UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

þ		Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2009

o		Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                      to                     

FORESTAR GROUP INC.

Delaware (State or Other Jurisdiction of Incorporation or Organization)		26-1336998 (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. Yes þ     No o

     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). Yes o     No o

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o

Accelerated filer þ

Non-accelerated filer o (Do not check if a smaller reporting company)

Smaller reporting company o

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o     No þ

     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 July 31, 2009
Common Stock, par value $1.00 per share		35,857,909

 

 

FORESTAR GROUP INC.
TABLE OF CONTENTS

PART I — FINANCIAL INFORMATION			3
Item 1. Financial Statements			3
Consolidated Balance Sheets			3
Consolidated Statements of Income			4
Consolidated Statements of Cash Flows			5
Notes to the Consolidated Financial Statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			19
Item 3. Quantitative and Qualitative Disclosures About Market Risk			34
Item 4. Controls and Procedures			34
PART II — OTHER INFORMATION			35
Item 1. Legal Proceedings			35
Item 1A. Risk Factors			35
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			35
Item 3. Defaults Upon Senior Securities			35
Item 4. Submission of Matters to a Vote of Security Holders			35
Item 5. Other Information			36
Item 6. Exhibits			36
SIGNATURES			37
Certification of CEO Pursuant to Section 302
Certification of CFO Pursuant to Section 302
Certification of CEO Pursuant to Section 906
Certification of CFO Pursuant to Section 906
EX-10.1
EX-10.3
EX-10.4
EX-31.1
EX-31.2
EX-32.1
EX-32.2

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

FORESTAR GROUP INC.
Consolidated Balance Sheets

		(Unaudited)
		June 30,				December 31,
		2009				2008
		(In thousands)
ASSETS
Cash and cash equivalents		$	17,053			$	8,127
Real estate			561,738				610,586
Assets held for sale			41,011				—
Investment in unconsolidated ventures			112,089				117,554
Timber			21,810				50,989
Receivables, net			3,926				4,262
Prepaid expense			2,536				2,425
Property and equipment, net			6,048				6,211
Deferred tax asset			28,849				17,184
Other assets			14,469				17,238
TOTAL ASSETS		$	809,529			$	834,576
LIABILITIES AND SHAREHOLDERS’ EQUITY
Accounts payable		$	4,847			$	7,438
Accrued employee compensation and benefits			1,955				3,389
Accrued property taxes			6,181				6,808
Accrued interest			781				1,199
Income taxes payable			29,932				—
Other accrued expenses			6,659				11,448
Other liabilities			18,852				12,940
Debt			237,766				337,402
TOTAL LIABILITIES			306,973				380,624
COMMITMENTS AND CONTINGENCIES
EQUITY
Forestar Group Inc. shareholders’ equity:
Preferred stock, par value $0.01 per share, 25,000,000 authorized shares, none issued			—				—
Common stock, par value $1.00 per share, 200,000,000 authorized shares, 35,952,832 issued at June 30, 2009 and 35,839,390 issued at December 31, 2008			35,953				35,839
Additional paid-in capital			379,561				377,810
Retained earnings			83,794				36,769
Accumulated other comprehensive loss			(891	)			(1,260	)
Treasury stock, at cost, 94,923 shares at June 30, 2009 and 90,819 at December 31, 2008			(1,899	)			(1,866	)
Total Forestar Group Inc. shareholders’ equity			496,518				447,292
Noncontrolling interests			6,038				6,660
TOTAL EQUITY			502,556				453,952
TOTAL LIABILITIES AND EQUITY		$	809,529			$	834,576

Please read the notes to the consolidated financial statements.

FORESTAR GROUP INC.
Consolidated Statements of Income
(Unaudited)

		Second Quarter								First Six Months
		2009				2008				2009				2008
		(In thousands, except per share amounts)
REVENUES
Real estate sales		$	23,069			$	17,061			$	37,128			$	39,851
Commercial operating properties and other			5,378				7,057				10,106				12,710
Real estate			28,447				24,118				47,234				52,561
Mineral resources			7,018				24,386				12,939				30,654
Fiber resources and other			5,001				3,093				9,370				5,605
			40,466				51,597				69,543				88,820
COSTS AND EXPENSES
Cost of real estate sales			(7,836	)			(8,479	)			(12,578	)			(21,986	)
Cost of commercial operating properties and other			(3,991	)			(4,564	)			(7,807	)			(8,429	)
Cost of mineral resources			(2	)			—				(78	)			—
Cost of fiber resources			(1,103	)			(925	)			(1,936	)			(1,471	)
Other operating			(9,522	)			(13,833	)			(19,994	)			(22,134	)
General and administrative			(5,943	)			(5,947	)			(14,758	)			(12,784	)
Gain on sale of assets			79,214				—				79,214				—
			50,817				(33,748	)			22,063				(66,804	)
OPERATING INCOME			91,283				17,849				91,606				22,016
Equity in (loss) earnings of unconsolidated ventures			(4,048	)			2,018				(4,620	)			3,552
Interest expense			(5,047	)			(5,002	)			(10,213	)			(10,668	)
Other non-operating income			44				72				95				154
INCOME BEFORE TAXES			82,232				14,937				76,868				15,054
Income tax expense			(31,120	)			(4,811	)			(28,805	)			(4,666	)
CONSOLIDATED NET INCOME			51,112				10,126				48,063				10,388
Less: Net income attributable to noncontrolling interests			(195	)			(530	)			(1,038	)			(1,030	)
NET INCOME ATTRIBUTABLE TO FORESTAR GROUP INC.		$	50,917			$	9,596			$	47,025			$	9,358
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
Basic			35,808				35,422				35,745				35,390
Diluted			36,037				36,117				35,903				36,063
NET INCOME PER COMMON SHARE
Basic		$	1.42			$	0.27			$	1.32			$	0.26
Diluted		$	1.41			$	0.27			$	1.31			$	0.26

Please read the notes to the consolidated financial statements.

