AMERICAN REALTY INVESTORS INC quarterly report, Q2 FY2019

American Realty Investors, Inc. — Q2 2019 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2019. Financial statements are unaudited; dollar amounts below are in millions unless otherwise noted.

Business context

ARL is an externally advised real estate company with commercial properties, apartments, development land and mortgage notes. At quarter-end it reported seven commercial properties, nine directly owned apartment communities with 1,512 units, approximately 2,293 acres of land, and a 50% investment in Victory Abode Apartments (VAA), which owned 51 communities with 9,643 units. ARL consolidates TCI and IOR. More than 80% of ARL shares are owned by related-party entities.

Financial performance and position

Metric	Q2 2019	Q2 2018	Six months 2019	Six months 2018
Rental and other property revenue	$11.8	$31.6	$23.8	$62.7
Operating income (loss)	($4.4)	$3.6	($6.1)	$8.5
Net income (loss) attributable to ARL	($2.8)	$5.9	($8.9)	$5.2
Net income (loss) applicable to common shares	($2.8)	$5.6	($8.9)	$4.7
Basic and diluted EPS	($0.17)	$0.35 basic	($0.56)	$0.30 basic

Operating margin, calculated as operating income or loss divided by property revenue, was approximately negative 37% for Q2 and negative 26% for the first half, versus positive 11% and 14%, respectively, in 2018. These comparisons are affected by the substantial change in the consolidated property portfolio.

Cash flow, first half: Operating activities used $15.5; investing activities used $7.9; financing activities used $1.0. Cash and restricted cash totaled $82.2 at June 30, compared with $106.6 at the start of the year. Of the ending total, $37.6 was unrestricted cash and $44.6 was restricted.
Debt: Notes payable were $301.2 gross ($293.1 net of deferred costs and including accrued interest); bonds were $159.4 gross ($157.3 net and including accrued interest). Combined reported balances were approximately $450.4. Debt increased from year-end on the notes payable balance, while bonds declined. Variable-rate notes payable totaled $41.6; management estimated a 100-basis-point rate increase would add about $0.2 to annual interest expense.
Liquidity and equity: Total assets were $817.6, total liabilities $506.9, and shareholders’ equity $310.7. Notes and interest receivable were $159.6 net of a $14.3 loss allowance; investment in VAA was $67.1. The filing does not present a classified current-liability total or current ratio.

Material changes versus prior period

Revenue fell $19.8 in Q2 and $38.9 in the first half, mainly because 49 apartment properties were contributed to VAA in late 2018 and were no longer consolidated. Their revenue and expenses are no longer reported line by line; ARL instead records its equity-method share of VAA results.
Operating costs and depreciation declined alongside the smaller consolidated portfolio. Mortgage and loan interest expense also fell, by $6.5 in Q2 and $12.2 in the first half.
General and administrative expense rose to $4.1 in Q2 and $6.7 in the first half, principally reflecting higher advisor fees and, for the quarter, higher professional fees and franchise taxes.
Foreign-currency results swung from gains of $5.9 in Q2 2018 and $7.6 in the first half of 2018 to losses of $2.3 and $8.1, respectively, in 2019, largely due to NIS-denominated bonds.
First-half land-sale gains were $4.7 versus $1.3 in 2018. ARL also recorded a $0.08 loss on the sale of a Florida apartment property.

Outlook, risks and unusual items

Management expects TCI to generate excess cash from property operations in 2019 but says it will not be enough to meet all obligations as they come due. Planned liquidity measures include selling land and income-producing real estate, refinancing, and obtaining additional real-estate-secured borrowing. No earnings or revenue guidance is provided.
On July 28, 2019, after quarter-end, the company issued Series C bonds for NIS 275 million (approximately $78 million) at 4.65% annual interest, secured by a commercial building. On August 9, approximately $42 million of proceeds was used to repay that building’s mortgage.
Related-party exposure is significant: the balance sheet included $61.7 due from a related party, and notes and interest receivable included $106.1 from related parties. During Q2, the company purchased $31.9 of related-party notes; related-party interest income was $12.3 for the first half. Management cautions that related-party transactions may not be on arm’s-length terms.
The company is primary guarantor on a $39.1 mezzanine loan to UHF; UHF was reported in compliance with loan covenants at June 30. The filing also describes litigation involving ARL/affiliates, including the Berger case; defendants deny the allegations and motions to dismiss were pending. Management says ordinary-course litigation is not expected to materially affect the company, while continuing to defend the matters described.
Other risks include property demand and leasing, financing availability and cost, development delays or overruns, asset-sale timing, interest rates, and foreign-exchange exposure. Management reported no material environmental liability known and no change in risk factors from the 2018 Form 10-K. Disclosure controls were reported effective.

Key facts for investors to verify

How much of the revenue and earnings decline reflects VAA deconsolidation versus underlying property performance, and how VAA’s losses may affect future equity-method results.
Repayment and collectability of related-party notes and receivables, including UHF/FBH exposures and the $31.9 of notes purchased during Q2.
Near-term debt maturities, refinancing progress, and whether planned asset sales and new borrowing will cover obligations; management says expected TCI operating cash is insufficient on its own.
Foreign-exchange sensitivity and the effect of NIS-denominated bonds, including the post-quarter Series C issuance and use of proceeds.
Terms, collateral and potential exposure associated with the UHF mezzanine-loan guarantee, and developments in pending litigation.