FORESTAR GROUP INC. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-Q)

The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our consolidated financial
statements and related notes included in this quarterly report and with our
annual report on Form 10-K for the fiscal year ended September 30, 2021. Some of
the information contained in this discussion and analysis constitutes
forward-looking statements that involve risks and uncertainties. Actual results
could differ materially from those discussed in these forward-looking
statements. Factors that could cause or contribute to these differences include,
but are not limited to, those described in the "Forward-Looking Statements"
section following this discussion.


Our operations


We are a residential lot development company with operations in 55 markets in 23
states as of December 31, 2021. In October 2017, we became a majority-owned
subsidiary of D.R. Horton. Through our alignment with and support from D.R.
Horton, we have grown our business into a national, well-capitalized residential
lot developer selling lots to D.R. Horton and other homebuilders. As our
controlling shareholder, D.R. Horton has significant influence in guiding our
strategic direction and operations. Our strategy is focused on making
investments in land acquisition and development to expand our residential lot
development business across a geographically diversified national platform and
consolidating market share in the fragmented U.S. lot development industry. We
are primarily investing in short duration, phased development projects that
generate returns similar to production-oriented homebuilders. This strategy is a
unique, lower-risk business model that we expect will produce more consistent
returns than other public and private land developers. We also make strategic
short-term investments in finished lots (lot banking) and undeveloped land with
the intent to sell these assets within a short time period, primarily to D.R.
Horton, utilizing available capital prior to its deployment into longer term lot
development projects.

COVID-19

During 2020, the impacts of the COVID-19 pandemic significantly disrupted
economic activity and temporarily affected our business operations and the
demand for our residential lots. As economic activity resumed, housing market
conditions and demand for residential lots improved and has remained strong
throughout fiscal 2021 and into fiscal 2022. However, multiple disruptions in
the supply chain, combined with the strong demand for residential lots, have
resulted in shortages in certain construction materials, which, together with
tightness in the labor market, has caused our development cycles to lengthen in
certain markets. We believe we are well-positioned to effectively operate
through changing economic conditions because of our low net leverage and strong
liquidity position, our low overhead model and our strategic relationship with
D.R. Horton.

Business Segment

We manage our operations through our real estate segment, which is our core
business and generates substantially all of our revenues. The real estate
segment primarily acquires land and develops infrastructure for single-family
residential communities and generates revenues from sales of residential
single-family finished lots to local, regional and national homebuilders. We
have other business activities for which the related assets and operating
results are immaterial, and therefore, are included in our real estate segment.

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Results of Operations

The following tables and related discussion show selected operational and financial data as at and for the three months ended December 31, 2021 and 2020.

Operating results

The components of profit before income taxes were as follows:

Three months completed the 31st of December,

                                                                                2021                   2020
                                                                                     (In millions)
Revenues                                                                $           407.6          $    307.1
Cost of sales                                                                       334.2               262.9
Selling, general and administrative expense                                          21.5                15.5
Equity in earnings of unconsolidated ventures                                        (1.1)               (0.2)
Gain on sale of assets                                                               (0.5)                  -
Interest and other income                                                               -                (0.3)
Income before income taxes                                              $            53.5          $     29.2



Lot Sales

The residential lots sold consist of:

                                          Three Months Ended December 31,
                                                2021                      2020
Development projects                         4,381                        3,102
Lot banking projects                           135                          465
                                             4,516                        3,567

Average sales price per lot (a)   $         89,000                     $ 

86,000

_______________

(a) Excluding the impact of the change in contractual liabilities.

Revenues

Revenues consist of:
                                            Three Months Ended December 31,
                                                   2021                      2020
                                                     (In millions)
Residential lot sales:
Development projects               $           393.0                       $ 271.1
Lot banking projects                             9.0                          35.7
Decrease in contract liabilities                 2.1                           0.2
                                               404.1                         307.0
Tract sales and other                            3.5                           0.1
Total revenues                     $           407.6                       $ 307.1



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Residential lots sold and residential lot sales revenues have increased as we
have grown our business primarily through our strategic relationship with D.R.
Horton. In the three months ended December 31, 2021, we sold 4,014 residential
lots to D.R. Horton for $328.0 million compared to 3,389 residential lots sold
to D.R. Horton for $294.0 million in the prior year period. In the three months
ended December 31, 2021, we sold 502 residential lots to customers other than
D.R. Horton for $74.0 million compared to 178 residential lots sold to customers
other than D.R. Horton for $12.8 million in the prior year period.