FORESTAR GROUP INC.
Consolidated Statements of Cash Flows
(Unaudited)

		First Six Months
		2009				2008
		(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Consolidated net income		$	48,063			$	10,388
Adjustments:
Depreciation and amortization			4,234				3,467
Deferred income taxes			(11,864	)			(3,443	)
Tax benefits not recognized for book purposes			5,291				—
Equity in loss (earnings) of unconsolidated ventures			4,620				(3,552	)
Distributions of earnings of unconsolidated ventures			259				883
Distributions of earnings to noncontrolling interests			(1,673	)			(2,980	)
Share-based compensation			4,321				3,528
Non-cash real estate cost of sales			12,262				20,863
Non-cash cost of assets sold			36,902				—
Real estate development and acquisition expenditures			(14,619	)			(50,834	)
Reimbursements from utility or improvement districts			2,029				374
Other changes in real estate			327				(290	)
Gain on termination of timber lease			(185	)			(1,376	)
Cost of timber cut			1,813				1,258
Deferred income			(145	)			2,331
Asset impairments			841				—
Other			127				(821	)
Changes in:
Receivables			(801	)			9
Prepaid and other			1,108				(794	)
Accounts payable and other accrued liabilities			(10,405	)			1,079
Income taxes payable			29,932				(806	)
Net cash provided by (used in) operating activities			112,437				(20,716	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Property, equipment, software and reforestation			(4,506	)			(1,368	)
Investment in unconsolidated ventures			(1,494	)			(11,339	)
Return of investment in unconsolidated ventures			2,263				4,375
Net cash used in investing activities			(3,737	)			(8,332	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of debt			(142,302	)			(39,547	)
Additions to debt			42,666				70,556
Deferred financing fees			—				(1,078	)
Return of investment to noncontrolling interests			(170	)			—
Exercise of stock options			15				872
Payroll taxes on restricted stock and stock options			(31	)			(1,832	)
Tax benefit from share-based compensation			—				81
Other			48				238
Net cash (used in) provided by financing activities			(99,774	)			29,290
Net increase in cash and cash equivalents			8,926				242
Cash and cash equivalents at beginning of period			8,127				7,520
Cash and cash equivalents at end of period		$	17,053			$	7,762

Please read the notes to the consolidated financial statements.

FORESTAR GROUP INC.
Notes to the Consolidated Financial Statements
(Unaudited)

Note 1 — Background

     Prior to December 28, 2007, we were a wholly-owned subsidiary of Temple-Inland Inc. On December 28, 2007, Temple-Inland distributed all of the issued and outstanding shares of our common stock to its shareholders in a transaction commonly referred to as a spin-off.

Note 2 — 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, and variable interest entities of which we are the primary beneficiary. We eliminate all material intercompany accounts and transactions. Noncontrolling interests in consolidated pass-through entities are recognized before income taxes. We account for our investment in other entities in which we have significant influence over operations and financial policies using the equity method (we recognize our share of the entities’ income or loss and any preferential returns and treat distributions as a reduction of our investment). We account for our investment in other entities in which we do not have significant influence over operations and financial policies using the cost method (we recognize as income distribution of accumulated earnings).

     We prepare our unaudited interim financial statements in accordance with U.S. generally accepted accounting principles 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 related to allocating costs to real estate and measuring 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 2008 Annual Report on Form 10-K.

     Certain prior year items have been reclassified to conform to the current year’s presentation.

Note 3 — New Accounting Pronouncements

     In first quarter 2009, we adopted the following new accounting pronouncements:

	•		FASB Staff Position (FSP) FAS 157-2, Effective Date of FASB Statement 157 — This FSP delayed the effective date of Statement of Financial Accounting Standard (SFAS) No. 157, Fair Value Measurements, for certain nonfinancial assets and nonfinancial liabilities. Adoption of this FSP did not significantly affect how we determine fair value but has resulted in certain additional disclosures. Please read Note 10 — Fair Value for disclosures.
	•		FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities — This staff position specifies that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents are participating securities and should be included in the computation of earnings per share pursuant to the two-class method. Adoption of this FSP did not have a significant effect on our earnings per share.
	•		SFAS No. 141(R), Business Combinations — This standard requires most identifiable assets, liabilities, noncontrolling interests and goodwill acquired in a business combination to be recorded at full fair value. The standard also changes the approach to determining the purchase price, the accounting for acquisition cost and several acquisition related accounting practices. Adoption of this pronouncement did not have a significant effect on our earnings or financial position.
	•		SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements — This standard specifies that noncontrolling interests be reported as a part of equity, not as a liability or other item outside of equity. Upon adoption, we reclassified $6,660,000 of noncontrolling interests to shareholders’ equity at year-end 2008 and we reclassified $1,030,000 of minority interest expense to net income attributable to noncontrolling interests for first six months 2008. The following table presents a reconciliation of the changes in shareholders’ equity in first six months 2009:

		Forestar				Noncontrolling
		Group Inc.				Interests				Total
		(In thousands)
Balance as of December 31, 2008		$	447,292			$	6,660			$	453,952
Net income			47,025				1,038				48,063
Unrealized gain			369				—				369
Distributions to noncontrolling interests			—				(1,843	)			(1,843	)
Contributions from noncontrolling interests			—				183				183
Other (primarily share-based compensation)			1,832				—				1,832
Balance as of June 30, 2009		$	496,518			$	6,038			$	502,556

•

SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities-an amendment of FASB Statement No. 133 — This standard requires enhanced disclosures about derivative instruments including how and why they are used; how they are accounted for; and how they affect an entity’s financial position, financial performance and cash flows. Adoption of this pronouncement did not have a significant effect on our earnings or financial position.

     In second quarter 2009, we adopted the following new accounting pronouncements:

	•		FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly — This FSP provides guidance for estimating fair value when the volume and level of activity for an asset or liability have significantly decreased. Adoption of this FSP affects how we consider Level 2 and Level 3 inputs in determining fair values but did not have a significant effect on our earnings or financial position.
	•		FSP FAS 107-1 and Accounting Principles Board (APB) Opinion 28-1, Interim Disclosures about Fair Value of Financial Instruments — This FSP requires an entity to provide disclosures about fair value of financial instruments at interim reporting periods. Adoption of this FSP did not significantly affect how we determine fair value but has resulted in certain additional disclosures. Please read Note 10 — Fair Value for disclosures.
	•		SFAS No. 165, Subsequent Events — Issued May 2009, this Statement establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before the financial statements are issued, introduces the concept of financial statements being available to be issued and requires disclosures regarding the date through which subsequent events were evaluated. Adoption of this standard did not have a significant effect on our earnings or financial position but does affect our disclosures regarding subsequent events.
	•		SEC SAB 112 — Effective June 10, 2009, amends or rescinds guidance included in the SAB Series to make it consistent with recent FASB pronouncements, namely, SFAS No. 141 (revised 2007), Business Combinations, and SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements. Adoption did not have a significant effect on our earnings or financial position.

