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Forestar Group Inc. Q1 2010 Filing Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2010. Forestar Group Inc. operates in three primary segments: Real Estate, Mineral Resources, and Fiber Resources. The company is executing a strategic initiative to generate cash flow by selling higher and better use (HBU) timberland, having sold approximately 95,000 acres in 2009. As of Q1 2010, approximately 74,000 acres remain classified as assets held for sale.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Total revenues decreased 9.3% year-over-year. Real estate revenues dropped due to lower undeveloped land sales in a difficult market. Fiber resources revenues fell 54.6% due to reduced timber volume following 2009 land sales and wet weather.
• Mineral Growth: Mineral resources revenues increased 20.4% to $7.1 million, driven by higher lease bonus revenues in the East Texas Basin.
• Improved Loss Position: Net loss attributable to Forestar improved by $0.92 million compared to Q1 2009, despite higher share-based compensation expenses ($3.5 million vs. $1.7 million).
• Cash Flow Deterioration: Net cash used in operating activities increased significantly to $19.8 million, primarily due to a $10 million loan to a third-party investor in the JW Marriott San Antonio Hill Country Resort and higher tax payments.
• Debt Reduction: Total debt decreased by $12.2 million, partly due to a lender foreclosure on a consolidated variable interest entity which reduced debt by $13.2 million.

Outlook, Risks, and Management Commentary

• Market Conditions: Management notes continued difficulty in the single-family residential market characterized by oversupply and low consumer confidence. Timberland market conditions have deteriorated due to limited capital availability, potentially delaying the sale of remaining HBU assets.
• Liquidity: The company maintains $196.8 million in unused borrowing capacity under its senior credit facility, which matures December 1, 2010, with an option to extend through June 2012. The company is in compliance with all financial covenants.
• Contingencies:
  • Venture Debt: Four partnerships in which Forestar participates have approximately $77.8 million in borrowings maturing in 2010. While guaranteed by third parties, there is no assurance of refinancing, and Forestar may be required to provide additional equity.
  • Foreclosure: A lender foreclosure on a consolidated VIE in Austin, Texas, resulted in a $11.9 million reduction in real estate assets and a $13.2 million reduction in debt.
  • Environmental: Estimated remediation costs of $4.3 million for a former paper manufacturing site in California are expected to be paid in 2010 and 2011.
• Guidance: The company anticipates an effective tax rate of approximately 35% for 2010.

Investor Verification Checklist

• Refinancing Risk: Verify the status of the $77.8 million in venture debt maturing in 2010 and the likelihood of third-party guarantees holding.
• Timberland Sales: Monitor progress on the sale of the remaining 74,000 acres of HBU timberland given the reported deterioration in market conditions.
• Loan Recovery: Assess the collectability of the $10 million loan issued to the JW Marriott San Antonio Hill Country Resort investor.
• Real Estate Inventory: Review the aging of residential lots and commercial acres in the entitlement process, particularly in Texas and Georgia markets.
• Cash Burn: Evaluate the sustainability of the $19.8 million operating cash outflow in the context of current cash reserves ($6.6 million) and available credit lines.