Sales of plots and other income during the three months ended December 31, 2021
consisted primarily of 38 acres of parcels sold to third parties for $3.5 million.


Cost of sales in the three months ended December 31, 2021 increased as compared
to the prior year period primarily due to the increase in the number of lots
sold. Cost of sales related to tract sales and other revenues in the three
months ended December 31, 2021 was $2.7 million.

Selling, general and administrative (SG&A) and other income statement items


SG&A expense in the three months ended December 31, 2021 was $21.5 million
compared to $15.5 million in the prior year period. SG&A expense as a percentage
of revenues was 5.3% and 5.0% in the three months ended December 31, 2021 and
2020, respectively. Our SG&A expense primarily consists of employee compensation
and related costs. Our business operations employed 271 and 179 employees at
December 31, 2021 and 2020, respectively.

Equity in earnings of unconsolidated joint ventures in both periods reflects our share of earnings in joint ventures which we account for using the equity method.

Gain on sale of assets during the three months ended December 31, 2021 consists of a gain of $0.5 million related to the sale of an investment.

Interest and other income primarily represents interest earned on our cash deposits.

Income taxes


Our income tax expense for the three months ended December 31, 2021 and 2020 was
$13.0 million and $7.1 million, respectively, and our effective tax rate was
24.3% in both periods. Our effective tax rate for both periods includes an
expense for state income taxes and nondeductible expenses and a benefit related
to noncontrolling interests.

At December 31, 2021, we had deferred tax liabilities, net of deferred tax
assets, of $23.0 million. The deferred tax assets were partially offset by a
valuation allowance of $1.2 million, resulting in a net deferred tax liability
of $24.2 million. At September 30, 2021, deferred tax liabilities, net of
deferred tax assets, were $23.2 million. The deferred tax assets were partially
offset by a valuation allowance of $1.2 million, resulting in a net deferred tax
liability of $24.4 million. The valuation allowance for both periods was
recorded because it is more likely than not that a portion of our state deferred
tax assets, primarily net operating loss (NOL) carryforwards, will not be
realized because we are no longer operating in some states or the NOL
carryforward periods are too brief to realize the related deferred tax asset. We
will continue to evaluate both the positive and negative evidence in determining
the need for a valuation allowance on our deferred tax assets. Any reversal of
the valuation allowance in future periods will impact our effective tax rate.
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Land and Lot Position

Our position on the lands and lots at December 31, 2021 and September 30, 2021 can be summed up as follows:

                                                                        December 31,              September 30,
                                                                            2021                       2021
Lots owned                                                                  65,700                    64,400
Lots controlled through land and lot purchase contracts                     37,600                    32,600
Total lots owned and controlled                                            103,300                    97,000



At December 31, 2021, our lot position consisted of 103,300 residential lots, of
which approximately 65,700 were owned and 37,600 were controlled through
purchase contracts. Of our total owned residential lots, approximately 20,000
were under contract to sell to D.R. Horton. Additionally, D.R. Horton has the
right of first offer on approximately 18,300 of our owned residential lots based
on executed purchase and sale agreements. At December 31, 2021, our lots owned
included approximately 4,900 lots that were fully developed, of which
approximately 200 are related to lot banking. At December 31, 2021, we had
approximately 1,000 lots under contract to sell to customers other than D.R.
Horton.


Cash and capital resources


At December 31, 2021, we had $162.5 million of cash and cash equivalents and
$343.7 million of available borrowing capacity on our revolving credit facility.
We have no senior note maturities until fiscal 2026. We believe we are
well-positioned to effectively operate through changing economic conditions
because of our low net leverage and strong liquidity position, our low overhead
model and our strategic relationship with D.R. Horton.

At December 31, 2021, our ratio of debt to total capital (debt divided by
stockholders' equity plus debt) was 40.0% compared to 41.0% at September 30,
2021 and 42.3% at December 31, 2020. Our ratio of net debt to total capital
(debt net of unrestricted cash divided by stockholders' equity plus debt net of
unrestricted cash) was 33.9% compared to 35.2% at September 30, 2021 and 31.8%
at December 31, 2020. Over the long term, we intend to maintain our ratio of net
debt to total capital at approximately 40% or less. We believe that the ratio of
net debt to total capital is useful in understanding the leverage employed in
our operations.

We believe that our existing cash resources and revolving credit facility will
provide sufficient liquidity to fund our near-term working capital needs. Our
ability to achieve our long-term growth objectives will depend on our ability to
obtain financing in sufficient amounts. 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. Subject to market conditions we may, at any time, be
considering or preparing for the purchase or sale of our debt securities, the
sale of our common stock or a combination thereof.

Bank credit facility


We have a $410 million senior unsecured revolving credit facility with an
uncommitted accordion feature that could increase the size of the facility
to $600 million, subject to certain conditions and availability of additional
bank commitments. The maturity date of the facility is April 16, 2025. The
facility also provides for the issuance of letters of credit with a sublimit
equal to the greater of $100 million and 50% of the revolving credit commitment.
Borrowings under the revolving credit facility are subject to a borrowing base
calculation based on the book value of our real estate assets and unrestricted
cash. Letters of credit issued under the facility reduce the available borrowing
capacity. There were no borrowings or repayments under the facility in the three
months ended December 31, 2021. At December 31, 2021, there were no borrowings
outstanding and $66.3 million of letters of credit issued under the revolving
credit facility, resulting in available capacity of $343.7 million.

The revolving credit facility includes customary affirmative and negative
covenants, events of default and financial covenants. The financial covenants
require a minimum level of tangible net worth, a minimum level of liquidity, and
a maximum allowable leverage ratio. These covenants are measured as defined in
the credit agreement governing the facility and are reported to the lenders
quarterly. A failure to comply with these financial covenants could allow the
lending banks to terminate the availability of funds under the revolving credit
facility or cause any outstanding borrowings to become due and payable prior to
maturity. At December 31, 2021, we were in compliance with all of the covenants,
limitations and restrictions of our revolving credit facility.

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Senior Notes

We have outstanding senior notes as described below that were issued pursuant to
Rule 144A and Regulation S under the Securities Act of 1933, as amended. The
notes represent senior unsecured obligations that rank equally in right of
payment to all existing and future senior unsecured indebtedness and may be
redeemed prior to maturity, subject to certain limitations and premiums defined
in the respective indenture. The notes are guaranteed by each of our
subsidiaries to the extent such subsidiaries guarantee our revolving credit
facility.

Our $400 million principal amount of 3.85% senior notes (the "2026 notes")
mature May 15, 2026 with interest payable semi-annually. On or after May 15,
2023, the 2026 notes may be redeemed at 101.925% of their principal amount plus
any accrued and unpaid interest. In accordance with the indenture, the
redemption price decreases annually thereafter and the 2026 notes can be
redeemed at par on or after May 15, 2025 through maturity. The annual effective
interest rate of the 2026 notes after giving effect to the amortization of
financing costs is 4.1%.

We also have outstanding $300 million principal amount of 5.0% senior notes (the
"2028 notes"), which mature March 1, 2028 with interest payable semi-annually.
On or after March 1, 2023, the 2028 notes may be redeemed at 102.5% of their
principal amount plus any accrued and unpaid interest. In accordance with the
indenture, the redemption price decreases annually thereafter and the 2028 notes
can be redeemed at par on or after March 1, 2026 through maturity. The annual
effective interest rate of the 2028 notes after giving effect to the
amortization of financing costs is 5.2%.

The indentures governing the senior notes require that, upon the occurrence of
both a change of control and a rating decline (each as defined in the respective
indenture), we offer to purchase the notes at 101% of their principal amount. If
we or our restricted subsidiaries dispose of assets, under certain
circumstances, we will be required to either invest the net cash proceeds from
such asset sales in our business within a specified period of time, repay
certain senior secured debt or debt of our non-guarantor subsidiaries, or make
an offer to purchase a principal amount of the notes equal to the excess net
cash proceeds at a purchase price of 100% of their principal amount. The
indentures contain covenants that, among other things, restrict our ability and
the ability of our restricted subsidiaries to pay dividends or distributions,
repurchase equity, prepay subordinated debt and make certain investments; incur
additional debt or issue mandatorily redeemable equity; incur liens on assets;
merge or consolidate with another company or sell or otherwise dispose of all or
substantially all of our assets; enter into transactions with affiliates; and
allow to exist certain restrictions on the ability of subsidiaries to pay
dividends or make other payments. At December 31, 2021, we were in compliance
with all of the limitations and restrictions associated with our senior note
obligations.

Effective April 30, 2020, our Board of Directors authorized the repurchase of up
to $30 million of our debt securities. The authorization has no expiration date.
All of the $30 million authorization was remaining at December 31, 2021.