     In addition, the following pending pronouncements have not yet been adopted:

	•		SFAS No. 166, Accounting for Transfers of Financial Assets — an amendment of FASB Statement No. 140 — This standard, issued in conjunction with SFAS No. 167, amends SFAS No. 140, removes the concept of a qualifying special-purpose entity from FIN 46(R) and requires additional disclosures. Based upon our current understanding, we do not believe adoption will have a significant effect on our earnings or financial position. This new standard is effective first quarter 2010.
	•		SFAS No. 167, Amendments to FASB Interpretation No. 46(R) — This standard, issued in conjunction with SFAS No. 166, amends certain requirements of FIN 46(R) to improve financial reporting related to consolidation of and disclosures about variable interest entities. We are currently evaluating the effect, if any, on our earnings or financial position. This new standard is effective first quarter 2010.
	•		SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles — This Statement replaces SFAS No. 162 and establishes the FASB Accounting Standards Codification (Codification) as the single source of authoritative accounting principles to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. Based upon our current understanding, adoption will not have an impact on our earnings or financial position but will change accounting guidance references in our disclosures. The Codification is effective third quarter 2009.

Note 4 — Strategic Initiatives and Assets Held for Sale

     In first quarter 2009, we announced our near-term strategic initiatives to enhance shareholder value by generating significant cash flow, principally from the sale of about 175,000 acres of higher and better use (HBU) timberland. As a result, we classified to assets held for sale about 171,000 acres of undeveloped land principally located in Alabama and Georgia with a carrying value of $51,390,000 and related timber with a carrying value of $24,749,000.

     In accordance with our strategic initiatives, in second quarter 2009, we sold about 75,000 acres of timber and timberland in Georgia and Alabama for $119,702,000 to Hancock Timber Resource Group, which acquired the assets on behalf of its investor clients. The transaction generated net proceeds of $116,116,000, which were principally used to reduce our outstanding debt, and resulted in a gain on sale of $79,214,000. In addition, in second quarter 2009 we entered into a definitive agreement with Holland M. Ware to sell about 20,000 acres of HBU timberland in Georgia. The sale closed August 4, 2009. Please read Note 18 - Subsequent Events for additional information about this sale. We intend to use the after-tax cash proceeds from this sale to reduce our outstanding debt.

     At second quarter-end 2009, we have classified to assets held for sale about 95,000 acres of undeveloped land located in Alabama, Georgia and Texas with a carrying value of $26,486,000, related timber with a carrying value of $13,939,000 and other assets with a carrying value of $586,000. These assets are being actively marketed.

Note 5 — Real Estate

     Real estate consists of:

		June 30,				December 31,
		2009				2008
		(In thousands)
Entitled, developed and under development projects		$	447,785			$	445,394
Undeveloped land			90,456				143,749
Commercial operating properties			46,924				43,987
			585,165				633,130
Accumulated depreciation			(23,427	)			(22,544	)
		$	561,738			$	610,586

     Included in entitled, developed and under development projects are the estimated costs of assets we expect to convey to utility or improvement districts of $75,396,000 at second quarter-end 2009 and $76,173,000 at year-end 2008, including $49,529,000 at second quarter-end 2009 and year-end 2008 related to our Cibolo Canyons project near San Antonio, Texas. These costs relate to water, sewer and other infrastructure assets for which the utility or improvement districts have agreed to reimburse us. We billed these districts $3,109,000 in first six months 2009 and $14,814,000 in first six months 2008. We collected $2,029,000 in first six months 2009 and $374,000 in first six months 2008 from these districts. We expect to collect the remaining amounts billed when these districts achieve adequate tax bases to support payment.

     We recognized asset impairment charges of $600,000 in first six months 2009 related to a condominium project in Texas. We did not recognize any asset impairment charges in first six months 2008. Asset impairment charges are included in cost of real estate sales.

     Depreciation expense primarily related to commercial operating properties was $883,000 in first six months 2009 and $852,000 in first six months 2008 and is included in other operating expense.

Note 6 — Timber

     We have about 256,000 acres of timber, primarily in Georgia. The cost of timber cut was $1,813,000 in first six months 2009 and $1,258,000 in first six months 2008.

Note 7 — Investment in Unconsolidated Ventures

     At second quarter-end 2009, we had ownership interests ranging from 25 to 50 percent in 10 ventures that we account for using the equity method. We have no real estate ventures that are accounted for using the cost method. Our three largest ventures at second quarter-end 2009 are CL Realty, Temco and Palisades West. We own a 50 percent interest in both CL Realty and Temco, and Cousins Real Estate Corporation owns the other 50 percent interest. We own a 25 percent interest in Palisades West, Cousins Properties Incorporated owns a 50 percent interest and Dimensional Fund Advisors LP owns the remaining 25 percent interest. Information regarding these ventures follows:

	•		CL Realty, L.L.C. was formed in 2002 for the purpose of developing residential and mixed-use communities in Texas and across the southeastern United States. At second quarter-end 2009, the venture had 15 residential and mixed-use communities, of which 10 are in Texas, 3 are in Florida and 2 are in Georgia, representing about 7,500 residential lots and 560 commercial acres.
	•		Temco Associates, LLC was formed in 1991 for the purpose of acquiring and developing residential real estate sites in Georgia. At second quarter-end 2009, the venture had 5 residential and mixed-use communities, representing about 1,560 residential lots, all of which are located in Paulding County, Georgia. The venture also owns approximately 5,600 acres of undeveloped land in Paulding County, Georgia.
	•		Palisades West LLC was formed in 2006 for the purpose of constructing a commercial office park in Austin, Texas. The project includes two office buildings totaling approximately 375,000 square feet and an accompanying parking garage. Construction of the project was completed in fourth quarter 2008 and is approximately 68% leased at second quarter-end 2009. Our remaining commitment for investment in this venture as of second quarter-end 2009 is $2,579,000. Effective fourth quarter 2008, we entered into a 10-year operating lease for approximately 32,000 square feet that we occupy as our corporate headquarters.

