10-Q 1 for-0331201710q.htm 10-Q Document

 
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 March 31, 2017
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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth 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
¨
Emerging growth company
¨
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
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 May 5, 2017
Common Stock, par value $1.00 per share
 
41,857,512
 



FORESTAR GROUP INC.
TABLE OF CONTENTS
 

2


PART I—FINANCIAL INFORMATION
Item 1. Financial Statements
FORESTAR GROUP INC.
Consolidated Balance Sheets
(Unaudited)
 
First
Quarter-End
 
Year-End
 
2017
 
2016
 
(In thousands, except share data)
ASSETS
 
Cash and cash equivalents
$
337,432

 
$
265,798

Real estate
289,909

 
293,003

Assets of discontinued operations
5

 
14

Assets held for sale
29,867

 
30,377

Investment in unconsolidated ventures
79,262

 
77,611

Receivables, net
18,535

 
8,931

Income taxes receivable

 
10,867

Prepaid expenses
2,412

 
2,000

Property and equipment, net
2,621

 
3,116

Deferred tax asset, net
294

 
323

Goodwill

 
37,900

Other assets
3,257

 
3,268

TOTAL ASSETS
$
763,594

 
$
733,208

LIABILITIES AND EQUITY
 
 
 
Accounts payable
$
5,615

 
$
4,804

Accrued employee compensation and benefits
1,713

 
4,126

Accrued property taxes
910

 
2,008

Accrued interest
529

 
1,585

Income taxes payable
4,566

 

Earnest money deposits
13,304

 
10,511

Other accrued expenses
7,238

 
12,598

Liabilities of discontinued operations
1,163

 
5,295

Liabilities held for sale
459

 
103

Other liabilities
28,986

 
19,702

Debt, net
111,783

 
110,358

TOTAL LIABILITIES
176,266

 
171,090

COMMITMENTS AND CONTINGENCIES

 

EQUITY
 
 
 
Forestar Group Inc. shareholders’ equity:
 
 
 
Common stock, par value $1.00 per share, 200,000,000 authorized shares, 44,803,603 issued at first quarter-end 2017 and year-end 2016
44,804

 
44,804

Additional paid-in capital
549,926

 
553,005

Retained earnings
37,807

 
12,602

Treasury stock, at cost, 3,005,101 shares at first quarter-end 2017 and 3,187,253 shares at year-end 2016
(46,716
)
 
(49,760
)
Total Forestar Group Inc. shareholders’ equity
585,821

 
560,651

Noncontrolling interests
1,507

 
1,467

TOTAL EQUITY
587,328

 
562,118

TOTAL LIABILITIES AND EQUITY
$
763,594

 
$
733,208

Please read the notes to consolidated financial statements.

3


FORESTAR GROUP INC.
Consolidated Statements of Income (Loss) and Comprehensive Income (Loss)
(Unaudited)
 
First Quarter
 
2017
 
2016
 
(In thousands, except per share amounts)
REVENUES
 
 
 
Real estate sales and other
$
20,752

 
$
26,408

Commercial and income producing properties

 
9,690

Real estate
20,752

 
36,098

Mineral resources
1,497

 
1,082

Other
56

 
438

 
22,305

 
37,618

COSTS AND EXPENSES
 
 
 
Cost of real estate sales and other
(12,032
)
 
(13,262
)
Cost of commercial and income producing properties
11

 
(5,162
)
Cost of mineral resources
(38,315
)
 
(230
)
Cost of other
(301
)
 
(385
)
Other operating expenses
(4,957
)
 
(12,091
)
General and administrative
(4,691
)
 
(6,479
)
 
(60,285
)
 
(37,609
)
GAIN ON SALE OF ASSETS
74,215

 
13,581

OPERATING INCOME
36,235

 
13,590

Equity in earnings of unconsolidated ventures
6,362

 
47

Interest expense
(2,235
)
 
(7,639
)
Other non-operating income
676

 
74

INCOME FROM CONTINUING OPERATIONS BEFORE TAXES
41,038

 
6,072

Income tax expense
(16,211
)
 
(2,152
)
NET INCOME FROM CONTINUING OPERATIONS
24,827

 
3,920

INCOME (LOSS) FROM DISCONTINUED OPERATIONS, NET OF TAXES
418

 
(8,216
)
CONSOLIDATED NET INCOME (LOSS)
25,245

 
(4,296
)
Less: Net (income) loss attributable to noncontrolling interests
(40
)
 
(80
)
NET INCOME (LOSS) ATTRIBUTABLE TO FORESTAR GROUP INC.
$
25,205

 
$
(4,376
)
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
 
 
 
Basic
42,097

 
34,302

Diluted
42,406

 
42,320

NET INCOME (LOSS) PER BASIC SHARE
 
 
 
Continuing operations
$
0.59

 
$
0.11

Discontinued operations
0.01

 
(0.24
)
NET INCOME (LOSS) PER BASIC SHARE
$
0.60

 
$
(0.13
)
NET INCOME (LOSS) PER DILUTED SHARE
 
 
 
Continuing operations
0.58

 
0.09

Discontinued operations
0.01

 
(0.19
)
NET INCOME (LOSS) PER DILUTED SHARE
0.59

 
(0.10
)
TOTAL COMPREHENSIVE INCOME (LOSS)
$
25,205

 
$
(4,376
)
Please read the notes to consolidated financial statements.

4


FORESTAR GROUP INC.
Consolidated Statements of Cash Flows
(Unaudited) 
 
First Quarter
 
2017
 
2016
 
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Consolidated net income (loss)
$
25,245

 
$
(4,296
)
Adjustments:
 
 
 
Depreciation, depletion and amortization
1,485

 
4,785

Change in deferred income taxes
29

 

Equity in earnings of unconsolidated ventures
(6,362
)
 
(47
)
Distributions of earnings of unconsolidated ventures
4,974

 
1,304

Share-based compensation
843

 
1,380

Real estate cost of sales
12,240

 
12,841

Real estate development and acquisition expenditures, net
(13,740
)
 
(14,794
)
Reimbursements from utility and improvement districts
1,180

 
306

Asset impairments
37,900

 

Gain on sale of assets
(74,215
)
 
(2,604
)
Other
945

 
1,820

Changes in:
 
 
 
Notes and accounts receivable
(1,925
)
 
13,979

Prepaid expenses and other
(647
)
 
(660
)
Accounts payable and other accrued liabilities
(5,764
)
 
(6,702
)
Income taxes
15,433

 
(2,303
)
Net cash provided by (used for) operating activities
(2,379
)
 
5,009

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Property, equipment, software, reforestation and other
(17
)
 
(3,501
)
Oil and gas properties and equipment
(2,400
)
 
(426
)
Investment in unconsolidated ventures
(1,915
)
 
(3,019
)
Proceeds from sales of assets
77,510

 
56,828

Return of investment in unconsolidated ventures
1,511

 
1,567

Net cash provided by investing activities
74,689

 
51,449

CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Payments of debt

 
(11,185
)
Additions to debt
304

 
1,307

Distributions to noncontrolling interests, net

 
(171
)
Payroll taxes on issuance of stock-based awards
(980
)
 
(205
)
Net cash used for financing activities
(676
)
 
(10,254
)
 
 
 
 
Net increase in cash and cash equivalents
71,634

 
46,204

Cash and cash equivalents at beginning of period
265,798

 
96,442

Cash and cash equivalents at end of period
$
337,432

 
$
142,646

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.
We prepare our unaudited interim financial statements in accordance with U.S. generally accepted accounting principles ("U.S. GAAP") 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 and measuring long-lived assets for impairment. 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 2016 Annual Report on Form 10-K.
At year-end 2016, we had divested substantially all of our oil and gas working interest properties. As a result of this significant change in our operations, we have reported the results of operations and financial position of these assets as discontinued operations within the consolidated statements of income (loss) and comprehensive income (loss) and consolidated balance sheets for all periods presented.
Note 2—New and Pending Accounting Pronouncements
Adoption of New Accounting Standards
In March 2016, the FASB issued ASU 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, as part of its simplification initiative. The areas for simplification in this update involve several aspects of the accounting for share-based payment transactions, including income tax consequences, classification of awards as either equity or liabilities, and the classification on the statement of cash flows. The updated standard is effective for annual and interim periods beginning after December 31, 2016. Effective first quarter 2017, stock-based compensation (SBC) excess tax benefits or deficiencies are reflected in the consolidated statements of income (loss) and comprehensive income (loss) as a component of the provision for income taxes, whereas they previously were recognized in equity to the extent additional paid-in capital pool was available. Additionally, our consolidated statements of cash flows now presents excess tax benefits as an operating activity, with the prior periods adjusted accordingly. Finally, we have elected to account for forfeitures as they occur, rather than estimate expected forfeitures. As a result of the adoption of ASU 2016-09 in first quarter 2017, there were no material impacts to our consolidated financial statements.
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, 2017. The guidance permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect initially applying the guidance recognized at the date of initial application (the cumulative catch-up transition method). We currently anticipate adopting the standard using the cumulative catch-up transition method. We anticipate this standard will not have a material impact on our consolidated financial statements. While we are continuing to assess all potential impacts of the standard, we expect revenue related to lot and tract sales to remain substantially unchanged. Due to the complexity of certain of our real estate sale transactions, the revenue recognition treatment required under the standard will be dependent on contract-specific terms, and may vary in some instances from recognition at the time of the sale closing.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), in order to provide increased transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The updated standard is effective for financial statements issued for annual periods beginning after December 15, 2019 and interim periods within fiscal years beginning after December 31, 2020 with early

6


adoption permitted. We are currently evaluating the effect that the updated standard will have on our earnings, financial position and disclosures.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230), in order to address eight specific cash flow issues with the objective of reducing the existing diversity in practice. The updated standard is effective for financial statements issued for annual periods beginning after December 15, 2017 and interim periods within those fiscal years with early adoption permitted. We are currently evaluating the effect that the updated standard will have on our earnings, financial position and disclosures.
In November, 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230). This ASU requires that a statement of cash flow explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash investments. This standard is effective for fiscal years beginning after December 15, 2017. The adoption of ASU 2016-18 will modify our current disclosures and reclassifications relating to the consolidated statements of cash flows, but we do not expect it to have a material effect on our consolidated financial statements.

