increased food and beverage sales.
Units sold in our owned and consolidated ventures consist of:
 
Third Quarter
 
First Nine Months
 
2014
 
2013
 
2014
 
2013
Owned and consolidated ventures:
 
 
 
 
 
 
 
Residential Lots Sold
286

 
414

 
1,603

 
1,028

Revenue per Lot Sold
$
72,352

 
$
56,866

 
$
52,052

 
$
55,417

Commercial Acres Sold

 
2

 
3

 
37

Revenue per Commercial Acre Sold
$

 
$
426,554

 
$
96,774

 
$
115,892

Undeveloped Acres Sold
637

 
1,314

 
12,916

 
3,233

Revenue per Acre Sold
$
3,179

 
$
5,001

 
$
2,248

 
$
3,668

Ventures accounted for using the equity method:
 
 
 
 
 
 
 
Residential Lots Sold
37

 
133

 
231

 
325

Revenue per Lot Sold
$
83,711

 
$
55,251

 
$
70,325

 
$
54,752

Commercial Acres Sold
4

 
17

 
4

 
19

Revenue per Commercial Acre Sold
$
589,203

 
$
239,710

 
$
589,203

 
$
277,739

Undeveloped Acres Sold

 
26

 
258

 
68

Revenue per Acre Sold
$

 
$
2,650

 
$
2,306

 
$
2,650

Operating expenses consist of:
 
Third Quarter
 
First Nine Months
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
Employee compensation and benefits
$
2,605

 
$
2,434

 
$
8,118

 
$
5,708

Property taxes
1,558

 
1,669

 
5,043

 
5,714

Professional services
807

 
871

 
4,218

 
2,997

Depreciation and amortization
725

 
721

 
2,068

 
2,463

Other
1,909

 
2,803

 
5,547

 
6,297

 
$
7,604

 
$
8,498

 
$
24,994

 
$
23,179

The increase in employee compensation and benefits in first nine months 2014 is principally related to increase in staffing and incentive compensation. The increase in professional services in first nine 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.

22


Information about our real estate projects and our real estate ventures follows:
 
Third
Quarter-End
 
2014
 
2013
Owned and consolidated ventures:
 
 
 
Entitled, developed and under development projects
 
 
 
Number of projects
65

 
65

Residential lots remaining
14,772

 
19,378

Commercial acres remaining
1,722

 
2,020

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

 
13

Acres in entitlement process
24,430

 
25,830

Acres undeveloped
78,918

 
87,714

Ventures accounted for using the equity method:
 
 
 
Ventures’ entitled, developed and under development projects
 
 
 
Number of projects
8

 
7

Residential lots remaining
2,984

 
3,380

Commercial acres remaining
236

 
289

Ventures’ undeveloped land and land in the entitlement process
 
 
 
Acres undeveloped
5,073

 
5,587

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: