10-Q 1 for-0930201710q.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 September 30, 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 October 31, 2017
Common Stock, par value $1.00 per share
 
41,938,936
 



FORESTAR GROUP INC.
TABLE OF CONTENTS
 

2


PART I—FINANCIAL INFORMATION
Item 1. Financial Statements
FORESTAR GROUP INC.
Consolidated Balance Sheets
(Unaudited)
 
Third
Quarter-End
 
Year-End
 
2017
 
2016
 
(In thousands, except share data)
ASSETS
 
Cash and cash equivalents
$
395,359

 
$
265,798

Real estate
267,251

 
293,003

Assets of discontinued operations

 
14

Assets held for sale
14,453

 
30,377

Investment in unconsolidated ventures
72,920

 
77,611

Receivables, net
13,004

 
8,931

Income taxes receivable
23,818

 
10,867

Prepaid expenses
2,641

 
2,000

Property and equipment, net
1,046

 
3,116

Deferred tax asset, net
269

 
323

Goodwill

 
37,900

Other assets
2,772

 
3,268

TOTAL ASSETS
$
793,533

 
$
733,208

LIABILITIES AND EQUITY
 
 
 
Accounts payable
$
3,972

 
$
4,804

Accrued employee compensation and benefits
2,556

 
4,126

Accrued property taxes
2,280

 
2,008

Accrued interest
533

 
1,585

Earnest money deposits
11,946

 
10,511

Other accrued expenses
7,203

 
12,598

Liabilities of discontinued operations

 
5,295

Liabilities held for sale

 
103

Other liabilities
18,275

 
19,702

Debt, net
115,505

 
110,358

TOTAL LIABILITIES
162,270

 
171,090

COMMITMENTS AND CONTINGENCIES

 

EQUITY
 
 
 
Forestar Group Inc. shareholders’ equity:
 
 
 
Preferred stock, par value $0.01 per share, 200,000 authorized shares at third quarter-end 2017 and none at year-end 2016, none issued

 

Common stock, par value $1.00 per share, 200,000,000 authorized shares, 44,803,603 issued at third quarter-end 2017 and year-end 2016
44,804

 
44,804

Additional paid-in capital
549,382

 
553,005

Retained earnings
80,430

 
12,602

Treasury stock, at cost, 2,864,667 shares at third quarter-end 2017 and 3,187,253 shares at year-end 2016
(44,532
)
 
(49,760
)
Total Forestar Group Inc. shareholders’ equity
630,084

 
560,651

Noncontrolling interests
1,179

 
1,467

TOTAL EQUITY
631,263

 
562,118

TOTAL LIABILITIES AND EQUITY
$
793,533

 
$
733,208

Please read the notes to consolidated financial statements.

3


FORESTAR GROUP INC.
Consolidated Statements of Income (Loss) and Comprehensive Income (Loss)
(Unaudited)
 
Third Quarter
 
First Nine Months
 
2017
 
2016
 
2017
 
2016
 
(In thousands, except per share amounts)
REVENUES
 
 
 
 
 
 
 
Real estate sales and other
$
33,136

 
$
45,285

 
$
81,789

 
$
114,711

Commercial and income producing properties

 
12

 
91

 
13,065

Real estate
33,136

 
45,297

 
81,880

 
127,776

Mineral resources

 
1,423

 
1,502

 
3,842

Other

 
487

 
74

 
1,199

 
33,136

 
47,207

 
83,456

 
132,817

COSTS AND EXPENSES
 
 
 
 
 
 
 
Cost of real estate sales and other
(21,762
)
 
(24,884
)
 
(50,142
)
 
(105,023
)
Cost of commercial and income producing properties
(14
)
 
(4,375
)
 
(3
)
 
(15,326
)
Cost of mineral resources

 
(182
)
 
(38,315
)
 
(572
)
Cost of other
(109
)
 
(363
)
 
(518
)
 
(867
)
Other operating expenses
(3,220
)
 
(6,471
)
 
(13,905
)
 
(26,879
)
General and administrative
(5,340
)
 
(5,177
)
 
(38,403
)
 
(16,508
)
 
(30,445
)
 
(41,452
)
 
(141,286
)
 
(165,175
)
GAIN ON SALE OF ASSETS
9,690

 
501

 
113,411

 
121,732

OPERATING INCOME
12,381

 
6,256

 
55,581

 
89,374

Equity in earnings of unconsolidated ventures
1,764

 
3,637

 
10,873

 
3,872

Interest expense
(2,038
)
 
(3,369
)
 
(6,439
)
 
(17,926
)
Loss on extinguishment of debt, net

 

 

 
(35,864
)
Other non-operating income
1,140

 
1,249

 
2,438

 
1,620

INCOME FROM CONTINUING OPERATIONS BEFORE TAXES
13,247

 
7,773

 
62,453

 
41,076

Income tax (expense) benefit
(5,214
)
 
9,666

 
(33,353
)
 
(7,415
)
NET INCOME FROM CONTINUING OPERATIONS
8,033

 
17,439

 
29,100

 
33,661

INCOME (LOSS) FROM DISCONTINUED OPERATIONS, NET OF TAXES
37,193

 
(7,164
)
 
38,840

 
(17,428
)
CONSOLIDATED NET INCOME
45,226

 
10,275

 
67,940

 
16,233

Less: Net (income) attributable to noncontrolling interests
(24
)
 
(610
)
 
(112
)
 
(1,330
)
NET INCOME ATTRIBUTABLE TO FORESTAR GROUP INC.
$
45,202

 
$
9,665

 
$
67,828

 
$
14,903

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
 
 
 
 
 
 
 
Basic
42,270

 
34,099

 
42,204

 
34,234

Diluted
42,626

 
42,260

 
42,512

 
42,334

NET INCOME (LOSS) PER BASIC SHARE
 
 
 
 
 
 
 
Continuing operations
$
0.19

 
$
0.40

 
$
0.69

 
$
0.77

Discontinued operations
$
0.88

 
$
(0.17
)
 
$
0.92

 
$
(0.42
)
NET INCOME (LOSS) PER BASIC SHARE
$
1.07

 
$
0.23

 
$
1.61

 
$
0.35

NET INCOME (LOSS) PER DILUTED SHARE
 
 
 
 
 
 
 
Continuing operations
$
0.19

 
$
0.40

 
$
0.68

 
$
0.76

Discontinued operations
$
0.87

 
$
(0.17
)
 
$
0.91

 
$
(0.41
)
NET INCOME (LOSS) PER DILUTED SHARE
$
1.06

 
$
0.23

 
$
1.59

 
$
0.35

TOTAL COMPREHENSIVE INCOME (LOSS)
$
45,202

 
$
9,665

 
$
67,828

 
$
14,903

Please read the notes to consolidated financial statements.