Note 3—Real Estate
Real estate consists of:
 
First
Quarter-End
 
Year-End
 
2017
 
2016
 
(In thousands)
Entitled, developed and under development projects
$
260,459

 
$
263,859

Land in the entitlement process and other
29,450

 
29,144

 
$
289,909

 
$
293,003

Our estimated costs of assets for which we expect to be reimbursed by utility and improvement districts were $46,660,000 at first quarter-end 2017 and $45,157,000 at year-end 2016, including $15,344,000 at first quarter-end 2017 and $14,749,000 at year-end 2016 related to our Cibolo Canyons project near San Antonio, Texas. In first quarter 2017, we have collected $1,180,000 in reimbursements that were previously submitted to these districts. At first quarter-end 2017, our inception-to-date submitted and approved reimbursements for the Cibolo Canyons project were $54,376,000 of which we have collected $45,132,000. These costs are principally for water, sewer and other infrastructure assets that we have incurred and submitted or will submit to utility or improvement districts for approval and reimbursement. We expect to be reimbursed by utility and improvement districts when these districts achieve adequate tax basis or otherwise have funds available to support payment.
Note 4—Investment in Unconsolidated Ventures
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. U.S. GAAP requires consolidation of Variable Interest Entities (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 a venture is a VIE and 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 reassess upon reconsideration events.
At first quarter-end 2017, we had ownership interests in 16 ventures that we accounted for using the equity method, none of which are a VIE.








7


Combined summarized balance sheet information for our ventures accounted for using the equity method follows:
 
Venture Assets
 
Venture Borrowings(a)
 
Venture Equity
 
Our Investment
 
First
Quarter-End
 
Year-End
 
First
Quarter-End
 
Year-End
 
First
Quarter-End
 
Year-End
 
First
Quarter-End
 
Year-End
 
2017
 
2016
 
2017
 
2016
 
2017
 
2016
 
2017
 
2016
 
(In thousands)
242, LLC (b)
$
23,530

 
$
26,503

 
$

 
$
1,107

 
$
22,905

 
$
23,136

 
$
10,904

 
$
10,934

CL Ashton Woods, LP (c)
3,064

 
2,653

 

 

 
2,948

 
2,198

 
2,067

 
1,107

CL Realty, LLC
8,056

 
8,048

 

 

 
7,964

 
7,899

 
3,982

 
3,950

CREA FMF Nashville LLC (b)
54,071

 
56,081

 
36,018

 
37,446

 
17,470

 
17,091

 
4,894

 
4,923

Elan 99, LLC
49,539

 
49,652

 
36,391

 
36,238

 
12,447

 
13,100

 
11,202

 
11,790

FMF Littleton LLC
70,434

 
70,282

 
45,744

 
44,446

 
23,634

 
23,798

 
6,086

 
6,128

FMF Peakview LLC

 

 

 

 

 

 

 

FOR/SR Forsyth LLC
10,794

 
10,672

 
1,569

 
1,568

 
9,233

 
8,990

 
8,310

 
8,091

HM Stonewall Estates, Ltd (c)
1,184

 
852

 

 

 
1,096

 
852

 
579

 
477

LM Land Holdings, LP (c)
26,424

 
25,538

 
3,851

 
3,477

 
21,573

 
20,945

 
9,900

 
9,685

MRECV DT Holdings LLC
4,318

 
4,155

 

 

 
4,318

 
4,144

 
3,886

 
3,729

MRECV Edelweiss LLC
5,276

 
3,484

 

 

 
5,276

 
3,484

 
5,027

 
3,358

MRECV Juniper Ridge LLC
4,169

 
4,156

 

 

 
4,169

 
4,156

 
3,428

 
3,741

MRECV Meadow Crossing II LLC
2,615

 
2,492

 

 

 
2,614

 
2,491

 
2,352

 
2,242

Miramonte Boulder Pass, LLC
9,333

 
10,738

 
3,126

 
4,006

 
4,710

 
5,265

 
4,505

 
5,330

Temco Associates, LLC
4,387

 
4,368

 

 

 
4,280

 
4,253

 
2,140

 
2,126

Other ventures

 

 

 

 

 

 

 

 
$
277,194

 
$
279,674

 
$
126,699

 
$
128,288

 
$
144,637

 
$
141,802

 
$
79,262

 
$
77,611


8


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)
 
First Quarter
 
First Quarter
 
First Quarter
 
2017
 
2016
 
2017
 
2016
 
2017
 
2016
 
(In thousands)
242, LLC (b)
$
12,738

 
$

 
$
8,465

 
$
(300
)
 
$
4,318

 
$
(150
)
CL Ashton Woods, LP (c)
1,782

 
696

 
750

 
367

 
959

 
439

CL Realty, LLC
199

 
133

 
2,465

 
47

 
1,232

 
23

CREA FMF Nashville LLC (b)
1,405

 
901

 
(170
)
 
(571
)
 
(54
)
 
(171
)
Elan 99, LLC
902

 
20

 
(653
)
 
(410
)
 
(588
)
 
(369
)
FMF Littleton LLC
1,415

 
321

 
(165
)
 
(170
)
 
(41
)
 
(42
)
FMF Peakview LLC

 
939

 

 
(248
)
 

 
(50
)
FOR/SR Forsyth LLC

 

 
(32
)
 

 
(28
)
 

HM Stonewall Estates, Ltd (c)
496

 
546

 
243

 
220

 
103

 
103

LM Land Holdings, LP (c)
1,053

 
1,000

 
628

 
640

 
215

 
144

MRECV DT Holdings LLC
301

 
98

 
299

 
98

 
269

 
88

MRECV Edelweiss LLC
185

 
87

 
185

 
87

 
166

 
78

MRECV Juniper Ridge LLC
13

 
3

 
13

 
3

 
12

 
3

MRECV Meadow Crossing II LLC
122

 

 
122

 
(34
)
 
110

 
(31
)
Miramonte Boulder Pass, LLC
1,642

 

 
44

 
(125
)
 
(325
)
 
(62
)
Temco Associates, LLC
48

 
99

 
27

 
67

 
14

 
34

Other ventures

 

 

 
26

 

 
10

 
$
22,301

 
$
4,843

 
$
12,221

 
$
(303
)
 
$
6,362

 
$
47


 _____________________
(a) 
Total includes current maturities of $125,498,000 at first quarter-end 2017, of which $108,675,000 is non-recourse to us, and $89,756,000 at year-end 2016, of which $78,557,000 is non-recourse to us.
(b) 
Includes unamortized deferred gains on real estate we contributed to ventures. We recognize deferred gains as income as the real estate is sold to third parties. Deferred gains of $1,372,000 are reflected as a reduction to our investment in unconsolidated ventures at first quarter-end 2017.
(c) 
Includes unrecognized basis difference of $578,000 which is reflected as an increase of our investment in unconsolidated ventures at first quarter-end 2017. 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.
In first quarter 2017, we invested $1,915,000 in these ventures and received $6,485,000 in distributions. In first quarter 2016, we invested $3,019,000 in these ventures and received $2,871,000 in distributions. Distributions include both return of investments and distribution of earnings.
The increase in our share of earnings and distributions from these ventures in first quarter 2017 is primarily due to higher earnings from 242, LLC which benefited from the sale of 46 commercial acres for $9,719,000 generating $6,612,000 in earnings to the venture. Based on our 50% interest in the venture, our pro-rata share of the earnings associated with this sale was $3,306,000 and our pro-rata share of the total distributable cash was $4,348,000. In addition, CL Realty, LLC, a venture in which we own a 50% interest, sold certain mineral assets to us for $2,400,000. Subsequent to closing of this transaction, we received $1,200,000 from the venture, representing our pro-rata share of distributable cash.
In first quarter 2016, we sold our interest in FMF Peakview LLC (3600), a 304-unit multifamily joint venture project near Denver, generating $13,167,000 in net proceeds and recognizing a gain of $9,613,000 which is included in gain on sale of assets.