     Combined summarized balance sheet information for our ventures accounted for using the equity method follows:

		June 30, 2009																				December 31, 2008
		CL								Palisades				Other								CL								Palisades				Other
		Realty				Temco				West				Ventures				Total				Realty				Temco				West				Ventures				Total
		(In thousands)
Real estate		$	117,822			$	60,841			$	124,197			$	92,205			$	395,065			$	124,417			$	60,791			$	120,953			$	94,094			$	400,255
Total assets			119,143				61,886				124,707				99,726				405,462				126,726				61,832				123,290				102,930				414,778
Borrowings, principally non-recourse(a)			3,830				3,168				—				76,838				83,836				4,901				3,198				—				75,638				83,737
Total liabilities			6,260				4,166				51,378				86,935				148,739				8,683				3,570				50,548				89,580				152,381
Equity			112,883				57,720				73,329				12,791				256,723				118,043				58,262				72,742				13,350				262,397
Our investment in real estate ventures:
Our share of their equity(b)			56,441				28,860				18,332				16,425				120,058				59,022				29,131				18,779				18,295				125,227
Unrecognized deferred gain(c)			(7,059	)			—				—				(910	)			(7,969	)			(7,059	)			—				—				(614	)			(7,673	)
Investment in real estate ventures		$	49,382			$	28,860			$	18,332			$	15,515			$	112,089			$	51,963			$	29,131			$	18,779			$	17,681			$	117,554

     Combined summarized income statement information for our ventures accounted for using the equity method follows:

		Second Quarter								First Six Months
		2009				2008				2009				2008
						(In thousands)
Revenues:
CL Realty		$	157			$	1,590			$	1,757			$	4,675
Temco			341				1,613				1,198				2,290
Palisades West			4,328				55				6,057				109
Other ventures			1,908				3,406				4,071				6,602
Total		$	6,734			$	6,664			$	13,083			$	13,676
(Loss) Earnings:
CL Realty(d)		$	(5,478	)		$	3,094			$	(4,974	)		$	5,407
Temco			(523	)			488				(943	)			209
Palisades West			1,889				52				2,037				90
Other ventures			(1,519	)			73				(324	)			(226	)
Total		$	(5,631	)		$	3,707			$	(4,204	)		$	5,480

		Second Quarter								First Six Months
		2009				2008				2009				2008
						(In thousands)
Our equity in their (loss) earnings:
CL Realty(c)		$	(2,739	)		$	1,547			$	(2,487	)		$	2,690
Temco			(261	)			244				(471	)			103
Palisades West			472				13				509				22
Other ventures(b)			(1,520	)			207				(2,171	)			730
Recognition of deferred gain(c)			—				7				—				7
Total		$	(4,048	)		$	2,018			$	(4,620	)		$	3,552

     In first six months 2009, we invested $1,494,000 in these ventures and received $2,522,000 in distributions; in first six months 2008, we invested $11,339,000 in these ventures and received $5,258,000 in distributions. Distributions include both return of investments and distributions of earnings.

Note 8 — Debt

     Debt consists of:

		June 30,				December 31,
		2009				2008
		(In thousands)
Term loan facility — average interest rate of 4.32% at second quarter-end 2009 and 4.77% at year-end 2008		$	136,000			$	175,000
Revolving loan facility — average interest rate of 5.12% at year-end 2008			—				59,900
Secured promissory note — interest rate of 2.81% at second quarter-end 2009 and 3.01% at year-end 2008			19,716				16,000
Other indebtedness due through 2011 at variable interest rates based on prime (3.25% at second quarter-end 2009 and year-end 2008) and fixed interest rates ranging from 8.00% to 9.50%			82,050				86,502
		$	237,766			$	337,402

     Our senior credit facility and other debt agreements contain terms, conditions and financial covenants customary for such agreements including minimum levels of interest coverage and limitations on leverage. At second quarter-end 2009, we were in compliance with the terms, conditions and financial covenants of these agreements.

     In second quarter 2009, we reduced our term loan by $39,000,000 and repaid our revolving line of credit in the amount of $72,000,000 from proceeds received as a result of selling about 75,000 acres of timber and timberland in Georgia and Alabama, in accordance with our near-term strategic initiatives.

     At second quarter-end 2009, our senior credit facility provides for a $136,000,000 term loan and a $290,000,000 revolving line of credit. The term loan and revolving line of credit may be prepaid at any time without penalty. The senior credit facility matures December 1, 2010. The revolving line of credit includes a $100,000,000 sublimit for letters of credit, of which $13,071,000 was outstanding at second quarter-end 2009. Total borrowings under our senior credit facility (including the face amount of letters of credit) may not exceed a borrowing base formula, and include a $35,000,000 minimum liquidity requirement at each quarter-end. At second quarter-end 2009, we had $215,286,000 in net unused borrowing capacity under our senior credit facility.

     At our option, we can borrow at LIBOR plus 4 percent or Prime plus 2 percent. All borrowings under the senior credit facility are secured by (a) an initial pledge of approximately 250,000 acres of undeveloped land, (b) assignments of current and future leases, rents and contracts, including our mineral leases, (c) a security interest in our primary operating account, (d) pledge of the equity interests in current and future material operating subsidiaries or joint venture interests, or if such pledge is not permitted, a pledge of the right to distributions from such entities, and (e) negative pledge (without a mortgage) on all other wholly-owned assets. The senior credit facility provides for releases of real estate provided that borrowing base compliance is maintained.

     We incurred origination and other fees related to our credit facility of $10,573,000, of which $5,162,000 is unamortized at second quarter-end 2009 and is included in other assets. Amortization of deferred financing fees in connection with our senior credit facility was $1,766,000 in first six months 2009 and $1,739,000 in first six months 2008.

     At second quarter-end 2009, commercial operating properties having a book value of $23,166,000 were subject to liens in connection with $19,716,000 of debt.

     At second quarter-end 2009, entitled, developed and under development projects having a book value of $161,343,000 were subject to liens in connection with $82,050,000 of principally non-recourse debt.

     On July 16, 2009, we amended our senior credit facility, portions of which were amended effective June 30, 2009. Please read Note 18 — Subsequent Events for a summary of the principal amendments.

Note 9 — Derivative Instruments

     We are exposed to certain risks arising from both our business operations and economic conditions. We principally manage exposures to a wide variety of business and operational risks through management of our core business activities. We manage economic risks including interest rate and liquidity by managing the amount, sources and duration of our debt funding and through the use of derivative instruments. Specifically, we may enter into derivative instruments to mitigate the risk inherent in interest rate fluctuations.

     Cash Flow Hedges

     Our objective for using interest rate derivatives is to manage exposure to significant movements in interest rates. To accomplish this objective, we use interest rate swaps as part of our interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for our fixed-rate payment over the life of the agreements without exchange of the underlying notional amount.

     At second quarter-end 2009, our $100,000,000 notional amount interest rate swap agreement, which matures in 2010, requires that we pay a fixed interest rate of 6.57 percent and receive a floating interest rate of one month LIBOR plus 4 percent (4.32 percent at second quarter-end 2009).

     We defer and include in other comprehensive income the effective portion of changes in the fair value of our cash flow hedge. We recognize the ineffective portion of the hedge as income or loss. The effectiveness of the hedge relationship is periodically assessed by comparing the present value of the cumulative change in the expected future cash flows on the variable leg of the swap with the present value of the cumulative change in the expected future hedged cash flows. In first six months 2009 and 2008, there was no hedge ineffectiveness.