4


FORESTAR GROUP INC.
Consolidated Statements of Cash Flows
(Unaudited) 
 
First Nine Months
 
2017
 
2016
 
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Consolidated net income
$
67,940

 
$
16,233

Adjustments:
 
 
 
Depreciation, depletion and amortization
4,121

 
9,885

Change in deferred income taxes
54

 
(16
)
Equity in earnings of unconsolidated ventures
(10,873
)
 
(3,872
)
Distributions of earnings of unconsolidated ventures
14,745

 
4,793

Share-based compensation
2,567

 
2,665

Real estate cost of sales
50,547

 
56,817

Real estate development and acquisition expenditures, net
(38,355
)
 
(56,552
)
Reimbursements from utility and improvement districts
9,841

 
13,698

Asset impairments
37,900

 
57,065

Loss on debt extinguishment, net

 
35,864

Gain on sale of assets
(113,214
)
 
(108,114
)
Other
2,346

 
3,639

Changes in:
 
 
 
Notes and accounts receivable
(4,011
)
 
20,734

Prepaid expenses and other
(428
)
 
1,536

Accounts payable and other accrued liabilities
(9,235
)
 
(13,556
)
Income taxes
(12,951
)
 
(11,012
)
Net cash provided by operating activities
994

 
29,807

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Property, equipment, software and other
(46
)
 
(5,902
)
Oil and gas properties and equipment
(2,400
)
 
(579
)
Investment in unconsolidated ventures
(4,462
)
 
(5,615
)
Proceeds from sales of assets
130,146

 
319,351

Return of investment in unconsolidated ventures
4,452

 
3,948

Net cash provided by investing activities
127,690

 
311,203

CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Payments of debt

 
(311,724
)
Additions to debt
1,789

 
2,749

Deferred financing fees
(148
)
 

Distributions to noncontrolling interests, net
(400
)
 
(2,378
)
Exercise of stock options
616

 

Repurchases of common stock

 
(3,537
)
Payroll taxes on issuance of stock-based awards
(980
)
 
(221
)
Other

 
(211
)
Net cash provided by (used for) financing activities
877

 
(315,322
)
 
 
 
 
Net increase in cash and cash equivalents
129,561

 
25,688

Cash and cash equivalents at beginning of period
265,798

 
96,442

Cash and cash equivalents at end of period
$
395,359

 
$
122,130

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 of 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 will now present excess tax benefits as an operating activity, if applicable. 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 nine months 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. 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 anticipate adopting the standard using the cumulative catch-up transition method. We have reached conclusions on our key accounting assessments related to the standard and are finalizing our accounting policies. Based on our initial assessment, we believe the timing of revenue recognition for our primary revenue stream, residential lot and tract sales, will not materially change. We are still finalizing our accounting policies and assessing disclosure requirements. Upon adopting FASB ASC Topic 606, we will provide additional disclosures in the notes to our consolidated financial statements. 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 limited circumstances 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

6


beginning after December 15, 2019 and interim periods within fiscal years beginning after December 31, 2020 with early 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 of the updated standard, but we do not expect it to have a material effect on our consolidated financial statements.
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.
In May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation (Topic 718), in order to provide guidance about which changes to terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. The updated standard is effective for financial statements issued for annual periods beginning after December 15, 2017. We are currently evaluating the effect that the updated standard will have on our earnings, financial position and disclosures, but we do not expect it to have a material effect on our consolidated financial statements.
Note 3—Merger
On June 29, 2017, we entered into an Agreement and Plan of Merger with D.R. Horton, Inc. ("D.R. Horton") pursuant to which D.R. Horton would acquire 75 percent of the Company's common stock, par value $1.00 per share ("Our Common Stock") for $17.75 per share (the “Merger Agreement”). The Merger Agreement was unanimously approved by our and D.R. Horton’s boards of directors.
Subject to the terms and conditions of the Merger Agreement, at the effective time of the merger (the "Merger"), all of Our Common Stock would be converted into the right to receive, either
(i) an amount in cash per share of Our Common Stock equal to $17.75 (the “Cash Consideration”); or
(ii) one share of Our Common Stock,
in each case at the election of the holder of such share of Our Common Stock, subject to proration procedures applicable to oversubscription and undersubscription for Cash Consideration by stockholders.
Please see Note 19—Subsequent Events for information regarding consummation of the merger with D.R. Horton on October 5, 2017, and related matters.
In connection with merger activities, in first nine months 2017, we paid a $20,000,000 merger agreement termination fee to Starwood Capital Group and incurred $5,624,000 in professional fees and other costs related to proposed merger transactions, all of which are included in general and administrative expenses.
Note 4—Held for Sale
In first quarter 2017, we sold all of our remaining owned mineral assets for approximately $85,700,000. We generated $82,422,000 in total gains related to the sale of our mineral assets in first nine months 2017 of which $8,200,000 was recognized in third quarter 2017 as a result of the expiration of a title review period.
In second quarter 2017, we sold approximately 19,000 acres of timberland and undeveloped land in Georgia and Texas for $46,197,000 in three transactions generating combined net proceeds of $45,396,000. We generated combined gains of $28,674,000 in first nine months 2017 of which $625,000 was recognized in third quarter 2017 upon receipt of certain regulatory approvals and release of funds held in escrow.
At third quarter-end 2017, assets held for sale principally includes a multifamily site in Austin, central Texas groundwater assets, and water wells related to our nonparticipating royalty interests in water rights located in east Texas.

7


The major classes of assets and liabilities held for sale are as follows:
 
Third
Quarter-End
Year-End
 
2017
2016
 
(In thousands)
Assets Held for Sale:
 
 
Real estate
$
5,743

$
19,931

Timber

1,682

Other intangible assets (a)
1,681

1,681

Oil and gas properties and equipment, net

782

Property and equipment, net (b)
7,029

6,301

 
$
14,453

$
30,377

 
 
 
Liabilities Held for Sale:
 
 
Other liabilities

103

 
$

$
103

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

Note 5—Real Estate
Real estate consists of:
 
Third
Quarter-End
 
Year-End
 
2017
 
2016
 
(In thousands)
Entitled, developed and under development projects
$
237,064

 
$
263,859

Land in the entitlement process and other
30,187

 
29,144

 
$
267,251

 
$
293,003

Our estimated costs of assets for which we expect to be reimbursed by utility and improvement districts were $45,253,000 at third quarter-end 2017 and $45,157,000 at year-end 2016, including $13,892,000 at third quarter-end 2017 and $14,749,000 at year-end 2016 related to our Cibolo Canyons project near San Antonio, Texas. In first nine months 2017, we have collected $9,376,000 in reimbursements that were previously submitted to these districts. At third quarter-end 2017, our inception-to-date submitted reimbursements for the Cibolo Canyons project were $56,750,000, of which $52,337,000 have been approved, and we have collected $46,567,000. 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 6—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.