9


Note 5—Goodwill
Carrying value of goodwill follows:
 
First
Quarter-End
 
Year-End
 
2017
 
2016
 
(In thousands)
Goodwill
$

 
$
37,900

Goodwill related to our owned mineral assets was $0 at first quarter-end 2017 and $37,900,000 at year-end 2016. In first quarter 2017, we recognized a non-cash impairment charge of $37,900,000 related to goodwill attributable to our mineral resources reporting unit. This impairment was a result of selling all of our remaining owned mineral assets in first quarter 2017 for approximately $85,700,000. Impairment charge is included in cost of mineral resources on our consolidated statements of income (loss) and comprehensive income (loss). In addition, we recognized $74,215,000 in total gains related to the sale of our mineral assets and recorded a deferred gain of $8,200,000 pending verification of accepted title of certain non-producing minerals in Texas and Louisiana.
Note 6—Held for Sale
At first quarter-end 2017, assets held for sale principally includes approximately 19,000 acres of timberland and undeveloped land and the related timber, a multifamily site in Austin, and central Texas groundwater assets.
The major classes of assets and liabilities of the properties held for sale are as follows:
 
First
Quarter-End
Year-End
 
2017
2016
 
(In thousands)
Assets Held for Sale:
 
 
Real estate
$
20,070

$
19,931

Timber
1,666

1,682

Other intangible assets (a)
1,681

1,681

Oil and gas properties and equipment, net
149

782

Property and equipment, net (b)
6,301

6,301

 
$
29,867

$
30,377

 
 
 
Liabilities Held for Sale:
 
 
Accrued interest
44


Earnest money deposits
415


Other liabilities

103

 
$
459

$
103

___________________
(a) Related to indefinite lived groundwater leases associated with our central Texas water assets.
(b) Related to water wells associated with our central Texas water assets.

Note 7—Discontinued Operations
At year-end 2016, we had divested substantially all of our oil and gas working interest properties. As a result of this significant change in our operations, we have reported the results of operations and financial position of these assets as discontinued operations within the consolidated statements of income (loss) and comprehensive income (loss) and consolidated balance sheets for all periods presented.
    


10



Summarized results from discontinued operations were as follows:
 
First Quarter
 
2017
 
2016
 
(In thousands)
Revenues
$
9

 
$
4,270

Cost of sales
(6
)
 
(4,964
)
Other operating expenses
(54
)
 
(1,323
)
Loss from discontinued operations before income taxes
$
(51
)
 
$
(2,017
)
Loss on sale of assets before income taxes

 
(10,977
)
Income tax benefit
469

 
4,778

Income (loss) from discontinued operations, net of taxes
$
418

 
$
(8,216
)

In first quarter 2016, we recorded a net loss of $10,977,000 on the sale of 190,960 net mineral acres leased from others and 185 gross (66 net) producing oil and gas working interest wells in Nebraska, Kansas, Oklahoma and North Dakota for total net proceeds of $32,227,000, which includes $3,269,000 in reimbursement of capital costs incurred on in-progress wells that were assumed by the buyer. A significant portion of the net loss on sale, $7,244,000, is related to write-off of allocated goodwill to sold producing oil and gas properties.
The major classes of assets and liabilities of discontinued operations at first quarter-end 2017 and year-end 2016 are as follows:
 
First
Quarter-End
 
Year-End
 
2017
 
2016
 
(In thousands)
Assets of Discontinued Operations:
 
 
 
Receivables, net of allowance for bad debt
$
5

 
$
6

Prepaid expenses

 
8

 
$
5

 
$
14

 
 
 
 
Liabilities of Discontinued Operations:
 
 
 
Accounts payable
$

 
$
67

Other accrued expenses
1,163

 
5,228

 
$
1,163

 
$
5,295

Significant operating activities and investing activities of discontinued operations are as follows:
 
First Quarter
 
2017
 
2016
 
(In thousands)
Operating activities:
 
 
 
Accounts payable and other accrued liabilities
(3,000
)
 

Loss on sale of assets

 
10,977

Depreciation, depletion and amortization

 
1,809

 
$
(3,000
)
 
$
12,786

 
 
 
 
Investing activities:
 
 
 
Oil and gas properties and equipment
$

 
$
(426
)
Proceeds from sales of assets

 
28,958

 
$

 
$
28,532


11


Note 8—Receivables
Receivables consist of:
 
First
Quarter-End
 
Year-End
 
2017
 
2016
 
(In thousands)
Funds held by escrow agent related to owned mineral assets sold, net of adjustments
$
7,689

 
$

Other receivables and accrued interest
1,466

 
1,505

Other loans secured by real estate, average interest rates of 4.85% at first quarter-end 2017 and 4.94% at year-end 2016
9,406

 
7,452

 
18,561

 
8,957

Allowance for bad debts
(26
)
 
(26
)
 
$
18,535

 
$
8,931

Other loans secured by real estate generally are secured by a deed of trust and due within three to five years.
Note 9—Equity
A reconciliation of changes in equity at first quarter-end 2017 follows:
 
Forestar
Group Inc.
 
Noncontrolling
Interests
 
Total
 
(In thousands)
Balance at year-end 2016
$
560,651

 
$
1,467

 
$
562,118

Net income
25,205

 
40

 
25,245

Other (primarily share-based compensation)
(35
)
 

 
(35
)

$
585,821

 
$
1,507

 
$
587,328


Note 10—Debt, net
Debt (a) consists of:
 
First
Quarter-End
 
Year-End
 
2017
 
2016
 
(In thousands)
8.50% senior secured notes due 2022, net
$
5,205

 
$
5,200

3.75% convertible senior notes due 2020, net of discount
105,787

 
104,673

Other indebtedness — interest rates ranging from 5.0% to 5.50%
791

 
485

 
$
111,783

 
$
110,358

___________________
(a) 
At first quarter-end 2017 and year-end 2016, $1,513,000 and $1,633,000 of unamortized deferred financing fees are deducted from our outstanding debt.
Our debt agreements contain financial covenants customary for such agreements including minimum levels of interest coverage and limitations on leverage. At first quarter-end 2017, we were in compliance with the financial covenants of these agreements.
At first quarter-end 2017, our senior secured credit facility provides for a $125,000,000 revolving line of credit, which matures on May 15, 2017 (with two one-year extension options), none of which was drawn at first quarter-end 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 $14,543,000 was outstanding at first quarter-end 2017. Total borrowings under our senior secured credit facility (including the face amount of letters of credit) may not exceed a borrowing base formula. At first quarter-end 2017, we had $53,665,000 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

12


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 certain reimbursements 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.
Our debt agreements contain financial covenants customary for such agreements including minimum levels of interest coverage and limitations on leverage. At first quarter-end 2017, our tangible net worth requirement was $445,215,000 computed as: $379,044,000 plus 85 percent of the aggregate net proceeds received by us from any equity offering, plus 75 percent of all positive net income, on a cumulative basis since third quarter-end 2015. The tangible net worth requirement is recalculated on a quarterly basis.
We may elect to make distributions to stockholders so long as the total leverage ratio is less than 40 percent, the interest coverage ratio is greater than 3.0:1.0 and available liquidity is not less than $125,000,000, all of which were satisfied at first quarter-end 2017. Regardless of whether the foregoing conditions are satisfied, we may make distributions in an aggregate amount not to exceed $50,000,000 to be funded from up to 65% of the net proceeds from sales of multifamily properties and non-core assets, such as the Radisson Hotel & Suites in Austin, and any oil and gas properties.
At first quarter-end 2017 and year-end 2016, we had $1,513,000 and $1,633,000 in unamortized deferred financing fees which were deducted from our debt. In addition, at first quarter-end 2017 and year-end 2016, unamortized deferred financing fees related to our senior secured credit facility included in other assets were $105,000 and $314,000. Amortization of deferred financing fees were $330,000 and $927,000 in first quarter 2017 and 2016 and were included in interest expense.
Note 11—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 first quarter 2017, we recognized a non-cash impairment charge of $37,900,000 related to goodwill attributable to our mineral resources reporting unit. The impairment was a result of selling all of our remaining owned mineral assets in first quarter 2017 for approximately $85,700,000.
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.







13


Information about our fixed rate financial instruments not measured at fair value follows:
 
First Quarter-End 2017
 
Year-End 2016
 
 
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
 
Valuation
Technique
 
(In thousands)
 
 
Fixed rate debt
$
(112,505
)
 
$
(112,116
)
 
$
(111,506
)
 
$
(109,789
)
 
Level 2

Note 12—Net Income (Loss) per Share
Basic and diluted earnings per share is computed using treasury stock method for first quarter 2017 and two-class method for first quarter 2016. 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 previously determined that our 6.00% tangible equity units issued in 2013 were participating securities. In December 2016, we issued 7,857,000 shares of our common stock upon the mandatory settlement of the stock purchase contract related to the 6.00% tangible equity units. Per share amounts are computed by dividing earnings available to common shareholders by the weighted average shares outstanding during each period. In periods with a net loss, no such adjustment is made to earnings as the holders of the participating securities have no obligation to fund losses.
The computations of basic and diluted earnings per share are as follows:
 
First Quarter
 
2017
 
2016
 
(In thousands)
Numerator:
 
 
 
Continuing operations
 
 
 
Net income from continuing operations
$
24,827

 
$
3,920

Less: Net (income) loss attributable to noncontrolling interest
(40
)
 
(80
)
Earnings available for diluted earnings per share
$
24,787

 
$
3,840

Less: Undistributed net income from continuing operations allocated to participating securities

 

Earnings from continuing operations available to common shareholders for basic earnings per share
$
24,787

 
$
3,840

 
 
 
 
Discontinued operations
 
 
 
Net income (loss) from discontinued operations available for diluted earnings per share
$
418

 
$
(8,216
)
Less: Undistributed net income from discontinued operations allocated to participating securities

 

Earnings (loss) from discontinued operations available to common shareholders for basic earnings per share
$
418

 
$
(8,216
)
Denominator:
 
 
 
Weighted average common shares outstanding — basic
42,097

 
34,302

Weighted average common shares upon conversion of participating securities

 
7,857

Dilutive effect of stock options, restricted stock and equity-settled awards
309

 
161

Total weighted average shares outstanding — diluted
42,406

 
42,320

Anti-dilutive awards excluded from diluted weighted average shares
1,808

 
2,450

We intend to settle the remaining principal amount of our 3.75% convertible senior notes due 2020 (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 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 first quarter 2017 did not exceed the conversion price which resulted in no additional diluted outstanding shares.