Other note payable


Our other note payable of $12.5 million was issued as part of a transaction to
acquire real estate for development. The note is non-recourse and is secured by
the underlying real estate, accrues interest at 4.0% per annum and matures in
October 2023.

Issuance of Common Stock

We have an effective shelf registration statement, filed with the Securities and
Exchange Commission in October 2021, registering $750 million of equity
securities, of which $300 million was reserved for sales under our at-the-market
equity offering program that became effective in November 2021. In the three
months ended December 31, 2021, we issued 84,547 shares of common stock under
our at-the-market equity offering program for proceeds of $1.7 million, net of
commissions and other issuance costs totaling $0.1 million. At December 31,
2021, $748.2 million remained available for issuance under the shelf
registration statement, of which $298.2 million was reserved for sales under the
at-the-market equity offering program.

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Operating Cash Flow Activities

In the three months ended December 31, 2021, net cash provided by operating
activities was $5.8 million compared to $158.7 million of cash used in operating
activities in the three months ended December 31, 2020. The cash provided by
operating activities in the current period was primarily the result of the net
income generated in the period and increases in liabilities and other accrued
expenses, partially offset by the increase in our real estate. The cash used in
operating activities in the prior year period was primarily due to the increase
in real estate.

Investing Cash Flow Activities


In the three months ended December 31, 2021, net cash provided by investing
activities was $3.2 million compared to $2.0 million in the three months ended
December 31, 2020. The cash provided by investing activities in the current
period consists primarily of cash received from the sale of an investment.
Additionally, cash provided by investing activities in both periods includes
distributions received from our unconsolidated ventures.

Financing of treasury activities

Within three months December 31, 2021the net cash allocated to financing activities was $0.1 million compared to $0.2 million within three months
December 31, 2020.

Contractual obligations and off-balance sheet arrangements


In support of our residential lot development business, we issue letters of
credit under our revolving credit facility and we have a surety bond program
that provides financial assurance to beneficiaries related to the execution and
performance of certain development obligations. At December 31, 2021, we had
outstanding letters of credit of $66.3 million under the revolving credit
facility and surety bonds of $528.2 million, issued by third parties to secure
performance under various contracts. We expect that our performance obligations
secured by these letters of credit and bonds will generally be completed in the
ordinary course of business and in accordance with the applicable contractual
terms. When we complete our performance obligations, the related letters of
credit and bonds are generally released shortly thereafter, leaving us with no
continuing obligations. We have no material third-party guarantees.


Significant Accounting Policies and Estimates

There have been no material changes in our critical accounting policies or estimates from those disclosed in our 2021 Annual Report on Form 10-K.

New and pending accounting pronouncements

Please read Note 1-Basis of Presentation of the Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.

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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:
•the effect of D.R. Horton's controlling level of ownership on us and the
holders of our securities;
•our ability to realize the potential benefits of the strategic relationship
with D.R. Horton;
•the effect of our strategic relationship with D.R. Horton on our ability to
maintain relationships with our customers;
•the impact of COVID-19 on the economy and our business;
•the cyclical nature of the homebuilding and lot development industries and
changes in economic, real estate and other conditions;
•the impacts of weather conditions and natural disasters;
•health and safety incidents relating to our operations;
•supply shortages and other risks of acquiring land, construction materials and
skilled labor;
•competitive conditions in our industry;
•our ability to achieve our strategic initiatives;
•continuing liabilities related to assets that have been sold;
•the impact of governmental policies, laws or regulations and actions or
restrictions of regulatory agencies;
•the cost and availability of property suitable for residential lot development;
•general economic, market or business conditions where our real estate
activities are concentrated;
•our dependence on relationships with national, regional and local homebuilders;
•our ability to obtain or the availability of surety bonds to secure our
performance related to construction and development activities and the pricing
of bonds;
•obtaining reimbursements and other payments from governmental districts and
other agencies and timing of such payments;
•our ability to succeed in new markets;
•the conditions of the capital markets and our ability to raise capital to fund
expected growth;
•our ability to manage and service our debt and comply with our debt covenants,
restrictions and limitations;
•the volatility of the market price and trading volume of our common stock;
•our ability to hire and retain key personnel;
•the impact of significant inflation, higher interest rates or deflation; and
•the strength of our information technology systems and the risk of
cybersecurity breaches and our ability to satisfy privacy and data protection
laws and regulations.

Other factors, including the risk factors described in Item 1A of our 2021
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.
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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.

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