8


At third quarter-end 2017, we had ownership interests in 15 ventures that we accounted for using the equity method, none of which are a VIE.
Combined summarized balance sheet information for our ventures accounted for using the equity method follows:
 
Venture Assets
 
Venture Borrowings(a)
 
Venture Equity
 
Our Investment
 
Third
Quarter-End
 
Year-End
 
Third
Quarter-End
 
Year-End
 
Third
Quarter-End
 
Year-End
 
Third
Quarter-End
 
Year-End
 
2017
 
2016
 
2017
 
2016
 
2017
 
2016
 
2017
 
2016
 
(In thousands)
242, LLC (b)
$
19,600

 
$
26,503

 
$

 
$
1,107

 
$
19,376

 
$
23,136

 
$
9,140

 
$
10,934

CL Ashton Woods, LP
581

 
2,653

 

 

 
558

 
2,198

 
446

 
1,107

CL Realty, LLC
8,287

 
8,048

 

 

 
8,156

 
7,899

 
4,078

 
3,950

CREA FMF Nashville LLC (b)
53,986

 
56,081

 
35,676

 
37,446

 
17,162

 
17,091

 
4,803

 
4,923

Elan 99, LLC
49,003

 
49,652

 
36,373

 
36,238

 
11,283

 
13,100

 
10,155

 
11,790

FMF Littleton LLC
68,536

 
70,282

 
46,006

 
44,446

 
21,745

 
23,798

 
5,508

 
6,128

FMF Peakview LLC

 

 

 

 

 

 

 

FOR/SR Forsyth LLC
11,566

 
10,672

 
1,548

 
1,568

 
9,985

 
8,990

 
8,986

 
8,091

HM Stonewall Estates, Ltd

 
852

 

 

 

 
852

 

 
477

LM Land Holdings, LP (c)
22,816

 
25,538

 
906

 
3,477

 
13,771

 
20,945

 
6,619

 
9,685

MRECV DT Holdings LLC
3,573

 
4,155

 

 

 
3,573

 
4,144

 
3,216

 
3,729

MRECV Edelweiss LLC/MRECV Lender VIII LLC
7,824

 
3,484

 

 

 
7,824

 
3,484

 
7,042

 
3,358

MRECV Juniper Ridge LLC
3,784

 
4,156

 

 

 
3,784

 
4,156

 
3,405

 
3,741

MRECV Meadow Crossing II LLC
3,103

 
2,492

 

 

 
3,103

 
2,491

 
2,793

 
2,242

Miramonte Boulder Pass, LLC
7,488

 
10,738

 
1,391

 
4,006

 
4,775

 
5,265

 
4,567

 
5,330

Temco Associates, LLC
4,426

 
4,368

 

 

 
4,323

 
4,253

 
2,162

 
2,126

Other ventures

 

 

 

 

 

 

 

 
$
264,573

 
$
279,674

 
$
121,900

 
$
128,288

 
$
129,418

 
$
141,802

 
$
72,920

 
$
77,611


9


Combined summarized income statement information for our ventures accounted for using the equity method follows:
 
 Venture Revenues
 
 Venture Earnings (Loss)
 
Our Share of Earnings (Loss)
 
Third Quarter
 
First Nine Months
 
Third Quarter
 
First Nine Months
 
Third Quarter
 
First Nine Months
 
2017
 
2016
 
2017
 
2016
 
2017
 
2016
 
2017
 
2016
 
2017
 
2016
 
2017
 
2016
 
(In thousands)
242, LLC (b)
$

 
$
937

 
$
13,073

 
$
937

 
$
(342
)
 
$
15

 
$
8,040

 
$
(449
)
 
$
(171
)
 
$
14

 
$
4,106

 
$
(218
)
CL Ashton Woods, LP
451

 
288

 
3,079

 
1,977

 
262

 
83

 
1,360

 
601

 
307

 
129

 
1,739

 
892

CL Realty, LLC
300

 
140

 
499

 
386

 
256

 
72

 
2,657

 
136

 
128

 
37

 
1,328

 
68

CREA FMF Nashville LLC (b)
1,410

 
1,291

 
4,280

 
3,273

 
(159
)
 
(145
)
 
(479
)
 
(1,214
)
 
(47
)
 
1,484

 
(144
)
 
1,164

Elan 99, LLC
1,188

 
461

 
3,116

 
628

 
(562
)
 
(867
)
 
(1,816
)
 
(2,211
)
 
(506
)
 
(779
)
 
(1,635
)
 
(1,989
)
FMF Littleton LLC
1,702

 
944

 
4,713

 
1,791

 
227

 
(183
)
 
47

 
(531
)
 
57

 
(47
)
 
12

 
(133
)
FMF Peakview LLC

 

 

 
939

 

 

 

 
(248
)
 

 

 

 
(50
)
FOR/SR Forsyth LLC

 

 

 

 
(42
)
 
(21
)
 
(110
)
 
(38
)
 
(38
)
 
(19
)
 
(99
)
 
(34
)
HM Stonewall Estates, Ltd

 
822

 
496

 
1,948

 

 
280

 
243

 
794

 

 
120

 
103

 
347

LM Land Holdings, LP (c)
2,703

 
3,505

 
19,636

 
6,531

 
2,110

 
2,502

 
8,327

 
4,557

 
757

 
836

 
2,746

 
1,481

MRECV DT Holdings LLC
351

 
162

 
939

 
379

 
337

 
157

 
923

 
372

 
303

 
141

 
831

 
334

MRECV Edelweiss LLC/MRECV Lender VIII LLC
293

 
106

 
716

 
287

 
291

 
106

 
713

 
280

 
262

 
96

 
642

 
252

MRECV Juniper Ridge LLC
413

 
151

 
1,023

 
356

 
412

 
151

 
1,022

 
357

 
371

 
135

 
920

 
321

MRECV Meadow Crossing II LLC
253

 
112

 
612

 
141

 
254

 
112

 
612

 
94

 
229

 
101

 
551

 
84

Miramonte Boulder Pass, LLC
2,312

 
1,015

 
4,848

 
1,678

 
105

 
(126
)
 
109

 
(285
)
 
101

 
(63
)
 
(262
)
 
(142
)
Temco Associates, LLC
48

 
77

 
144

 
224

 
21

 
32

 
70

 
111

 
11

 
16

 
35

 
56

Other ventures

 
6,520

 

 
6,520

 

 
2,166

 

 
2,109

 

 
1,436

 