14


Note 13—Income Taxes
Our effective tax rate from continuing operations was 40 percent in first quarter 2017, which includes a nine percent benefit from a valuation allowance decrease due to a decrease in our deferred tax assets and an 11 percent detriment associated with a non-cash impairment related to goodwill associated with our owned mineral assets which were sold in first quarter 2017. Our effective tax rate from continuing operations was 35 percent in first quarter 2016. Our effective tax rates also include the effect of state income taxes, nondeductible items and benefits from noncontrolling interests.
At first quarter-end 2017 and year-end 2016, we have a valuation allowance for our deferred tax assets of $68,944,000 and $73,405,000 for the portion of the deferred tax assets that we have determined is more likely than not to be unrealizable under U.S. GAAP.
In determining our valuation allowance, we assessed available positive and negative evidence to estimate whether sufficient future taxable income will be generated to permit use of the existing deferred tax assets under U.S. GAAP. A significant piece of objective evidence evaluated was the cumulative loss incurred over the three-year period ended March 31, 2017, principally driven by impairments of oil and gas and real estate properties in prior years. Such evidence limits our ability to consider other subjective evidence, such as our projected future taxable income.
The amount of the deferred tax asset considered realizable could be adjusted if negative evidence in the form of cumulative losses is no longer present and additional weight is given to subjective evidence, such as our projected future taxable income.
Our unrecognized tax benefits totaled $811,000 at first quarter-end 2017, all of which would affect our effective tax rate, if recognized.
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 we 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.
On October 4, 2014, James Huffman, a former director and CEO of CREDO Petroleum Corporation (Credo), which we acquired in 2012 and is now known as Forestar Petroleum Corporation, filed Huffman vs. Forestar Petroleum Corporation, Case Number 14CV33811, Civ. Div., Dist. Ct., City and County of Denver, Colorado, claiming entitlement to certain overriding royalty interests under a Credo compensation program. The case was settled for $3,000,000 in first quarter 2017.
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 can be reasonably estimated. 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 of discontinued operations. At first quarter-end 2017 and year-end 2016, our estimated asset retirement obligation was $1,155,000 and $1,258,000, of which $1,155,000 is included in liabilities of discontinued operations and the remaining balance at year-end 2016 was in liabilities held for sale.
Note 15—Segment Information
We manage our operations through three segments: real estate, mineral resources and other. Real estate secures entitlements and develops infrastructure on our lands for single-family residential and mixed-use communities, and manages our undeveloped land and commercial and income producing properties, which consists of three multifamily projects and one site. Mineral resources manages our owned mineral interests. Other manages our timber, recreational leases and water resource initiatives.




15


Total assets allocated by segment are as follows:
 
First
Quarter-End
 
Year-End
 
2017
 
2016
 
(In thousands)
Real estate
$
404,322

 
$
403,062

Mineral resources
7,921

 
38,907

Other
11,509

 
11,531

Assets of discontinued operations
5

 
14

Assets not allocated to segments (a)
339,837

 
279,694

 
$
763,594

 
$
733,208

 
 _________________________
(a) 
Assets not allocated to segments at first quarter-end 2017 principally consist of cash and cash equivalents of $337,432,000. Assets not allocated to segments at year-end 2016 principally consist of cash and cash equivalents of $265,798,000 and an income tax receivable of $10,867,000.
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 and long-term incentive compensation, gain on sale of strategic timberland and undeveloped land, 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.
Segment revenues and earnings are as follows:
 
First Quarter
 
2017
 
2016
 
(In thousands)
Revenues:
 
 
 
Real estate
$
20,752

 
$
36,098

Mineral resources
1,497

 
1,082

Other
56

 
438

Total revenues
$
22,305

 
$
37,618

Segment earnings (loss):
 
 
 
Real estate
$
10,473

 
$
20,224

Mineral resources
37,816

 
553

Other
(387
)
 
(581
)
Total segment earnings
47,902

 
20,196

Items not allocated to segments (a)
(6,904
)
 
(14,204
)
Income (loss) from continuing operations before taxes attributable to Forestar Group Inc.
$
40,998

 
$
5,992

  _________________________
(a) 
Items not allocated to segments consist of:
 
First Quarter
 
2017
 
2016
 
(In thousands)
General and administrative expense
$
(4,028
)
 
$
(4,973
)
Shared-based and long-term incentive compensation expense
(895
)
 
(1,544
)
Interest expense
(2,235
)
 
(7,639
)
Other corporate non-operating income
254

 
(48
)
 
$
(6,904
)
 
$
(14,204
)

16


Note 16—Share-Based and Long-Term Incentive Compensation
Share-based and long-term incentive compensation expense consists of:
 
First Quarter
 
2017
 
2016
 
(In thousands)
Cash-settled awards
$
87

 
$
619

Equity-settled awards
618

 
479

Restricted stock

 
6

Stock options
138

 
276

Total share-based compensation
843

 
1,380

Deferred cash
52

 
164

 
$
895

 
$
1,544

Share-based and long-term incentive compensation expense is included in:
 
First Quarter
 
2017
 
2016
 
(In thousands)
General and administrative expense
$
663

 
$
1,506

Other operating expense
232

 
38

 
$
895

 
$
1,544


Share-Based Compensation
We did not grant any new equity-settled or cash-settled awards to employees in first quarter 2017.
In first quarter 2017, we granted 49,225 restricted stock units to our board of directors, of which 34,746 were annual restricted stock units which vest 25 percent at grant date and 25 percent at each subsequent quarterly board meeting. Expense associated with annual restricted stock units is included in share-based compensation expense.
Excluded from share-based compensation expense in the table above are fees earned by our board of directors in the amount of $188,000 and $265,000 in first quarter of 2017 and 2016 for which they elected to defer payment until retirement in the form of share-settled units. These expenses are included in general and administrative expense.
The fair value of awards granted to retirement eligible employees expensed at the date of grant was $600,000 in first quarter 2016. Unrecognized share-based compensation expense related to non-vested equity-settled awards, restricted stock and stock options is $1,421,000 at first quarter-end 2017.
In first quarter 2017 and 2016, we issued 182,152 and 165,167 shares out of our treasury stock associated with vesting of stock-based awards or exercise of stock options, net of 75,870 and 23,691 shares withheld having a value of $980,000 and $205,000 for payroll taxes in connection with vesting of stock-based awards or exercise of stock options.
Long-Term Incentive Compensation
We did not grant any long-term incentive compensation to employees in first quarter 2017.
In first quarter 2016 and 2015, we granted $620,000 and $587,000 of long-term incentive compensation in the form of deferred cash compensation. The 2016 deferred cash awards vest annually over two years, and the 2015 deferred cash awards vest after three years. The awards provide for accelerated vesting upon retirement, disability, death, or if there is a change in control. Expense associated with deferred cash awards is recognized ratably over the vesting period. The accrued liability was $296,000 and $539,000 at first quarter-end 2017 and year-end 2016 and is included in other liabilities.

Note 17—Subsequent Events

On April 13, 2017, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Terra Firma Merger Parent, L.P. (“Parent”), and Terra Firma Merger Sub, L.P. a wholly owned subsidiary of Parent (“Merger Sub”), both of which are affiliates of Starwood Capital Group.

17



The Merger Agreement provides that, among other things and in accordance with the terms and subject to the conditions thereof, we will be merged with and into Merger Sub (the “Merger”) with Merger Sub continuing as the surviving entity. As a result of the Merger, we will become a wholly-owned subsidiary of Parent. At the effective time of the Merger, each share of our common stock, par value $1.00 per share, issued and outstanding immediately prior to the effective time (other than shares owned by (i) us as treasury stock or by us or Parent or any direct or indirect wholly-owned subsidiary of either (which will be canceled without any conversion), or (ii) stockholders who have properly exercised and perfected appraisal rights under Delaware law) will be converted into the right to receive $14.25 per share in cash, without interest.

Subject to the terms of the Merger Agreement, at the effective time of the Merger, each equity award made or otherwise denominated in shares of our common stock that is outstanding immediately prior to the effective time of the Merger under our benefit plans will be canceled and of no further force or effect as of the effective time of the Merger. In exchange for the cancellation of such equity award, the holder of such equity award will receive the per share merger consideration ($14.25) for each share of our common stock underlying such equity award (plus payment of cash of all accrued dividend equivalents, if any, with respect to such equity awards and, in the case of equity awards that are stock options or stock appreciation rights, less the aggregate exercise or strike price thereunder, but not less than $0), whether or not otherwise vested as of the effective time of the Merger. With respect to any such equity awards that vest upon the achievement of performance-based metrics, the number of shares of our common stock subject to such equity awards shall be determined pursuant to the terms set forth in the applicable award agreements.