     The table below presents the fair value of our derivative instrument as well as its classification on the consolidated balance sheets:

Liability Derivatives

June 30, 2009

December 31, 2008

Balance Sheet

Fair

Balance Sheet

Fair

Location

Value

Location

Value

Derivatives designated as hedging instruments under SFAS No. 133:

Interest rate swap

Other liabilities

$

1,371

Other liabilities

$

1,939

     The change in fair value of our interest rate swap recognized in other comprehensive income was a gain of $369,000 in first six months 2009 and a gain of $664,000 in first six months 2008. No amounts were reclassified from other comprehensive income into income in first six months 2009 or first six months 2008.

     Please read Note 10 — Fair Value for a description of how the above derivative instrument is valued in accordance with SFAS No. 157.

Note 10 — Fair Value

     SFAS No. 157, Fair Value Measurements, provides a framework for measuring fair value and expands disclosures required about fair value measurements. This pronouncement establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

	•		Level 1 Inputs — Unadjusted quoted prices for identical assets or liabilities in active markets;
	•		Level 2 Inputs — Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in inactive markets, and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and
	•		Level 3 Inputs — Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable. Such inputs typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability.

		Fair Value Measurements
		Level 1				Level 2				Level 3				June 30,
		Inputs				Inputs				Inputs				2009
		(In thousands)
Financial Assets and Liabilities:
Interest rate swap agreement		$	(1,371	)		$	—			$	—			$	(1,371	)
Non-Financial Assets and Liabilities:
Real estate(a)		$	—			$	—			$	15,164			$	15,164
Assets held for sale		$	—			$	586			$	—			$	586

     Financial liabilities measured at fair value on a recurring basis include our interest rate swap agreement. The fair value of the interest rate swap agreement was determined using quoted prices in active markets for identical assets. In first six months 2009, the fair value of our interest rate swap increased, and as a result, we recognized an after-tax gain of $369,000 in accumulated other comprehensive income.

     Non-financial assets measured at fair value on a non-recurring basis include real estate assets and other assets measured for impairment. In first six months 2009, certain assets were remeasured and reported at fair value due to events or circumstances that indicated the carrying value may not be recoverable. We determined estimated fair value of real estate assets based on the present value of future probability weighted cash flows expected from the sale of the long-lived assets. As a result, we recognized asset impairment of $600,000 in first six months 2009. We determined estimated fair value of assets held for sale based on a non-binding agreement to purchase. As a result, we recognized asset impairment of $241,000 in first six months 2009.

     The carrying amounts and fair values of our financial instruments follow:

		June 30, 2009								December 31, 2008
		Carrying				Fair				Carrying				Fair
		Amount				Value				Amount				Value
		(In thousands)
Cash and cash equivalents		$	17,053			$	17,053			$	8,127			$	8,127
Receivables, net			3,926				3,926				4,262				4,262
Accounts payable			(4,847	)			(4,847	)			(7,438	)			(7,438	)
Interest rate swap agreement			(1,371	)			(1,371	)			(1,939	)			(1,939	)
Debt			(237,766	)			(237,939	)			(337,402	)			(337,684	)

     At second quarter-end 2009 and year-end 2008, carrying amounts of cash and cash equivalents, receivables and accounts payable approximate their fair values due to the short-term nature of these assets and liabilities. The interest rate swap agreement is carried at its fair value. The carrying amount of debt approximates fair value since it is primarily made up of variable-rate borrowings. We estimated the fair value of our fixed-rate borrowings using quoted market prices for similar securities (Level 2).

Note 11 — Capital Stock

     Pursuant to our shareholder rights plan, each share of common stock outstanding is coupled with one-quarter of a preferred stock purchase right (Right). Each Right entitles our shareholders to purchase, under certain conditions, one one-hundredth of a share of newly issued Series A Junior Participating Preferred Stock at an exercise price of $100. Rights will be exercisable only if someone acquires beneficial ownership of 20 percent or more of our common shares or commences a tender or exchange offer, upon consummation of which they would beneficially own 20 percent or more of our common shares. We will generally be entitled to redeem the Rights at $0.001 per Right at any time until the 10th business day following public announcement that a 20 percent position has been acquired. The Rights will expire on December 11, 2017.

     Please read Note 16 — Share-Based Compensation for information about additional shares of common stock that could be issued under terms of our share-based compensation plans.

     As a result of our spin-off from Temple-Inland, all of Temple-Inland’s outstanding share-based compensation awards were equitably adjusted into separate awards: one related to our common stock, one related to Temple-Inland common stock and one related to Guaranty Financial Group, Inc. common stock. Guaranty was another wholly-owned subsidiary of Temple-Inland that was spun off on December 28, 2007. All awards issued as part of this adjustment are subject to their original vesting schedules.

     At second quarter-end 2009, Temple-Inland and Guaranty directors and employees held 26,000 equity-settled restricted stock awards on our stock. The following table summarizes outstanding stock option awards on our stock held by Temple-Inland and Guaranty directors and employees at second quarter-end 2009:

Weighted

Aggregate

Average

Intrinsic Value

Weighted

Remaining

(Current

Average

Contractual

Value Less

Shares

Exercise Price

Term

Exercise Price)

(In thousands)

(Per share)

(In years)

(In thousands)

Outstanding

1,704

$

19.25

5

$

647

Exercisable

1,530

$

18.10

4

$

647

Note 12 — Other Comprehensive Income

     Other comprehensive income consists of:

		Second Quarter								First Six Months
		2009				2008				2009				2008
		(In thousands)
Consolidated net income		$	51,112			$	10,126			$	48,063			$	10,388
Change in fair value of interest rate swap agreement			320				1,529				568				1,022
Income tax effect of change in fair value			(112	)			(535	)			(199	)			(358	)
Other comprehensive income			51,320				11,120				48,432				11,052
Less: Comprehensive income attributable to noncontrolling interests			(195	)			(530	)			(1,038	)			(1,030	)
Other comprehensive income attributable to Forestar Group Inc.		$	51,125			$	10,590			$	47,394			$	10,022

Note 13 — Net Income per Share

     Our basic and diluted weighted average common shares outstanding used to compute net income per share are as follows:

		Second Quarter								First Six Months
		2009				2008				2009				2008
		(In thousands)
Weighted average common shares outstanding — basic			35,808				35,422				35,745				35,390
Dilutive effect of stock options			60				511				26				474
Dilutive effect of restricted stock and restricted stock units			169				184				132				199
Weighted average common shares outstanding — diluted			36,037				36,117				35,903				36,063

     At second quarter-end 2009, the effect of 2,329,000 stock options and unvested shares of restricted stock were not included in the computation of diluted weighted average shares outstanding because their impact would have been anti-dilutive.