 
1,439

 
$
11,424

 
$
16,531

 
$
57,174

 
$
27,995

 
$
3,170

 
$
4,334

 
$
21,718

 
$
4,435

 
$
1,764

 
$
3,637

 
$
10,873

 
$
3,872


 _____________________
(a) 
Total includes current maturities of $86,206,000 at third quarter-end 2017, of which $81,531,000 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 third quarter-end 2017.
(c) 
Includes unrecognized basis difference of $496,000 which is reflected as an increase of our investment in unconsolidated ventures at third quarter-end 2017. The difference will be amortized as expense over the life of the investment and included in our share of earnings (loss) from the respective venture.
In first nine months 2017, we invested $4,462,000 in these ventures and received $19,197,000 in distributions. In first nine months 2016, we invested $5,615,000 in these ventures and received $8,741,000 in distributions. Distributions include both return of investments and distribution of earnings.
The increase in our share of earnings from our unconsolidated ventures in first nine months 2017 compared with first nine months 2016 is primarily due to higher lot sale activity and earnings from LM Land Holdings, LP which benefited from the sale of 42 commercial acres for $13,600,000 generating venture earnings of $10,683,000, of which $6,321,000 was deferred and will be recognized as development is completed. Based on our 37.5% interest in this venture, our pro-rata share of the earnings associated with this sale was $1,636,000 and our pro-rata share of the distributable cash was $4,411,000. Venture earnings from 242, LLC also 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. 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 we recognized a gain of $10,363,000 which is included in gain on sale of assets.

10


Note 7—Goodwill
Carrying value of goodwill follows:
 
Third
Quarter-End
 
Year-End
 
2017
 
2016
 
(In thousands)
Goodwill
$

 
$
37,900

Goodwill related to our owned mineral assets was $0 at third quarter-end 2017 and $37,900,000 at year-end 2016. In first nine months 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 our remaining owned mineral assets for approximately $85,700,000 in first quarter 2017. Impairment charge is included in cost of mineral resources on our consolidated statements of income (loss) and comprehensive income (loss).
Note 8—Discontinued Operations
At year-end 2016, we had divested of 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.
Summarized results from discontinued operations were as follows:
 
Third Quarter
 
First Nine Months
 
2017
 
2016
 
2017
 
2016
 
(In thousands)
Revenues
$
2

 
$
180

 
$
15

 
$
5,827

Cost of sales
(42
)
 
(108
)
 
(52
)
 
(6,593
)
Other operating expenses
(763
)
 
(3,318
)
 
226

 
(5,707
)
Income (loss) from discontinued operations before income taxes
$
(803
)
 
$
(3,246
)
 
$
189

 
$
(6,473
)
Gain (loss) on sale of assets before income taxes
(297
)
 
955

 
(197
)
 
(13,618
)
Income tax benefit (expense)
38,293

 
(4,873
)
 
38,848

 
2,663

Income (loss) from discontinued operations, net of taxes
$
37,193

 
$
(7,164
)
 
$
38,840

 
$
(17,428
)

In first nine months 2017, other operating expenses include a benefit of $1,043,000 due to a reduction of an accrual resulting from a change in estimate related to potential environmental liabilities to plug and abandon certain oil and gas wells in Wyoming. Other operating expenses in third quarter 2016 include loss contingency charges of $1,100,000 related to litigation and $1,155,000 related to potential environmental liabilities to plug and abandon certain oil and gas wells in Wyoming.
On September 22, 2017, in accordance with our previously announced initiative to sell non-core assets, we sold the common stock of Forestar Petroleum Corporation for $100,000. With the completion of this transaction we have now sold all of our oil and gas assets and related entities. This transaction resulted in a significant tax loss. The corresponding tax benefit is reported in discontinued operations as a discrete event in third quarter 2017.
In first nine months 2016, we recorded a net loss of $13,618,000 on the sale of nearly 199,263 net mineral acres leased from others and 379 gross (95 net) producing oil and gas working interest wells in Nebraska, Kansas, Oklahoma and North Dakota for total sales proceeds of $80,084,000, 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.

    




11


The major classes of assets and liabilities of discontinued operations at third quarter-end 2017 and year-end 2016 are as follows:
 
Third
Quarter-End
 
Year-End
 
2017
 
2016
 
(In thousands)
Assets of Discontinued Operations:
 
 
 
Receivables, net of allowance for bad debt
$

 
$
6

Prepaid expenses

 
8

 
$

 
$
14

 
 
 
 
Liabilities of Discontinued Operations:
 
 
 
Accounts payable
$

 
$
67

Other accrued expenses

 
5,228

 
$

 
$
5,295

Significant operating activities and investing activities of discontinued operations included in our consolidated statements of cash flows are as follows:
 
First Nine Months
 
2017
 
2016
 
(In thousands)
Operating activities:
 
 
 
Asset impairments
$

 
$
612

Accounts payable and other accrued liabilities
(3,000
)
 

Loss on sale of assets
197

 
13,618

Depreciation, depletion and amortization

 
2,202

 
$
(2,803
)
 
$
16,432

 
 
 
 
Investing activities:
 
 
 
Oil and gas properties and equipment
$

 
$
(579
)
Proceeds from sales of assets
200

 
76,815

 
$
200

 
$
76,236

Note 9—Receivables
Receivables consist of:
 
Third
Quarter-End
 
Year-End
 
2017
 
2016
 
(In thousands)
Other receivables and accrued interest
6,958

 
1,505

Other loans secured by real estate, average interest rates of 5.13% at third quarter-end 2017 and 4.94% at year-end 2016
6,072

 
7,452

 
13,030

 
8,957

Allowance for bad debts
(26
)
 
(26
)
 
$
13,004

 
$
8,931





12


Note 10—Equity
A reconciliation of changes in equity at third 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
67,828

 
112

 
67,940

Distributions to noncontrolling interests

 
(400
)
 
(400
)
Other (primarily share-based compensation)
1,605

 

 
1,605


$
630,084

 
$
1,179

 
$
631,263


Note 11—Debt, net
Debt consists of:
 
Third
Quarter-End
 
Year-End
 
2017
 
2016
 
(In thousands)
8.50% senior secured notes due 2022, net
$
5,216

 
$
5,200

3.75% convertible senior notes due 2020, net of discount
108,014

 
104,673

Other indebtedness — 5.50% interest rate
2,275

 
485

 
$
115,505

 
$
110,358

At third quarter-end 2017, our senior secured credit facility provided a line of credit commitment of $50,000,000, none of which was drawn, and included a $50,000,000 sublimit for letters of credit, of which $14,267,000 was outstanding. Total borrowings under our senior secured credit facility (including the face amount of letters of credit) were limited by a borrowing base formula. At third quarter-end 2017, we had $14,810,000 in net unused borrowing capacity under our senior secured credit facility.
At third quarter-end 2017, the proposed Merger was expected to constitute a “fundamental change” under our 3.75% convertible senior notes, which would provide holders with the right to convert their notes or sell their notes to us at par, subject to certain conditions.
Please see Note 19—Subsequent Events for information regarding consummation of the merger with D.R. Horton and related matters, including (a) termination of our senior secured credit facility, (b) entry into a new letter of credit facility, (c) entry into a supplemental indenture in regard to our 3.75% convertible senior notes due 2020, and (d) redemption of the 8.50% senior secured notes due 2022.
At third quarter-end 2017 and year-end 2016, we had $1,273,000 and $1,633,000 in unamortized deferred financing fees which were deducted from our debt. In addition, at third quarter-end 2017 and year-end 2016, unamortized deferred financing fees related to our senior secured credit facility included in other assets were $91,000 and $314,000. Amortization of deferred financing fees were $731,000 and $3,253,000 in first nine months 2017 and 2016 and were included in interest expense.
Note 12—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.