The Merger Agreement contains specified termination rights for us and Parent, including a mutual termination right in the event that the Merger is not consummated by October 10, 2017 (the “Outside Date”). We must pay Parent a $20,000,000 termination fee if Parent terminates the Merger Agreement following a change of recommendation, or failure to reaffirm the recommendation, of the Merger by our board of directors, or if we terminate the Merger Agreement to enter into a definitive agreement with a third party with respect to a superior proposal, as set forth in, and subject to the conditions of, the Merger Agreement. Under certain additional circumstances described in the Merger Agreement, we must also pay Parent a $20,000,000 termination fee if the Merger Agreement is terminated in certain specified circumstances while an alternative acquisition proposal to the Merger has been publicly made or communicated to our board of directors and not withdrawn and, within twelve months following such termination, we enter into a definitive agreement with respect to a business combination transaction of the type described in the relevant provisions of the Merger Agreement, or such a transaction is consummated. The Merger Agreement further provides that, upon termination of the Merger Agreement (i) in the event our stockholders do not approve the Merger, (ii) by Parent in certain circumstances involving a material breach by us of any of our representations, warranties or covenants under the Merger Agreement, or (iii) at the Outside Date as a result of the failure of the condition to the Merger that we shall have consummated certain divestiture transactions or received a minimum amount of proceeds with respect thereto, we will be required to pay to Parent up to $4,000,000 (with respect to clauses (i) and (ii)) or $3,000,000 (with respect to clause (iii)) for expenses incurred by Parent (with such payment credited to any termination fee subsequently paid by us). In the event the Merger Agreement is terminated by us in certain circumstances involving a material breach by Parent or Merger Sub of any of its representations, warranties or covenants under the Merger Agreement or if Parent fails to consummate the closing within two business days of the date the closing should have occurred under the Merger Agreement, Parent is required to pay us a $40,000,000 termination fee.

The Merger has been unanimously approved by our board of directors. Closing of the transaction is subject to the approval of our shareholders and certain other closing conditions and is expected to close in the third quarter of 2017.

On April 26, 2017, we sold approximately 11,000 acres of timberland and undeveloped land, including the associated mitigation banking assets, in Georgia for $20,000,000 generating an estimated gain on sale of assets of approximately $8,600,000.

On May 8, 2017, we sold approximately 4,400 acres of timberland and undeveloped land, including the associated water rights, in Texas for $16,000,000 generating an estimated gain on sale of assets of approximately $12,000,000.


18



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 2016 Annual Report on Form 10-K. Unless otherwise indicated, information is presented as of first quarter-end 2017, 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, or on a national or global scale;
our ability to achieve some or all of our key 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;
future residential 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;
the levels of resale housing inventory 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, job growth and fluctuations in commodity prices;
demand for multifamily communities, which can be affected by a number of factors including local markets and economic conditions;
competitive actions by other companies;
changes in governmental policies, laws or regulations and actions or restrictions of regulatory agencies;
our ability to make interest and principal payments on our debt or amend and satisfy the other covenants contained in our senior secured credit facility, indentures and other debt agreements;
our partners’ ability to fund their capital commitments and otherwise fulfill their operating and financial obligations;
inability to obtain permits for, or changes in laws, governmental policies or regulations affecting, water withdrawal or usage;
the occurrence of any event, change or other circumstances that could give rise to the termination of the agreement and plan of merger between Forestar and affiliates of Starwood Capital Group;
the effect of the announcement of our merger with affiliates of Starwood Capital Group on our ability to maintain relationships with our vendors and customers and retain key personnel; and
the final resolutions or outcomes with respect to our contingent and other liabilities related to our business.

Other factors, including the risk factors described in Item 1A of our 2016 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.

19


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.
Key Initiatives
Reducing costs across our entire organization;
Reviewing the entire portfolio of our assets (complete non-core assets sales); and
Reviewing our capital structure (allocate capital to maximize shareholder value).
Merger Agreement

On April 13, 2017, we entered into a merger agreement with Terra Firma Merger Parent, L.P. (“Parent”), and Terra Firma Merger Sub, L.P. a wholly owned subsidiary of Parent (“Merger Sub”). Parent and Merger Sub are affiliates of Starwood Capital Group. If consummated, we will be merged with and into Merger Sub with Merger Sub continuing as the surviving entity. The closing of the transaction is subject to the approval of our shareholders and certain other closing conditions, and is expected to be completed in the third quarter of 2017. None of the consolidated financial statements and related disclosures in this Form 10-Q considers the potential impact of the pending merger. Please read Note 17—Subsequent Events for additional information relating to the merger.
Discontinued Operations
At year-end 2016, we had divested substantially all of our oil and gas working interest properties. As a result of this significant change in our operations, we have reported the results of operations and financial position of these assets as discontinued operations for all periods presented. The discussion of our results of operations is based on the results from our continuing operations unless otherwise indicated.
Results of Operations
A summary of our consolidated results by business segment follows:
 
First Quarter
 
2017
 
2016
 
(In thousands)
Revenues:
 
 
 
Real estate
$
20,752

 
$
36,098

Mineral resources
1,497

 
1,082

Other
56

 
438

Total revenues
$
22,305

 
$
37,618

Segment earnings (loss):
 
 
 
Real estate
$
10,473

 
$
20,224

Mineral resources
37,816

 
553

Other
(387
)
 
(581
)
Total segment earnings
47,902

 
20,196

Items not allocated to segments:
 
 
 
General and administrative expense
(4,028
)
 
(4,973
)
Share-based and long-term incentive compensation expense
(895
)
 
(1,544
)
Interest expense
(2,235
)
 
(7,639
)
Other corporate non-operating income
254

 
(48
)
Income (loss) from continuing operations before taxes attributable to Forestar Group Inc.
40,998

 
5,992

Income tax (expense) benefit
(16,211
)
 
(2,152
)
Net income (loss) from continuing operations attributable to Forestar Group Inc.
$
24,787

 
$
3,840





20


Significant aspects of our results of operations follow:
First Quarter 2017
First quarter 2017 real estate segment earnings decreased compared with first quarter 2016 primarily due to gains of $13,581,000 in first quarter 2016 related to sales of multifamily assets and no undeveloped land sales from our retail program in first quarter 2017. These items were partially offset by an increase in our share of earnings from unconsolidated ventures as a result of higher commercial tract and lot sales activity in first quarter 2017 compared with first quarter 2016.
First quarter 2017 mineral resources segment earnings increased due to gains of $74,215,000 associated with the sale of our owned mineral assets for a total purchase price of approximately $85,700,000, of which $77,510,000 in proceeds were received in first quarter 2017 and $8,200,000 in gains were deferred and the funds held in escrow pending verification of accepted title for non-producing fee minerals in Texas and Louisiana. In addition, as a result of selling our remaining mineral assets in first quarter 2017, we recognized a non-cash impairment charge of $37,900,000 related to goodwill.
First quarter 2017 interest expense decreased primarily due to reducing our debt outstanding by $277,790,000 in 2016.
Current Market Conditions
Sale of new U.S. single-family homes according to U.S. Census Bureau Department of Commerce in March 2017 were at a seasonably adjusted annual rate of 621,000. This is 5.8 percent higher than the revised February 2017 rate of 587,000 and 15.6 percent above the March 2016 rate. The reading was the highest rate since July 2016 with sales registering 12 percent higher during the first three months of this year than during the same period in 2016. Total housing starts declined 6.8 percent on a monthly basis and increased 9.2 percent on an annual basis to a seasonally adjusted annual rate of 1.22 million units in March 2017 per U.S. Department of Commerce. Single-family housing permits fell 1.1 percent in March 2017 compared to February 2017, however, they were not too far from the more than nine-year high reached in February 2017. A tightening labor market, which is generating steady wage growth, is underpinning the housing market. A survey on April 17, 2017 showed homebuilders confidence slipped in April 2017 from a near 12-year high in March 2017. However, measures of current sales and sales expectations remained at lofty levels. The S&P CoreLogic Case-Shiller Indices, which cover the entire nation, rose 5.8 percent in the 12 months ended in February 2017, the strongest increase in 31 months, up from a 5.6 percent year-over-year increase in January 2017.
Business Segments
We manage our operations through three business segments:
Real estate;
Mineral resources; and
Other
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 and long-term incentive compensation, gain on sale of strategic timberland and undeveloped land, 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.
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, and the overall strength or weakness of the U.S. economy.
Real Estate
We own directly or through ventures interests in 49 residential and mixed-use projects comprised of approximately 4,400 acres of real estate located in 10 states and 14 markets. Our real estate segment secures entitlements and develops infrastructure on our lands, primarily for single-family residential and mixed-use communities. We own approximately 11,000 acres of non-core timberland and undeveloped land in Georgia and approximately 8,000 acres in Texas. We own and manage our projects

21


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.
A summary of our real estate results follows:
 
First Quarter
 
2017
 
2016
 
(In thousands)
Revenues
$
20,752

 
$
36,098

Cost of sales
(12,021
)
 
(18,424
)
Operating expenses
(3,754
)
 
(11,088
)
 
4,977

 
6,586

Interest income
422

 
122

Gain on sale of assets

 
13,581

Equity in earnings of unconsolidated ventures
5,114

 
15

Less: Net (income) loss attributable to noncontrolling interests
(40
)
 
(80
)
Segment earnings
$
10,473

 
$
20,224

Revenues in our owned and consolidated ventures consist of:
 
First Quarter
 
2017
 
2016
 
(In thousands)
Residential real estate
$
20,048

 
$
17,045

Commercial real estate
447

 
2,655

Undeveloped land

 
5,703

Commercial and income producing properties

 
9,690

Other
257

 
1,005

 
$
20,752

 
$
36,098

Residential real estate revenues principally consist of the sale of single-family lots to local, regional and national homebuilders. Owned and consolidated venture residential lot sales volume in first quarter 2017 declined as compared with first quarter 2016, however, average price per lot sold increased 29 percent due to mix of product sold. In addition, residential real estate revenues included sale of approximately 96 residential tract acres for $4,000,000 generating segment earnings of $2,191,000 in first quarter 2017. Commercial real estate revenues principally consist of the sale of tracts to commercial developers that specialize in the construction and operation of income producing properties such as apartments, retail centers, or office buildings. The commercial real estate revenues in first quarter 2017 relate primarily to the sale of 4 acres from a wholly-owned project in Houston, generating segment earnings of $401,000 compared with first quarter 2016 sale of 8 acres from three projects in Houston and Dallas generating segment earnings of $2,204,000.
We did not sell any undeveloped land in first quarter 2017. In first quarter 2016, we sold 1,972 acres of undeveloped land for $5,703,000, or approximately $2,892 per acre, generating $4,314,000 in segment earnings.
Commercial and income producing properties revenue includes revenues from hotel room sales and other guest services, rental revenues from our operating multifamily properties and reimbursement for costs paid to subcontractors plus development and construction fees from certain multifamily projects. The decrease in commercial and income producing properties revenues in first quarter 2017 when compared with first quarter 2016 was primarily due to sale of Radisson Hotel & Suites and multifamily properties in 2016 as a result of our key initiative to sell non-core assets.