     At second quarter-end 2008, the effect of 1,434,000 stock options and unvested shares of restricted stock were not included in the computation of diluted weighted average shares outstanding because their impact would have been anti-dilutive.

Note 14— Commitments and Contingencies

     Litigation

     We are involved in various legal proceedings that arise from time to time in the ordinary course of doing business and 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. It is possible, however, 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. We own 288 acres near Antioch, California, portions of which were sites of a Temple-Inland paper manufacturing operation that are in remediation. In 2008, we increased our reserves for environmental remediation by about $2,900,000. We estimate the cost to complete remediation activities will be about $2,500,000, which is included in other accrued expenses. Our estimate requires us to make assumptions regarding the scope of required remediation, effectiveness of planned remediation activities and approvals by regulatory authorities. Our estimate is subject to revision as new information becomes available.

Note 15 — Segment Information

     We manage our operations through three segments: real estate, mineral resources and fiber resources. 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 operating properties. Mineral resources manages our oil and gas mineral interests. Fiber resources manages our timber and recreational leases.

     Assets allocated by segment are as follows:

		June 30,				December 31,
		2009				2008
		(In thousands)
Real estate		$	677,753			$	732,401
Mineral resources			1,189				376
Fiber resources			22,117				51,321
Assets not allocated to segments			108,470				50,478
Total assets		$	809,529			$	834,576

     We evaluate performance based on segment earnings before unallocated items and income taxes. Segment earnings consist of operating income, equity in earnings of unconsolidated ventures and net income attributable to noncontrolling interests. Unallocated items consist of general and administrative expense, share-based compensation, gain on sale of assets, interest expense and other non-operating income and expense. All our revenues are derived from U.S. operations and all our assets are located in the U.S. For first six months 2009, revenues from one customer of our real estate segment exceeded 10% of our total revenues.

     Segment revenues and earnings are as follows:

		Second Quarter								First Six Months
		2009				2008				2009				2008
		(In thousands)
Revenues:
Real estate		$	28,447			$	24,118			$	47,234			$	52,561
Mineral resources			7,018				24,386				12,939				30,654
Fiber resources			5,001				3,093				9,370				5,605
Total revenues		$	40,466			$	51,597			$	69,543			$	88,820
Segment earnings:
Real estate		$	5,007			$	874			$	5,549			$	4,417
Mineral resources			6,401				23,247				11,183				29,752
Fiber resources			3,290				1,411				6,199				4,251
Total segment earnings			14,698				25,532				22,931				38,420
Items not allocated to segments(a)			67,339				(11,125	)			52,899				(24,396	)
Income before taxes		$	82,037			$	14,407			$	75,830			$	14,024

		Second Quarter								First Six Months
		2009				2008				2009				2008
		(In thousands)
General and administrative expense		$	(4,257	)		$	(5,348	)		$	(11,876	)		$	(10,354	)
Share-based compensation expense			(2,615	)			(847	)			(4,321	)			(3,528	)
Gain on sale of assets			79,214				—				79,214				—
Interest expense			(5,047	)			(5,002	)			(10,213	)			(10,668	)
Other non-operating income			44				72				95				154
		$	67,339			$	(11,125	)		$	52,899			$	(24,396	)

     In second quarter 2009, gain on sale of assets of $79,214,000 represents our gain from selling about 75,000 acres of timber and timberland in Georgia and Alabama for $119,702,000 to Hancock Timber Resource Group, which acquired the assets on behalf of its investor clients.

     Share-based compensation increased principally due to our higher stock price in second quarter 2009 associated with our cash settled equity awards.

     In first six months 2009, general and administrative expense includes $3,180,000 paid to outside advisors regarding an evaluation by our Board of Directors of an unsolicited shareholder proposal.

Note 16 — Share-Based Compensation

Post-Spin Awards

     A summary of the awards granted under our 2007 Stock Incentive Plan follows.

Cash-settled awards

     Cash-settled awards granted to our employees in the form of restricted stock units or stock appreciation rights vest over two to four years from the date of grant and generally provide for accelerated vesting upon death, disability or if there is a change in control. Vesting for some awards is also conditioned upon achievement of a minimum one percent annualized return on assets over a three-year period.

     Cash-settled awards granted to our directors in the form of restricted stock units are fully vested at the time of grant and payable upon retirement.

     The following table summarizes the activity of awards granted under our plan for first six months 2009:

						Weighted
		Equivalent				Average Grant
		Units				Date Fair Value
		(In thousands)				(Per unit)
Non-vested at December 31, 2008			5			$	28.85
Granted			1,119				5.66
Vested			(118	)			8.65
Forfeited			(1	)			28.85
Non-vested at June 30, 2009			1,005			$	5.41

     In first six months 2009, we paid $22,000 to settle vested cash awards. The aggregate current value of non-vested awards at second quarter-end 2009 is $5,097,000.

Equity-settled awards

     There were no equity-settled awards in the form of restricted stock units granted in first six months 2009, and there were no unvested equity-settled restricted stock unit awards at second quarter-end 2009.

Restricted stock

     Restricted stock awards vest after three years if we achieve a minimum one percent annualized return on assets over such three-year period. The following table summarizes the activity of awards granted under our plan for first six months 2009:

						Weighted
		Equivalent				Average Grant
		Units				Date Fair Value
		(In thousands)				(Per share)
Non-vested at December 31, 2008			207			$	21.89
Granted			110				9.29
Vested			—				—
Forfeited			(1	)			28.85
Non-vested at June 30, 2009			316			$	17.45

     The aggregate current value of non-vested awards at second quarter-end 2009 is $3,752,000, or $11.88 per share.

Stock options

     Stock options have a ten-year term, generally become exercisable ratably over three to four years and provide for accelerated or continued vesting upon retirement, death, disability or if there is a change in control. Options were granted with an exercise price equal to the market value of our stock on the date of grant. The following table summarizes the activity of awards granted under our plan for first six months 2009:

										Weighted
										Average
						Weighted				Remaining
		Options				Average				Contractual
		Outstanding				Exercise Price				Term
		(In thousands)				(Per share)				(In years)
Balance at December 31, 2008			622			$	28.85				9
Granted			161				9.29
Exercised			—				—
Forfeited			(3	)			28.85
Balance at June 30, 2009			780			$	24.80				9
Exercisable at June 30, 2009			183			$	28.85				9

     The aggregate intrinsic value of stock options outstanding was $419,000 at second quarter-end 2009. There was no aggregate intrinsic value of stock options exercisable at second quarter-end 2009.