13


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 nine months 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.
Information about our fixed rate financial instruments not measured at fair value follows:
 
Third Quarter-End 2017
 
Year-End 2016
 
 
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
 
Valuation
Technique
 
(In thousands)
 
 
Fixed rate debt
$
(114,502
)
 
$
(119,246
)
 
$
(111,506
)
 
$
(109,789
)
 
Level 2
Note 13—Capital Stock
Pursuant to our tax benefits preservation plan ("Plan") adopted January 5, 2017, as amended on April 13, 2017 and June 29, 2017, each share of common stock outstanding at third quarter-end 2017 is coupled with one preferred stock purchase right ("Right"). Each Right entitles our stockholders to purchase, under certain conditions, one one-thousandth of a share ("Unit") of newly issued Series B Junior Participating Preferred Stock at a purchase price of $50 per Unit, subject to adjustment. Rights will be exercisable only if someone becomes a five-percent stockholder after adoption of the Plan without meeting certain customary exceptions. Stockholders owning five percent or more of our outstanding stock at the time of adoption of the Plan are grandfathered and will cause Rights to be distributed and become exercisable only if they acquire an additional one percent of our outstanding shares. Our board of directors has the discretion to exempt certain transactions and persons from the coverage of the Plan, and the Plan has been amended to exempt the Merger Agreement from the coverage of the Plan.
Please see Note 19—Subsequent Events for information regarding expiration of the Plan.
Note 14—Net Income (Loss) per Share
Basic and diluted earnings per share are computed using the treasury stock method for third quarter and first nine months 2017 and the two-class method for third quarter and first nine months 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.













14



The computations of basic and diluted earnings per share are as follows:
 
Third Quarter
 
First Nine Months
 
2017
 
2016
 
2017
 
2016
 
(In thousands)
Numerator:
 
 
 
 
 
 
 
Continuing operations
 
 
 
 
 
 
 
Net income (loss) from continuing operations
$
8,033

 
$
17,439

 
$
29,100

 
$
33,661

Less: Net (income) attributable to noncontrolling interest
(24
)
 
(610
)
 
(112
)
 
(1,330
)
Earnings (loss) available for diluted earnings per share
$
8,009

 
$
16,829

 
$
28,988

 
$
32,331

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

 
(3,152
)
 

 
(6,035
)
Earnings (loss) from continuing operations available to common shareholders for basic earnings per share
$
8,009

 
$
13,677

 
$
28,988

 
$
26,296

 
 
 
 
 
 
 
 
Discontinued operations
 
 
 
 
 
 
 
Net income (loss) from discontinued operations available for diluted earnings per share
$
37,193

 
$
(7,164
)
 
$
38,840

 
$
(17,428
)
Less: Undistributed net income from discontinued operations allocated to participating securities

 
1,342

 

 
3,253

Earnings (loss) from discontinued operations available to common shareholders for basic earnings per share
$
37,193

 
$
(5,822
)
 
$
38,840

 
$
(14,175
)
Denominator:
 
 
 
 
 
 
 
Weighted average common shares outstanding — basic
42,270

 
34,099

 
42,204

 
34,234

Weighted average common shares upon conversion of participating securities

 
7,857

 

 
7,857

Dilutive effect of stock options, restricted stock and equity-settled awards
356

 
304

 
308

 
243

Total weighted average shares outstanding — diluted
42,626

 
42,260

 
42,512

 
42,334

Anti-dilutive awards excluded from diluted weighted average shares
1,048

 
2,001

 
1,458

 
2,146

We intend to settle the remaining principal amount of our 3.75% convertible senior notes due in 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 third quarter 2017 did not exceed the conversion price which resulted in no additional diluted outstanding shares.
Note 15—Income Taxes
Our effective tax rate from continuing operations was 39 percent in third quarter 2017 and 53 percent for first nine months 2017. Our effective tax rate from continuing operations for first nine months 2017 exceeded the statutory rate due to a change in our valuation allowance due to current year transaction costs (termination fee and other costs) associated with our Merger. In addition, our effective tax rate from continuing operations for first nine months 2017 exceeded the statutory rate due to goodwill impairment associated with our first quarter 2017 sale of owned mineral assets and a benefit from a valuation allowance decrease due to net decreases in our deferred tax assets.
Our effective tax rate from continuing operations was a tax benefit of 124 percent in third quarter 2016 and a tax expense of 18 percent for first nine months 2016. Our effective tax rate from continuing operations for first nine months 2016 of 18 percent differs from the statutory rate of 35 percent primarily due to a benefit from decrease in our valuation allowance related to decrease in our deferred tax assets. In addition, 2017 and 2016 effective tax rates from continuing operations include the effect of state income taxes, nondeductible items and benefits of percentage depletion.
At third quarter-end 2017 and year-end 2016, we have a valuation allowance for our deferred tax assets of $66,461,000 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 September 30, 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.

15


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 approximately $442,000 at third quarter-end 2017, all of which would affect our effective tax rate, if recognized.

Note 16—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.
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. With the sale of our remaining oil and gas entities in third quarter 2017 we no longer 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. Prior to the sale, we recorded 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 third quarter-end 2017 and year-end 2016, our estimated asset retirement obligation was $0 and $1,258,000, of which $0 and $1,155,000 is included in liabilities of discontinued operations and the remaining balance at year-end 2016 was in liabilities held for sale. In first nine months 2017, we reduced our accrual related to potential environmental liabilities to plug and abandon certain oil and gas wells in Wyoming by $1,043,000 due to a change in estimate of our potential exposure. In connection with our sale of the stock of Forestar Petroleum on September 22, 2017, the buyer assumed substantially all liabilities of Forestar Petroleum including the obligation to plug and abandon certain oil and gas wells in Wyoming.
Note 17—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.
Total assets allocated by segment are as follows:
 
Third
Quarter-End
 
Year-End
 
2017
 
2016
 
(In thousands)
Real estate
$
363,395

 
$
403,062

Mineral resources

 
38,907

Other
9,196

 
11,531

Assets of discontinued operations

 
14

Assets not allocated to segments (a)
420,942

 
279,694

 
$
793,533

 
$
733,208

 
 _________________________
(a) 
Assets not allocated to segments at third quarter-end 2017 principally consist of cash and cash equivalents of $395,359,000 and an income tax receivable of $23,818,000. 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.