22


Units sold consist of:
 
First Quarter
 
2017
 
2016
Owned and consolidated ventures:
 
 
 
Residential lots sold
190

 
248

Revenue per lot sold
$
88,850

 
$
68,696

Commercial acres sold
4

 
8

Revenue per commercial acre sold
$
121,718

 
$
331,033

Undeveloped acres sold

 
1,972

Revenue per acre sold
$

 
$
2,892

Ventures accounted for using the equity method:
 
 
 
Residential lots sold
107

 
36

Revenue per lot sold
$
72,001

 
$
81,643

Commercial acres sold
46

 

Revenue per commercial acre sold
$
212,352

 
$

Undeveloped acres sold

 

Revenue per acre sold
$

 
$

Cost of sales in first quarter 2017 decreased when compared with first quarter 2016 primarily due to lower lot and commercial sale activity from our owned and consolidated projects and no undeveloped land sales in first quarter 2017. In addition, first quarter 2016 cost of sales included $526,000 of costs we incurred as general contractor and paid to subcontractors associated with multifamily properties which were sold in 2016.
Operating expenses consist of:
 
First Quarter
 
2017
 
2016
 
(In thousands)
Employee compensation and benefits
$
1,328

 
$
3,687

Property taxes
891

 
2,027

Professional services
722

 
1,205

Depreciation and amortization
35

 
856

Other
778

 
3,313

 
$
3,754

 
$
11,088

The decrease in employee compensation and benefits expense in first quarter 2017 is principally related to $1,422,000 in severance costs incurred in first quarter 2016 as a result of our key initiatives to reduce costs across our entire organization and our plan to divest non-core assets. The decrease in property taxes and depreciation and amortization is primarily due to sale of Radisson Hotel & Suites and wholly-owned multifamily properties in 2016. The decrease in other operating expenses is primarily due to $1,058,000 of pre-acquisition costs in first quarter 2016 associated with multifamily projects that we no longer intended to pursue and other cost reductions across the organization.
Interest income principally represents interest received on reimbursements from utility and improvement districts.
Gain on sale of assets in first quarter 2016 includes a gain of $9,613,000 related to sale of our interest in 360°, a 304-unit multifamily joint venture project near Denver and a gain of $3,968,000 associated with the sale of Music Row, a wholly-owned multifamily property in Nashville.
The increase in equity in earnings from our unconsolidated ventures in first quarter 2017 compared with first quarter 2016 is primarily due to higher residential lot and commercial real estate sales activity. Commercial sales activity includes 46 commercial acres sold from an unconsolidated venture project in Houston for $9,719,000, which generated venture earnings of $6,612,000. Based on our 50% interest, our pro-rata share of these earnings was $3,306,000.
We underwrite real estate development projects based on a variety of assumptions incorporated into our development plans, including the timing and pricing of sales and leasing and costs to complete development. Our development plans are periodically reviewed in comparison to our return projections and expectations, and we may revise our plans as business conditions warrant. If as a result of changes to our development plans the anticipated future net cash flows are reduced such

23


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 as of first quarter-end 2017 follows:
State
Entitled,
Developed,
and Under
Development
Projects
 
Land
in Entitlement Process and Other
 
Total
 
(In thousands)
Texas
$
165,001

 
$
2,615

 
$
167,616

Georgia
7,436

 
412

 
7,848

California
1,667

 
26,208

 
27,875

North & South Carolina
29,019

 
147

 
29,166

Colorado
29,722

 

 
29,722

Tennessee
21,751

 
68

 
21,819

Other
5,863

 

 
5,863

 
$
260,459

 
$
29,450

 
$
289,909

Mineral Resources
In first quarter 2017, we sold our remaining owned mineral assets for a total purchase price of approximately $85,700,000, of which $77,510,000 in proceeds was received in first quarter 2017 with the remaining $8,200,000 in proceeds held in escrow by a third-party pending acceptance of title for non-producing fee minerals in Texas and Louisiana. We recognized total gains of $74,215,000 in first quarter 2017 and deferred $8,200,000 in gains pending the completion of title review. With the completion of this sale we have divested substantially all of our oil and gas assets.
A summary of our mineral resources results follows:
 
First Quarter
 
2017
 
2016
 
(In thousands)
Revenues
$
1,497

 
$
1,082

Cost of mineral resources
(38,315
)
 
(230
)
Operating expenses
(826
)
 
(331
)
 
(37,644
)
 
521

Gain on sale of assets
74,215

 

Equity in earnings of unconsolidated ventures
1,245

 
32

Segment earnings
$
37,816

 
$
553

Revenues consist of:
 
First Quarter
 
2017
 
2016
 
(In thousands)
Oil royalties (a)
$
900

 
$
685

Gas royalties
487

 
316

Other (principally lease bonus and delay rentals)
110

 
81

 
$
1,497

 
$
1,082

 _________________________
(a) 
Oil royalties include revenues from oil, condensate and natural gas liquids (NGLs).
In first quarter 2017, royalty revenues increased principally due to higher oil and gas prices which was partially offset by lower oil and gas production volumes.
Cost of mineral resources principally represents our share of oil and gas production severance taxes, which are calculated based on a percentage of oil and gas produced. In first quarter 2017, cost of mineral resources also includes a non-cash impairment charge of $37,900,000 associated with goodwill related to the sale of our owned mineral assets.

24


Operating expenses principally consist of employee compensation and benefits, legal and professional services, property taxes and rent expense. The increase in operating expenses in first quarter 2017 compared with first quarter 2016 is primarily due to incentive compensation and legal expenses associated with the sale of our owned mineral assets.
Gain on sale of assets of $74,215,000 represents the combined gains from selling our remaining owned mineral assets in first quarter 2017.
In first quarter 2017, equity in earnings of unconsolidated ventures represents $1,245,000 in earnings from a venture in which we own a 50% interest. These earnings were principally a result of our purchase of certain mineral assets from the venture. We purchased these assets from the venture for $2,400,000 and subsequently received our pro-rata share of the earnings and distributable cash of $1,200,000 from the venture.

Oil and gas produced and average unit prices related to our royalty interests follows:
 
First Quarter
 
2017
 
2016
Consolidated entities:
 
 
 
Oil production (barrels)
17,400

 
19,300

Average oil price per barrel
$
50.20

 
$
32.97

NGL production (barrels)
600

 
3,800

Average NGL price per barrel
$
22.99

 
$
12.40

Total oil production (barrels), including NGLs
18,000

 
23,100

Average total oil price per barrel, including NGLs
$
49.38

 
$
29.57

Gas production (millions of cubic feet)
159.8

 
159.7

Average price per thousand cubic feet
$
3.05

 
$
1.98

Our share of ventures accounted for using the equity method:
 
 
 
Gas production (millions of cubic feet)
33.4

 
37.3

Average price per thousand cubic feet
$
2.98

 
$
1.78

Total consolidated and our share of equity method ventures:
 
 
 
Oil production (barrels)
17,400

 
19,300

Average oil price per barrel
$
50.20

 
$
32.97

NGL production (barrels)
600

 
3,800

Average NGL price per barrel
$
22.99

 
$
12.40

Total oil production (barrels), including NGLs
18,000

 
23,100

Average total oil price per barrel, including NGLs
$
49.38

 
$
29.57

Gas production (millions of cubic feet)
193.2

 
197.0

Average price per thousand cubic feet
$
3.03

 
$
1.94

Total BOE (barrel of oil equivalent) (a)
50,200

 
56,000

Average price per barrel of oil equivalent
$
29.37

 
$
19.06

 _________________________
(a) 
Gas is converted to barrels of oil equivalent (BOE) using a conversion of six Mcf to one barrel of oil.


25


Other
Our other segment, all of which is non-core, manages our timber holdings, recreational leases and water resource initiatives. At first quarter-end 2017, we had approximately 19,000 acres of timberland and undeveloped land we own directly, primarily in Georgia and Texas, which were classified as assets held for sale at first quarter-end 2017. Our other segment revenues are principally derived from the sales of wood fiber from our land and leases for recreational uses. At first quarter-end 2017, we had water interests in approximately 1.5 million acres, including a 45 percent nonparticipating royalty interest in groundwater produced or withdrawn for commercial purposes or sold from 1.4 million acres in Texas, Louisiana, Georgia and Alabama, and approximately 20,000 acres of groundwater leases in central Texas which were classified as assets held for sale at first quarter-end 2017.