     Stock options are valued based upon the Black-Scholes option pricing model. Awards granted in first six months 2009 were valued based upon the following assumptions:

Expected dividend yield			0.0	%
Expected stock price volatility			41.8	%
Risk-free interest rate			1.8	%
Expected life of options (years)			6
Weighted average estimated fair value of options granted		$	3.94

     We have limited historical experience as a stand alone company so we utilized alternative methods in determining our valuation assumptions. The expected life was based on the simplified method utilizing the midpoint between the vesting period and the contractual life of the awards. The expected stock price volatility was based on historical prices of our peers’ common stock for a period corresponding to the expected life of the options. Pre-vesting forfeitures are estimated based upon the pool of participants and their expected activity.

Pre-Spin Awards

     Prior to the spin-off, we participated in Temple-Inland’s share-based compensation plans, and as a result, certain of our employees received share-based compensation in the form of restricted or performance stock units, restricted stock or options to purchase shares of Temple-Inland’s common stock. Concurrent with Temple-Inland’s distribution of our common stock, all outstanding Temple-Inland awards were adjusted into three separate awards: one related to Forestar common stock, one related to Guaranty common stock and one related to Temple-Inland common stock.

Cash-settled awards

     Cash-settled awards generally vest and are paid after three years from the date of grant or the attainment of defined performance goals, generally measured over a three-year period. A summary of cash-settled awards outstanding to our employees at second quarter-end 2009, following the adjustments described previously, follows:

						Aggregate
		Equivalent				Current
		Units				Value
		(In thousands)
Awards on Forestar stock			24			$	283
Awards on Guaranty stock			24				5
Awards on Temple-Inland stock			72				939
						$	1,227

     In first six months 2009, we paid $394,000 to settle vested cash awards.

Stock options

     Stock options have a ten-year term, generally become exercisable ratably over four years and provide for accelerated or continued vesting upon retirement, death, disability or if there is a change in control. Options were granted with an exercise price equal to the market value of Temple-Inland common stock on the date of grant. A summary of stock option awards outstanding to our employees at second quarter-end 2009, following the adjustments described previously, follows:

										Weighted				Aggregate
										Average				Intrinsic Value
						Weighted				Remaining				(Current
						Average				Contractual				Value Less
		Shares				Exercise Price				Term				Exercise Price)
		(In thousands)				(Per share)				(In years)				(In thousands)
Outstanding on Forestar stock			86			$	21.12				5			$	33
Outstanding on Guaranty stock			86				13.55				5				—
Outstanding on Temple-Inland stock			255				16.89				5				345
														$	378
Exercisable on Forestar stock			70			$	19.34				5			$	33
Exercisable on Guaranty stock			70				12.41				5				—
Exercisable on Temple-Inland stock			209				15.47				5				345
														$	378

     No options were exercised in first six months 2009.

Share-Based Compensation Expense

     Share-based compensation expense for post-spin and pre-spin awards consists of:

		Second Quarter								First Six Months
		2009				2008				2009				2008
		(In thousands)
Cash-settled awards		$	1,693			$	55			$	2,473			$	195
Equity-settled awards			—				—				—				750
Restricted stock			455				328				799				517
Stock options			467				464				1,049				2,066
Pre-tax share-based compensation expense			2,615				847				4,321				3,528
Income tax benefit			(968	)			(322	)			(1,599	)			(1,341	)
		$	1,647			$	525			$	2,722			$	2,187

     Share-based compensation increased in second quarter and first six months 2009 principally due to a greater number of cash-settled awards issued in 2009.

     The fair value of awards granted to retirement-eligible employees and expensed at the date of grant was $135,000 in first six months 2009 and $1,321,000 in first six months 2008.

     Pre-tax share-based compensation expense is included in:

		Second Quarter								First Six Months
		2009				2008				2009				2008
		(In thousands)
General and administrative expense		$	1,686			$	598			$	2,882			$	2,429
Other operating expense			929				249				1,439				1,099
		$	2,615			$	847			$	4,321			$	3,528

     We did not capitalize any share-based compensation in first six months 2009 or 2008.

     Unrecognized share-based compensation for post-spin awards not vested was $6,969,000 at second quarter-end 2009. The weighted average period over which this amount will be recognized is estimated to be 2.2 years. Unrecognized share-based compensation for pre-spin awards not vested was $348,000 at second quarter-end 2009. The weighted average period over which this amount will be recognized is estimated to be 1.0 years.

     In connection with restricted stock vested and stock options exercised, we withheld shares having a value of $31,000 for payment of payroll taxes in first six months 2009. These shares are accounted for as treasury stock. Payroll taxes on restricted stock and stock options are reflected in financing activities in our consolidated statement of cash flows.

Note 17 — Income Taxes

     Our effective tax rate was 38% in second quarter 2009 and 37% in first six months 2009 both of which include less than a 1% benefit attributable to noncontrolling interests. Our effective tax rate was 32% in second quarter 2008 and 31% in first six months 2008 both of which include about a 2% benefit attributable to noncontrolling interests as well as benefits from percentage depletion and a federal income tax rate change for qualified timber gains due to the Food, Conservation and Energy Act of 2008. As a result of our adoption of SFAS No. 160, income before income taxes includes income from pass-through entities allocable to noncontrolling interests for which there is no income tax provided.

     We anticipate that our effective tax rate in 2009 will be about 37% of which less than 1% will be attributable to noncontrolling interests.

     We have not provided a valuation allowance for our deferred tax asset because we believe it is likely it will be recoverable in future periods.

     In second quarter 2009, we recorded a liability of $5,291,000 related to tax benefits not recognized for book purposes, which is included in other liabilities.

Note 18 — Subsequent Events

     We have evaluated subsequent events through August 6, 2009, the date of issuance of these financial statements.