16


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:
 
Third Quarter
 
First Nine Months
 
2017
 
2016
 
2017
 
2016
 
(In thousands)
Revenues:
 
 
 
 
 
 
 
Real estate
$
33,136

 
$
45,297

 
$
81,880

 
$
127,776

Mineral resources

 
1,423

 
1,502

 
3,842

Other

 
487

 
74

 
1,199

Total revenues
$
33,136

 
$
47,207

 
$
83,456

 
$
132,817

Segment earnings (loss):
 
 
 
 

 

Real estate
$
11,309

 
$
15,017

 
$
33,327

 
$
108,531

Mineral resources
8,112

 
1,182

 
45,580

 
2,668

Other
257

 
(196
)
 
(434
)
 
(974
)
Total segment earnings
19,678

 
16,003

 
78,473

 
110,225

Items not allocated to segments (a)
(6,455
)
 
(8,840
)
 
(16,132
)
 
(70,479
)
Income from continuing operations before taxes attributable to Forestar Group Inc.
$
13,223

 
$
7,163

 
$
62,341

 
$
39,746

  _________________________
(a) 
Items not allocated to segments consist of:
 
Third Quarter
 
First Nine Months
 
2017
 
2016
 
2017
 
2016
 
(In thousands)
General and administrative expense
$
(4,979
)
 
$
(4,505
)
 
$
(36,556
)
 
$
(13,992
)
Shared-based and long-term incentive compensation expense
(424
)
 
(1,024
)
 
(2,767
)
 
(2,980
)
Gain on sale of assets
625

 

 
28,674

 

Interest expense
(2,038
)
 
(3,369
)
 
(6,439
)
 
(17,926
)
Loss on extinguishment of debt, net

 

 

 
(35,864
)
Other corporate non-operating income
361

 
58

 
956

 
283

 
$
(6,455
)
 
$
(8,840
)
 
$
(16,132
)
 
$
(70,479
)

Note 18—Share-Based and Long-Term Incentive Compensation
Share-based and long-term incentive compensation expense consists of:
 
Third Quarter
 
First Nine Months
 
2017
 
2016
 
2017
 
2016
 
(In thousands)
Cash-settled awards
$
(66
)
 
$
(43
)
 
$
1,047

 
$
82

Equity-settled awards
268

 
765

 
1,171

 
1,869

Restricted stock

 
10

 

 
22

Stock options
106

 
217

 
349

 
692

Total share-based compensation
308

 
949

 
2,567

 
2,665

Deferred cash
116

 
75

 
200

 
315

 
$
424

 
$
1,024

 
$
2,767

 
$
2,980


17


Share-based and long-term incentive compensation expense is included in:
 
Third Quarter
 
First Nine Months
 
2017
 
2016
 
2017
 
2016
 
(In thousands)
General and administrative expense
$
361

 
$
672

 
$
1,847

 
$
2,516

Other operating expense
63

 
352

 
920

 
464

 
$
424

 
$
1,024

 
$
2,767

 
$
2,980


Share-Based Compensation
We did not grant any new equity-settled or cash-settled awards to employees in first nine months 2017.
In first nine months 2017, we granted 66,037 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 $135,000 and $169,000 in third quarter of 2017 and 2016 and $449,000 and $596,000 in the first nine months 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 nine months 2016. Unrecognized share-based compensation expense related to non-vested equity-settled awards, restricted stock and stock options is $864,000 at third quarter-end 2017.
In first nine months 2017 and 2016, we issued 322,586 and 263,371 shares out of our treasury stock associated with vesting of stock-based awards or exercise of stock options, net of 75,870 and 25,026 shares withheld having a value of $980,000 and $221,000 for payroll taxes in connection with vesting of stock-based awards or exercise of stock options.
Long-Term Incentive Compensation
In first nine months 2017 and 2016, we granted $1,180,000 and $620,000 of long-term incentive compensation to employees in the form of deferred cash awards. The 2017 deferred cash awards vest annually over three years and the 2016 awards vest annually over two years. Expense associated with deferred cash awards is recognized ratably over the vesting period.
Please see Note 19—Subsequent Events for information regarding consummation of the merger with D.R. Horton and related matters, including settlement of outstanding awards denominated in shares of stock.

18


Note 19—Subsequent Events

Completion of Merger

On June 29, 2017, we entered into the Merger Agreement with D.R. Horton and Force Merger Sub, Inc. (“Merger Sub”), a wholly owned subsidiary of D.R. Horton. At the effective time on October 5, 2017, we merged with Merger Sub and we continued as the surviving entity in the Merger. In the Merger, each existing share of our common stock issued and outstanding immediately prior to the effective time (the “Former Forestar Common Stock”) (except for shares of our common stock that were held by us as treasury shares or by us or D.R. Horton or our or their respective subsidiaries) were converted into the right to receive, at the election of the holders of such shares of Former Forestar Common Stock, either an amount in cash equal to the Cash Consideration ($17.75 per share) or one new share of our common stock (the “New Forestar Common Stock”), subject to proration procedures applicable to oversubscription and undersubscription for the Cash Consideration described in the Merger Agreement. The aggregate amount of Cash Consideration paid by D.R. Horton to holders of Former Forestar Common Stock in the Merger was $558,256,000. In the Merger, 10,487,873 shares of New Forestar Common Stock (representing 25% of the outstanding shares of New Forestar Common Stock immediately after the effective time) were issued to the holders of our common stock and 31,451,063 shares of New Forestar Common Stock (representing 75% of the outstanding share of the New Forestar Common Stock immediately after the effective time) were issued to D.R. Horton.
Subject to the terms of the Merger Agreement, at the effective time, each equity award made or otherwise denominated in shares of Former Forestar Common Stock that was outstanding immediately prior to the effective time under our equity compensation plans was cancelled and of no further force or effect as of the effective time. In exchange for the cancellation of the equity awards, each holder of such an equity award received from us the Cash Consideration for each share of Former Forestar Common Stock underlying such equity award (and in the case of equity awards that were stock options or stock appreciation rights, less the applicable exercise or strike price, but not less than $0), whether or not otherwise vested as of the effective time. With respect to any of our market-leveraged stock units, the number of shares of Former Forestar Common Stock subject to such equity awards were determined pursuant to the terms set forth in the applicable award agreements and based on a per share value equal to $17.75
We paid our financial advisor a transaction fee of $5,595,000 which was expensed upon closing of the Merger. New Forestar Common Stock continues to be listed and traded on the New York Stock Exchange under the ticker symbol, “FOR.”
As of October 5, 2017, we are a majority-owned subsidiary of D.R. Horton, the largest homebuilder by volume in the United States for fifteen consecutive years. We are evaluating the impact of any potential changes in our accounting policies and related party transactions with D.R. Horton post merger and will update our disclosures accordingly in future periods. The merger will be accounted for under the acquisition method in accordance with U.S. GAAP. D.R. Horton is the acquirer for accounting purposes and our consolidated financial statements will continue to be stated at historical cost.