A summary of our other results follows:
 
First Quarter
 
2017
 
2016
 
(In thousands)
Revenues
$
56

 
$
438

Cost of sales
(301
)
 
(385
)
Operating expenses
(145
)
 
(634
)
 
(390
)
 
(581
)
Equity in earnings of unconsolidated ventures
3

 

Segment earnings (loss)
$
(387
)
 
$
(581
)
Revenues consist of:
 
First Quarter
 
2017
 
2016
 
(In thousands)
Fiber
$

 
$
151

Water
9

 

Recreational leases and other
47

 
287

 
$
56

 
$
438


In first quarter 2017, we had no fiber revenues due to deferral of timber harvest activity in support of our key initiative to divest our non-core timberland and undeveloped land.
Water revenues for first quarter 2017 are related to groundwater royalties from our 45 percent nonparticipating royalty interests in groundwater produced or withdrawn for commercial purposes.
Cost of sales principally includes non-cash cost of timber cut and sold and delay rental payments paid to others related to groundwater leases in central Texas.

The decrease in operating expenses in first quarter 2017 when compared with first quarter 2016 is primarily due to our key initiative to reduce costs across entire organization and corresponding reduction in our workforce. Employee compensation and benefits includes $164,000 in severance costs incurred in first quarter 2016. Operating expenses associated with our water resources initiatives for first quarter 2017 and 2016 were $43,000 and $297,000.
Items Not Allocated to Segments
Unallocated items represent income and expenses managed on a company-wide basis and include general and administrative expenses, share-based and long-term incentive compensation, gain on sale of strategic timberland and undeveloped land, interest expense and other corporate non-operating income and expense. General and administrative expenses principally consist of accounting and finance, tax, legal, human resources, internal audit, information technology and our board of directors. These functions support all of our business segments and are not allocated.



26


General and administrative expense
General and administrative expenses consist of:
 
First Quarter
 
2017
 
2016
 
(In thousands)
Employee compensation and benefits
$
2,033

 
$
2,585

Professional and consulting services
978

 
946

Facility costs
212

 
230

Depreciation and amortization
87

 
119

Insurance costs
162

 
186

Other
556

 
907

 
$
4,028

 
$
4,973


The decrease in general and administrative expense in first quarter 2017 when compared with first quarter 2016 is primarily due to our key initiative to reduce costs across our entire organization. Employee compensation and benefits includes $486,000 in severance costs incurred in first quarter 2016.
Share-based and long-term incentive compensation expense

Our share-based compensation expense fluctuates principally due to a portion of our awards being cash-settled and as a result they are affected by changes in the market price of our common stock. The decrease in share-based and long-term incentive compensation expense in first quarter 2017 when compared with first quarter 2016 is primarily due to no new share-based or long-term incentive compensation awards granted to employees.
Interest expense

The decrease in interest expense in first quarter 2017 when compared with first quarter 2016 is due to a reduction of our debt outstanding by $277,790,000 in 2016.
Income Taxes
Our effective tax rate from continuing operations was 40 percent in first quarter 2017, which includes a nine percent benefit from a valuation allowance decrease due to a decrease in our deferred tax assets and an 11 percent detriment associated with a non-cash impairment related to goodwill associated with our owned mineral assets which were sold in first quarter 2017. Our effective tax rate from continuing operations was 35 percent in first quarter 2016. Our effective tax rates also include the effect of state income taxes, nondeductible items and benefits from noncontrolling interests.
At first quarter-end 2017 and year-end 2016, we have a valuation allowance for our deferred tax assets of $68,944,000 and $73,405,000 for the portion of the deferred tax assets that we have determined is more likely than not to be unrealizable under U.S. GAAP.
In determining our valuation allowance, we assessed available positive and negative evidence to estimate whether sufficient future taxable income will be generated to permit use of the existing deferred tax assets under U.S. GAAP. A significant piece of objective evidence evaluated was the cumulative loss incurred over the three-year period ended March 31, 2017, principally driven by impairments of oil and gas and real estate properties in prior years. Such evidence limits our ability to consider other subjective evidence, such as our projected future taxable income.
The amount of the deferred tax asset considered realizable could be adjusted if negative evidence in the form of cumulative losses is no longer present and additional weight is given to subjective evidence, such as our projected future taxable income.
Our unrecognized tax benefits totaled $811,000 at first quarter-end 2017, all of which would affect our effective tax rate, if recognized.
Capital Resources and Liquidity
Sources and Uses of Cash
The consolidated statements of cash flows for first quarter 2017 and 2016 reflects cash flows from both continuing and discontinued operations. We operate in cyclical industries and our cash flows fluctuate accordingly. Our principal sources of cash are proceeds from the sale of real estate, the cash flows from our mineral resources and income producing properties,

27


borrowings and reimbursements from utility and improvement districts. Our principal cash requirements are for the acquisition and development of real estate, either directly or indirectly through ventures, taxes, interest and compensation. Operating cash flows are affected by the timing of the payment of real estate development expenditures and the collection of proceeds from the eventual sale of the real estate, the timing of which can vary substantially depending on many factors including the size of the project, state and local permitting requirements and availability of utilities, and by the timing of oil and gas leasing and production activities. Working capital varies based on a variety of factors, including the timing of sales of real estate and timber, oil and gas leasing and production activities, collection of receivables, reimbursement from utility and improvement districts and the payment of payables and expenses.
We regularly evaluate alternatives for managing our capital structure and liquidity profile in consideration of expected cash flows, growth and operating capital requirements and capital market conditions. We may, at any time, be considering or be in discussions with respect to the purchase or sale of our common stock, debt securities, convertible securities or a combination thereof.
Cash Flows from Operating Activities
Cash flows from our real estate acquisition and development activities, undeveloped land sales, commercial and income producing properties, timber sales, income from oil and gas properties, recreational leases and reimbursements from utility and improvement districts are classified as operating cash flows.
In first quarter 2017, net cash used for operating activities was $2,379,000 compared to $5,009,000 in net cash provided by operating activities in first quarter 2016. The decrease in cash provided by operating activities year over year was primarily due to $14,703,000 funds received in first quarter 2016 that were previously held by a qualified intermediary for an intended like-kind exchange that was not completed related to a 2015 sale of undeveloped land and payment of $3,000,000 related to legal settlement in first quarter 2017.
Cash Flows from Investing Activities
Capital contributions to and capital distributions from unconsolidated ventures, costs incurred to acquire, develop and construct multifamily projects that will be held as commercial operating properties upon stabilization as investment property, business acquisitions and investment in oil and gas properties and equipment are classified as investing activities. In addition, proceeds from the sale of property and equipment, software costs and expenditures related to reforestation activities are also classified as investing activities.
In first quarter 2017, net cash provided by investing activities was $74,689,000 principally as a result of net proceeds of $77,510,000 from sale of our owned mineral assets, which included our purchase and subsequent sale of certain mineral interests from a venture in which we own a 50% interest for $2,400,000. In first quarter 2016, net cash provided by investing activities was $51,449,000 principally as a result of sales proceeds of $56,828,000, of which $28,958,000 are from sale of certain oil and gas properties and $27,870,000 are proceeds from sale of our interest in 3600, a 304-unit multifamily joint venture near Denver, and the sale of Music Row, a wholly-owned multifamily property in Nashville.
Cash Flows from Financing Activities
In first quarter 2017, net cash used for financing activities was $676,000 principally due to payroll taxes related to issuance of stock based awards which was partially offset by an increase in debt from a consolidated venture project. In first quarter 2016, net cash used for financing activities was $10,254,000 principally due to retirement of $8,600,000 of our 8.5% senior secured notes and $2,250,000 of payments related to amortizing notes associated with our tangible equity units.
Real Estate Acquisition and Development Activities
We secure entitlements and develop infrastructure, primarily for single family residential and mixed-use communities.
We categorize real estate development and acquisition expenditures as operating activities on the statement of cash flows. These development and acquisition expenditures include costs for development of residential lots and mixed-use communities.
Real estate development and acquisition expenditures were $13,740,000 and $14,794,000 in first quarter 2017 and 2016.
Liquidity
At first quarter-end 2017, our senior secured credit facility provides for a $125,000,000 revolving line of credit, which matures on May 15, 2017 (with two one-year extension options), none of which was drawn at first quarter-end 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 $14,543,000 was outstanding at first quarter-end 2017. Total borrowings under our senior

28


secured credit facility (including the face amount of letters of credit) may not exceed a borrowing base formula. At first quarter-end 2017, we had $53,665,000 in net unused borrowing capacity under our senior secured credit facility.
At first quarter-end 2017, net unused borrowing capacity under our senior secured credit facility is calculated as follows:
 
Senior Credit
Facility
 
(In thousands)
Borrowing base availability
$
68,208

Less: borrowings

Less: letters of credit
(14,543
)
 
$
53,665

Our net unused borrowing capacity during first quarter 2017 ranged from a high of $63,473,000 to a low of $53,665,000. Certain non-core assets support the borrowing base under our senior secured credit facility so we expect our borrowing capacity to continue to be reduced as non-core assets are sold. This facility is used primarily to fund our operating cash needs, which fluctuate due to timing of residential and commercial real estate sales, undeveloped land sales, reimbursements from utility and improvement districts, payment of payables and expenses and capital expenditures.
Our debt agreements contain financial covenants customary for such agreements including minimum levels of interest coverage and limitations on leverage. At first quarter-end 2017, we were in compliance with the financial covenants of these agreements.
The following table details our compliance with the financial covenants calculated as provided in the senior credit facility:
Financial Covenant
Requirement
 