     On July 16, 2009, we amended the terms of our senior credit facility, portions of which were amended effective June 30, 2009. The principal amendments were to maintain the interest coverage ratio at 1.50x through December 31, 2009 and, thereafter, adjust to 1.75x; to provide us with the option to extend the maturity date for up to $350,000,000 through June 30, 2012; to reduce the aggregate commitments by $850 per acre of HBU timberland sold pursuant to our near-term strategic initiatives, with such reduction being split 60% to reduce the term loan commitment and 40% to reduce the revolver commitment; to provide that if the interest coverage ratio is less than 2.0x, we will not be permitted to make any company or asset acquisitions without prior approval of the administrative agent; to include all our timberland and high value timberland as collateral and to add a new financial covenant requiring a minimum defined collateral-to-total commitment ratio of 1.75x; to revise the calculation of the consolidated tangible net worth covenant to increase the percentage of our cumulative positive net income included in the calculation from 50% to 75%; to add an additional requirement in the event we desire to pay a dividend on or repurchase our outstanding shares that we have a minimum pro-forma liquidity of $125,000,000 immediately after such payment; to revise the minimum liquidity financial covenant to require a minimum available liquidity at least equal to the lesser of the existing $35,000,000 requirement or 7.5% of the aggregate commitment under the senior credit facility; to establish a minimum interest rate floor of 2% per annum on non-hedged loans; and to increase the interest margin added to the LIBOR and base rate loans by 0.5% per annum. We incurred fees of $2,955,000 related to these amendments. Assuming the sale of about 175,000 acres of HBU timberland in accordance with our near-term strategic initiatives, the total aggregate commitment under our senior credit facility will be $316,250,000, consisting of $85,750,000 under the term loan and $230,500,000 under the revolving line of credit.

     On August 4, 2009, we completed our previously announced sale of about 20,000 acres of timber and timberland in Georgia to St. Regis Paper Company, LLC, assignee of Holland M. Ware, for approximately $39,500,000 in a cash transaction. We intend to use the proceeds from this sale to reduce outstanding debt in accordance with our near-term strategic initiatives.

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 2008 Annual Report on Form 10-K. Unless otherwise indicated, information is presented as of June 30, 2009, and references to acreage owned include 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 risk 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;
	•		economic, market or business conditions in Texas or Georgia, where our real estate activities are concentrated;
	•		the opportunities (or lack thereof) that may be presented to us and that we may pursue;
	•		future residential or commercial entitlements;
	•		expected development timetables and projected timing for sales of lots or other parcels of land;
	•		development approvals and the ability to obtain such approvals;
	•		the anticipated price ranges of lots in our developments;
	•		the number, price and timing of land sales or acquisitions;
	•		absorption rates and expected gains on land and lot sales;
	•		the levels of resale inventory in our development projects and the regions in which they are located;
	•		the development of relationships with strategic partners;
	•		fluctuations in costs and expenses;
	•		demand for new housing, which can be affected by the availability of mortgage credit;
	•		government energy policies;
	•		demand for oil and gas;
	•		fluctuations in oil and gas prices;
	•		competitive actions by other companies;
	•		changes in laws or regulations and actions or restrictions of regulatory agencies;
	•		the results of financing efforts, including our ability to obtain financing with favorable terms;
	•		our partners’ ability to fund their capital commitments;
	•		the ability to complete merger, acquisition or divestiture plans; regulatory or other limitations imposed as a result of a merger, acquisition or divestiture; and the success of the business following a merger, acquisition or divestiture;
	•		the final resolutions or outcomes with respect to our contingent and other corporate liabilities related to our business; and
	•		our customers may be unwilling or unable to meet lot takedown commitments due to liquidity limitations or slowing market conditions.

     Other factors, including the risk factors described in Item 1A of our 2008 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.

     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.

Background

     Prior to December 28, 2007, we were a wholly-owned subsidiary of Temple-Inland Inc. On December 28, 2007, Temple-Inland distributed all our issued and outstanding shares of common stock to its shareholders in a transaction commonly referred to as a spin-off. In 2008, we operated our first full year as a stand-alone public company and the following discussion and analysis reflect the post-spin results of operations and the effect on our financial condition.

Strategy

     Our strategy is to maximize and grow long-term shareholder value through:

	•		Entitlement and development of real estate;
	•		Realization of value from minerals, water and fiber resources; and
	•		Strategic and disciplined investment in our business.

     In first quarter 2009, we announced our near-term strategic initiatives to enhance shareholder value by generating significant cash flow, principally from the sale of about 175,000 acres of higher and better use (HBU) timberland. As a result, we classified to assets held for sale about 171,000 acres of undeveloped land principally located in Alabama and Georgia with a carrying value of $51,390,000 and related timber with a carrying value of $24,749,000.

     In accordance with our strategic initiatives, in second quarter 2009, we sold about 75,000 acres of timber and timberland in Georgia and Alabama for $119,702,000 to Hancock Timber Resource Group, which acquired the assets on behalf of its investor clients. The transaction generated net proceeds of $116,116,000, which were principally used to reduce our outstanding debt, and resulted in a gain on sale of $79,214,000. In addition, in second quarter 2009, we entered into a definitive agreement with Holland M. Ware to sell about 20,000 acres of HBU timberland in Georgia for approximately $39,500,000 in a cash transaction. The sale closed August 4, 2009. We intend to use the after-tax cash proceeds from this sale to reduce our outstanding debt.

     At second quarter-end 2009, we have classified to assets held for sale about 95,000 acres of undeveloped land located in Alabama, Georgia and Texas with a carrying value of $26,486,000, related timber with a carrying value of $13,939,000 and other assets with a carrying value of $586,000. These assets are being actively marketed.

Results of Operations

     Net income was $50,917,000, or $1.42 per basic share and $1.41 per diluted share, in second quarter 2009, compared with $9,596,000, or $0.27 per basic and diluted share, in second quarter 2008. Net income for first six months 2009 was $47,025,000, or $1.32 per basic share and $1.31 per diluted share, compared with $9,358,000, or $0.26 per basic and diluted share, in first six months 2008.

     A summary of our consolidated results follows:

		Second Quarter								First Six Months
		2009				2008				2009				2008
		(In thousands)
Revenues:
Real estate		$	28,447			$	24,118			$	47,234			$	52,561
Mineral resources			7,018				24,386				12,939				30,654
Fiber resources			5,001				3,093				9,370				5,605
Total revenues		$	40,466			$	51,597			$	69,543			$	88,820
Segment earnings:
Real estate		$	5,007			$	874			$	5,549			$	4,417
Mineral resources			6,401				23,247				11,183				29,752
Fiber resources			3,290				1,411				6,199				4,251
Total segment earnings			14,698				25,532				22,931				38,420
Items not allocated to segments:
General and administrative expense			(4,257	)			(5,348	)			(11,876	)			(10,354	)
Share-based compensation expense			(2,615	)			(847	)			(4,321	)			(3,528	)
Gain on sale of assets			79,214				—				79,214				—
Interest expense			(5,047	)			(5,002	)			(10,213	)			(10,668	)
Other non-operating income			44				72				95				154
Income before taxes			82,037				14,407				75,830				14,024
Income tax expense			(31,120	)			(4,811	)			(28,805	)			(4,666	)
Net income attributable to Forestar Group Inc.		$	50,917			$	9,596			$	47,025			$	9,358