Letter of Credit Facility
 
On October 5, 2017, we entered into a Letter of Credit Facility Agreement (the “LC Facility Agreement”) providing for a $30,000,000 secured standby letter of credit facility (the “LC Facility”) with Keybank National Association and other lenders party thereto, as banks, Keybank National Association, as letter of credit issuer and administrative agent, and Keybanc Capital Markets, as sole arranger and sole bookrunner.
The LC Facility is secured by $30,000,000 in cash deposited with the administrative agent. We are required to pay a letter of credit fee of 1.25% per annum on the outstanding face amount of the letters of credit issued under the LC Facility, as well as other customary fees and expenses. We also are required to pay an unused facility fee of 0.15% per annum, in each case on the daily amount by which the aggregate commitments exceed the sum of the outstanding letters of credit during each fiscal quarter or portion thereof.
The LC Facility Agreement includes customary representations and warranties, affirmative and negative covenants and other undertakings. The LC Facility Agreement also contains customary events of default. If an event of default occurs, all or a portion of the commitments under the LC Facility may be terminated and/or other rights held by the banks under any of the related facility documents (including against the collateral) may be exercised, subject to certain limitations.

Termination of Senior Credit Facility

On October 5, 2017, in connection with entry into the LC Facility, we terminated our existing senior credit facility (the “Prior Credit Facility”). The Prior Credit Facility provided for a $50,000,000 revolving line of credit that was scheduled to mature on May 15, 2018. This Prior Credit Facility could be prepaid at any time without penalty and included a $50,000,000

19


sublimit for letters of credit, of which $14,267,000 were outstanding at the time of termination and were transferred to the new LC Facility.

3.75% Convertible Senior Notes

On October 5, 2017, in connection with the consummation of the Merger, we entered into a Third Supplemental Indenture (together with the base indenture and the prior supplemental indentures, the "Indenture") to the Indenture relating to our 3.75% Convertible Senior Notes due 2020 (the “Convertible Notes”).
Pursuant to the Third Supplemental Indenture, the Convertible Notes are no longer convertible into shares of Former Forestar Common Stock and instead are convertible into cash and shares of New Forestar Common Stock based on the per-share weighted average of the cash and shares of New Forestar Common Stock received by our stockholders that affirmatively made an election in connection with the Merger. As a result of such elections, for each share of Former Forestar Common Stock a holder of Convertible Notes was previously entitled to receive upon conversion of Convertible Notes, such holder is instead entitled to receive $14.19785 in cash and 0.20012 of a share of New Forestar Common Stock.

The completion of the Merger constituted a Fundamental Change, as defined in the Indenture. On October 12, 2017, in accordance with the Indenture, we gave notice of the Fundamental Change to holders of the Convertible Notes and made an offer to purchase (a “Fundamental Change Offer”) all or any part (equal to $1,000 or an integral multiple of $1,000) of every holder’s Convertible Notes pursuant to the Fundamental Change Offer on the terms set forth in the Indenture. In the Fundamental Change Offer, we offered to repurchase the Convertible Notes for a price in cash equal to 100% of the aggregate principal amount of Convertible Notes, plus accrued and unpaid interest, if any, to the date of repurchase.

Expiration of Tax Benefits Preservation Plan
 
On October 5, 2017 immediately prior to the effective time of the merger, our Tax Benefit Preservation Plan expired pursuant to its terms and all Rights previously distributed to the holders of our common stock pursuant to the Plan expired.

8.50% Senior Secured Notes

On October 30, 2017 (the “Redemption Date”), we redeemed the remaining $5,315,000 aggregate principal amount of outstanding 8.50% Senior Secured Notes due 2022 (the “Notes”). Pursuant to the indenture governing the Notes, the Notes were redeemed for $5,928,063, which was the sum of (a) the present value of 104.250% of the outstanding principal amount of the Notes and the scheduled payments of interest thereon through June 1, 2018 discounted as set forth in such indenture to the Redemption Date, plus (b) accrued and unpaid interest to but not including the Redemption Date.

    

20


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 third 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, 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;
competitive actions by other companies;
changes in governmental policies, laws or regulations and actions or restrictions of regulatory agencies;
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 effect of D.R. Horton's controlling level of ownership on us and our stockholders;
our ability to realize the potential benefits of the strategic relationship with D.R. Horton;
the effect of our merger with D.R. Horton on our ability to maintain relationships with our vendors and customers; 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, in Item 1A of our first and second quarter 2017 Quarterly Reports on Form 10-Q, and in Item 1A of this third quarter 2017 Quarterly Report on Form 10-Q, may also cause actual results to differ materially from those projected by our forward-looking statements. New factors emerge from time to time and it is not possible for us to predict all such factors, nor can we assess the impact of any such factor on our business or the extent to which any factor, or combination of factors, may cause results to differ materially from those contained in any forward-looking statement.
Any forward-looking statement speaks only as of the date on which such statement is made, and, except as required by law, we expressly disclaim any obligation or undertaking to disseminate any updates or revisions to any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events.

21


Our Operations

We are a residential and real estate development company with operations in 14 markets in 10 states, where we own, directly or through joint ventures, interests in 44 residential and mixed-use projects. As of October 5, 2017, we are a majority-owned subsidiary of D.R. Horton, Inc. ("D.R. Horton"), the largest homebuilder by volume in the United States for fifteen consecutive years.
Merger
On June 29, 2017, we entered into the Merger Agreement with D.R. Horton and Force Merger Sub, Inc. (“Merger Sub”), a wholly owned subsidiary of D.R. Horton. At the effective time on October 5, 2017, we merged with Merger Sub and we continued as the surviving entity in the Merger. In the Merger, each existing share of our common stock issued and outstanding immediately prior to the effective time (the “Former Forestar Common Stock”) (except for shares of our common stock that were held by us as treasury shares or by us or D.R. Horton or our or their respective subsidiaries) were converted into the right to receive, at the election of the holders of such shares of Former Forestar Common Stock, either an amount in cash equal to the Cash Consideration ($17.75 per share) or one new share of our common stock (the “New Forestar Common Stock”), subject to proration procedures applicable to oversubscription and undersubscription for the Cash Consideration described in the Merger Agreement. The aggregate amount of Cash Consideration paid by D.R. Horton to holders of Former Forestar Common Stock in the Merger was $558,256,000. In the Merger, 10,487,873 shares of New Forestar Common Stock (representing 25% of the outstanding shares of New Forestar Common Stock immediately after the effective time) were issued to the holders of our common stock and 31,451,063 shares of New Forestar Common Stock (representing 75% of the outstanding share of the New Forestar Common Stock immediately after the effective time) were issued to D.R. Horton.
Key Initiatives