First Quarter-End 2017
Interest Coverage Ratio (a)
≥2.50:1.0
 
22.65:1.0

Total Leverage Ratio (b)
≤50%
 
24.4
%
Tangible Net Worth (c)
≥$445.2 million
 
$571.3 million

 ___________________________________
(a) 
Calculated as EBITDA (earnings before interest, taxes, depreciation, depletion and amortization), plus non-cash compensation expense, plus other non-cash expenses, divided by interest expense excluding loan fees. This covenant is applied at the end of each quarter on a rolling four quarter basis.
(b) 
Calculated as total funded debt divided by adjusted asset value. Total funded debt includes indebtedness for borrowed funds, secured liabilities, reimbursement obligations with respect to letters of credit or similar instruments, and our pro-rata share of joint venture debt outstanding. Adjusted asset value is defined as the sum of unrestricted cash and cash equivalents, timberlands, high value timberlands, raw entitled lands, entitled land under development, minerals business, Credo asset value, special improvement district receipts (SIDR) reimbursements value and other real estate owned at book value without regard to any indebtedness and our pro rata share of joint ventures’ book value without regard to any indebtedness. This covenant is applied at the end of each quarter.
(c) 
Calculated as the amount by which consolidated total assets (excluding Credo acquisition goodwill over $50,000,000) exceed consolidated total liabilities. At first quarter-end 2017, the requirement is $445,215,000 computed as: $379,044,000 plus 85 percent of the aggregate net proceeds received by us from any equity offering, plus 75 percent of all positive net income, on a cumulative basis since third quarter-end 2015. This covenant is applied at the end of each quarter.
To make additional discretionary investments, acquisitions, or distributions, we must maintain available liquidity equal to 10 percent of the aggregate commitments in place. At first quarter-end 2017, the minimum liquidity requirement was $12,500,000, compared with $385,550,000 in actual available liquidity based on the unused borrowing capacity under our senior secured credit facility plus unrestricted cash and cash equivalents. The failure to maintain such minimum liquidity does not constitute a default or event of default of our senior secured credit facility.
Discretionary investments in community development may be restricted in the event that the revenue/capital expenditure ratio is less than or equal to 1.0x. At first quarter-end 2017, our revenue/capital expenditure ratio was 2.4x. Revenue is defined as total gross revenues (excluding revenues attributed to Credo and multifamily properties), plus our pro rata share of the operating revenues from unconsolidated ventures. Capital expenditures are defined as consolidated development and acquisition expenditures (excluding investments related to Credo and multifamily properties), plus our pro rata share of unconsolidated ventures’ development and acquisition expenditures.

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We may elect to make distributions to our stockholders so long as the total leverage ratio is less than 40 percent, the interest coverage ratio is greater than 3.0:1.0 and available liquidity is not less than $125,000,000, all of which were satisfied at first quarter-end 2017. Regardless of whether the foregoing conditions are satisfied, we may make distributions in an aggregate amount not to exceed $50,000,000 to be funded from up to 65% of the net proceeds from sales of multifamily properties and non-core assets, such as the Radisson Hotel & Suites in Austin, and any oil and gas properties.
Contractual Obligations and Off-Balance Sheet Arrangements
In 2014, FMF Littleton LLC, an equity method venture in which we own a 25 percent interest, obtained a senior secured construction loan in the amount of $46,384,000 to develop a 385-unit multifamily project located in Littleton, Colorado. The outstanding balance was $45,744,000 at first quarter-end 2017. 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.
In 2014, CREA FMF Nashville LLC, an equity method venture in which we own a 30 percent interest, obtained a senior secured construction loan in the amount of $51,950,000 to develop a 320-unit multifamily project located in Nashville, Tennessee. The outstanding balance at first quarter-end 2017 was $36,018,000. 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 zero percent upon achievement of certain conditions. In first quarter 2017, the principal guaranty was reduced from 25 percent of principal to 15 percent of principal due to achievement of certain conditions.
Cibolo Canyons—San Antonio, Texas
Cibolo Canyons consists of the JW Marriott ® San Antonio Hill Country Resort & Spa development owned by third parties and a mixed-use development we own. Our net investment in Cibolo Canyons is $46,668,000 at first quarter-end 2017, all of which is related to the mixed-use development.
Mixed-Use Development
The mixed-use development we own consists of 2,100 acres planned to include approximately 1,800 residential lots and 155 commercial acres designated for multifamily and retail uses, of which 1,157 lots and 97 commercial acres have been sold through first quarter-end 2017.
In 2007, we entered into an agreement with the Cibolo Canyons Special Improvement District (CCSID) providing for reimbursement of certain infrastructure costs related to the mixed-use development. Reimbursements are subject to review and approval by CCSID and unreimbursed amounts accrue interest at 9.75 percent per annum. CCSID’s funding for reimbursements is principally derived from its ad valorem tax collections and bond proceeds collateralized by ad valorem taxes, less debt service on these bonds and annual administrative and public service expenses.
Because the amount of each reimbursement is dependent on several factors, including timing of CCSID approval and CCSID having an adequate tax base to generate funds that can be used to reimburse us, there is uncertainty as to the amount and timing of reimbursements under this agreement. We expect to recover our investment from lot and tract sales and reimbursement of approved infrastructure costs from CCSID. We have not recognized income from interest due, but not collected. As these uncertainties are clarified, we will modify our accounting accordingly.
Through first quarter-end 2017, we have submitted and were approved for reimbursement of approximately $54,376,000 of infrastructure costs, of which we have received reimbursements totaling $45,132,000, of which $0 was received in first quarter 2017. At first quarter-end 2017, we have $9,244,000 in pending reimbursements, excluding interest.
Resort Hotel, Spa and Golf Development
In 2007, we entered into agreements to facilitate third party construction and ownership of the JW Marriott ® San Antonio Hill Country Resort & Spa (the Resort), which includes a 1,002 room destination resort and two PGA Tour ® Tournament Players Club ® (TPC) golf courses.
In exchange for our commitment to the Resort, the third party owners assigned to us certain rights under an agreement between the third party owners and CCSID. This agreement includes the right to receive from CCSID 9 percent of hotel occupancy revenues and 1.5 percent of other resort sales revenues collected as taxes by CCSID through 2034. The amount we receive will be net of annual ad valorem tax reimbursements by CCSID to the third party owners of the resort through 2020. In addition, these payments will be net of debt service on bonds issued by CCSID collateralized by hotel occupancy tax (HOT) and other resort sales tax through 2034. The amounts we collect under this agreement are dependent on several factors

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including the amount of revenues generated by and ad valorem taxes imposed on the Resort and the amount of debt service incurred by CCSID.
In 2014, we received $50,550,000 from CCSID principally related to its issuance of $48,900,000 HOT and Sales and Use Tax Revenue Bonds, resulting in recovery of our full Resort investment. These bonds are obligations solely of CCSID and are payable from HOT and sales and use taxes levied on the Resort by CCSID. To facilitate the issuance of the bonds, 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. We also entered into an agreement with the owner of the Resort to assign its senior rights to us in exchange for consideration provided by us, including a surety bond to be drawn if CCSID tax collections are not sufficient to support ad valorem tax rebates payable. The surety bond has a balance of $6,631,000 at first quarter-end 2017. The surety bond decreases as CCSID makes annual ad valorem tax rebate payments, which obligation is scheduled to be retired in full by 2020. All future receipts are expected to be recognized as gains in the period collected. We received $0 in first quarter 2017.
Critical Accounting Policies and Estimates
There have been no significant changes in our critical accounting policies or estimates from those disclosed in our 2016 Annual Report on Form 10-K.
New and Pending Accounting Pronouncements
Please read Note 2—New and Pending Accounting Pronouncements to the consolidated financial statements included in this Quarterly Report on Form 10-Q.
Statistical and Other Data
A summary of our real estate projects in the entitlement process (a) at first quarter-end 2017 follows:
Project
County
 
Market
 
Project Acres (b)
California
 
 
 
 
 
Hidden Creek Estates
Los Angeles
 
Los Angeles
 
700

Terrace at Hidden Hills
Los Angeles
 
Los Angeles
 
30

Total
 
 
 
 
730

 _________________________
(a) 
A project is deemed to be in the entitlement process when customary steps necessary for the preparation of an application for governmental land-use approvals, like conducting pre-application meetings or similar discussions with governmental officials, have commenced, or an application has been filed. Projects listed may have significant steps remaining, and there is no assurance that entitlements ultimately will be received.
(b) 
Project acres, which are the total for the project regardless of our ownership interest, are approximate. The actual number of acres entitled may vary.

A summary of our non-core timberland and undeveloped land classified as assets held for sale at first quarter-end 2017 follows:
 
 
Acres
Timberland
 
 
Georgia
 
10,900

Texas
 
7,900

Total
 
18,800



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A summary of activity within our active projects in the development process, which includes entitled, developed and under development real estate projects, at first quarter-end 2017 follows:
 
 
 
 
 
 
Residential Lots/Units
 
Commercial Acres
Project
 
County
 
Interest
Owned
(a)
 
Lots/Units Sold
Since
Inception
 
Lots/Units
Remaining
 
Acres Sold
Since
Inception
 
Acres
   Remaining
 
Texas
 
 
 
 
 
 
 
 
 
 
 
 
Austin
 
 
 
 
 
 
 
 
 
 
 
 
Arrowhead Ranch
 
Hays
 
100
%
 
8

 
376

 

 
19

Hunter's Crossing
 
Bastrop
 
100
%
 
510

 

 
54

 
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