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Forestar Group Inc. Q1 2011 Filing Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2011. Forestar Group Inc. operates in three primary segments: Real Estate, Mineral Resources, and Fiber Resources. The company continues to execute strategic initiatives announced in 2009, focusing on selling higher-and-better-use timberland to reduce debt and repurchase stock. As of the reporting date, the company has sold approximately 119,000 acres of timberland, generating net proceeds of roughly $192 million.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 13% to $29.84 million, driven primarily by a 23% increase in Real Estate revenues ($21.14 million vs. $17.25 million) due to higher undeveloped land sales volume and improved residential lot sales.
• Profitability Improvement: The net loss attributable to Forestar decreased by approximately 17% compared to Q1 2010. Operating income turned positive at $0.98 million, compared to a loss of $(0.57) million in the prior year.
• Segment Performance:
  • Real Estate: Earnings surged to $2.58 million from $0.31 million.
  • Mineral Resources: Earnings declined to $5.60 million from $6.18 million due to increased costs in water resource development, despite higher oil prices.
  • Fiber Resources: Earnings dropped to $0.64 million from $1.44 million due to reduced harvest activity following timberland sales in 2010.
• Debt and Liquidity: Total debt increased by $9.01 million to $230.60 million, primarily to fund real estate development. However, the company expanded its senior credit facility by $30 million in February 2011, resulting in $168.11 million in unused borrowing capacity.

Outlook, Risks, and Management Commentary

• Market Conditions: Management notes that the single-family residential market remains difficult with product oversupply and depressed prices. Oil prices have risen due to geopolitical unrest, while natural gas prices remain soft.
• Strategic Initiatives: The company continues to market approximately 55,000 acres of undeveloped land classified as "assets held for sale" to generate cash flow. No assurance is given regarding the timing of these sales.
• Contingencies:
  • Cibolo Canyons: Significant investment ($88.6 million) in a mixed-use development and resort in San Antonio. Reimbursements from a Special Purpose Improvement District (SPID) are subject to uncertainty regarding tax base adequacy.
  • Variable Interest Entities (VIEs): The company participates in three partnerships with total liabilities of $84.2 million. While managed by third parties, Forestar may be required to provide additional equity under certain circumstances.
• Share-Based Compensation: Expenses increased to $4.10 million (from $3.53 million) due to new awards and accelerated recognition for retirement-eligible employees.

Investor Verification Checklist

• Debt Covenants: Verify continued compliance with the Interest Coverage Ratio (4.14:1.0) and Total Leverage Ratio (21.4%) given the increased debt load.
• Asset Sales Timing: Assess the likelihood and timeline for selling the remaining 55,000 acres of timberland held for sale to meet debt reduction targets.
• SPID Reimbursements: Monitor the collection status of the $36.55 million in approved but pending infrastructure reimbursements from the Cibolo Canyons SPID.
• VIE Exposure: Review the status of the three unconsolidated VIEs with $69.7 million in current maturities to ensure no additional capital calls are required.
• Real Estate Inventory: Evaluate the absorption rates of the 17,635 remaining residential lots in owned and consolidated ventures amidst difficult market conditions.