For the past two years we have focused on our key initiatives to reduce costs across our entire organization, review our portfolio of assets and complete non-core asset sales and review our capital structure to allocate capital to maximize shareholder value. The merger with D.R Horton provides us an opportunity to substantially grow our core community development business in the future by establishing a strategic relationship to supply finished lots to D. R. Horton at market prices under a master supply agreement. Under the terms of the master supply agreement, both companies will proactively identify land development opportunities to expand our portfolio of assets.
Discontinued Operations
At year-end 2016, we had divested of 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.
On September 22, 2017, in accordance with our previously announced initiative to sell non-core assets, we sold the common stock of Forestar Petroleum Corporation for $100,000. With the completion of this transaction we have now sold all of our oil and gas assets and related entities. This transaction resulted in a significant tax loss. The corresponding tax benefit is reported in discontinued operations as a discrete event in third quarter 2017.










22


Results of Operations
A summary of our consolidated results by business segment follows:
 
Third Quarter
 
First Nine Months
 
2017
 
2016
 
2017
 
2016
 
(In thousands)
Revenues:
 
 
 
 
 
 
 
Real estate
$
33,136

 
$
45,297

 
$
81,880

 
$
127,776

Mineral resources

 
1,423

 
1,502

 
3,842

Other

 
487

 
74

 
1,199

Total revenues
$
33,136

 
$
47,207

 
$
83,456

 
$
132,817

Segment earnings (loss):
 
 
 
 
 
 
 
Real estate
$
11,309

 
$
15,017

 
$
33,327

 
$
108,531

Mineral resources
8,112

 
1,182

 
45,580

 
2,668

Other
257

 
(196
)
 
(434
)
 
(974
)
Total segment earnings
19,678

 
16,003

 
78,473

 
110,225

Items not allocated to segments:
 
 
 
 
 
 
 
General and administrative expense
(4,979
)
 
(4,505
)
 
(36,556
)
 
(13,992
)
Share-based and long-term incentive compensation expense
(424
)
 
(1,024
)
 
(2,767
)
 
(2,980
)
Gain on sale of assets
625

 

 
28,674

 

Interest expense
(2,038
)
 
(3,369
)
 
(6,439
)
 
(17,926
)
Loss on extinguishment of debt, net

 

 

 
(35,864
)
Other corporate non-operating income
361

 
58

 
956

 
283

Income from continuing operations before taxes attributable to Forestar Group Inc.
13,223

 
7,163

 
62,341

 
39,746

Income tax (expense) benefit
(5,214
)
 
9,666

 
(33,353
)
 
(7,415
)
Net income from continuing operations attributable to Forestar Group Inc.
$
8,009

 
$
16,829

 
$
28,988

 
$
32,331

Significant aspects of our results of operations follow:
Third Quarter and First Nine Months 2017
Third quarter 2017, real estate segment earnings decreased compared with third quarter 2016 due to $12,810,000 in segment earnings from retail land sales, partially offset by non-cash impairment charges of $7,627,000 in third quarter 2016. First nine months 2017, real estate segment earnings decreased compared with first nine months 2016 primarily due to gains of $121,732,000 in 2016 as a result of executing our key initiative to opportunistically sell non-core assets. In addition, we generated segment earnings of $27,688,000 in first nine months 2016 from retail land sales. These items were partially offset by non-cash impairment charges of $56,453,000 related to six non-core community development projects and two multifamily sites in first nine months 2016. Segment earnings in 2017 reflect higher equity in earnings of unconsolidated ventures as a result of an increase in commercial tract and residential lot sales within these ventures in first nine months 2017 compared with first nine months 2016. We had no retail land sales in third quarter or first nine months 2017.
In first quarter 2017, we sold all of our remaining owned mineral assets for approximately $85,700,000. We generated $82,422,000 in gains related to the sale of our mineral assets in first nine months 2017 of which $8,200,000 was recognized in third quarter 2017 as a result of the expiration of a title review period. 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 in first nine months 2017 related to the mineral resources reporting unit goodwill.
First nine months 2017 general and administrative expense increased compared to first nine months 2016 primarily due to a merger agreement termination fee of $20,000,000 and $5,624,000 in professional fees and other costs incurred associated with proposed merger transactions.
Third quarter and first nine months 2017 gain on sale of assets increased compared to third quarter and first nine months 2016 due to the sale of approximately 19,000 acres of timberland and undeveloped land in Georgia and Texas for $46,197,000 in three transactions generating combined proceeds of $45,396,000. We generated combined gains of $28,674,000 in first nine months 2017 of which $625,000 was recognized in third quarter 2017 upon receipt of certain regulatory approvals and release of funds from escrow.

23


Third quarter and first nine months 2017 interest expense decreased primarily due to reducing our debt outstanding by $277,790,000 in 2016.
Loss on extinguishment of debt in first nine months 2016 represents the cash tender offer of our 8.5% senior secured notes and other open market purchases of debt securities.
Current Market Conditions
Sales of new U.S. single-family homes in September 2017, according to a joint release by the U.S. Census Bureau and the U.S. Department of Housing and Urban Development, were at a seasonally adjusted annual rate of 667,000 units, representing the highest reading since October 2007.  The reading registered 18.9% above the revised August rate of 561,000 and 17% above the September 2016 rate.  The report reflected strength in new residential home sales in all regions of the country, with particular strength reported in the South.  The U.S. Census Bureau and the U.S. Department of Housing and Urban Development jointly announced that housing starts for September 2017 registered a seasonally adjusted annual rate of 1,127,000 units, representing a 4.7% drop from the August estimate of 1,183,000 units but 6.1% above prior year.  The housing start decrease during the period was partially attributed to hurricanes disrupting construction activity in the South.  Single-family permits, generally viewed as a precursor to housing starts, registered 1,215,000 in September 2017, reflecting a 4.5% decrease from the revised August rate of 1,272,000 and a 4.3% decrease from prior year.  Homebuilder confidence, as measured by the National Association of Homebuilders/Wells Fargo Housing Market Index, declined three points in September to a reading of 64  from a downwardly revised reading of 67 in August.  The decline reflected builders’ concerns about near term labor availability and increases in building material costs in certain markets due to the recent hurricane activity.  On a regional basis, the three month moving av