American Realty Investors, Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Unless noted otherwise, dollar figures below are in millions. The company is an externally advised real estate owner and lender; its portfolio included 50 apartment communities (8,226 units), eight commercial properties, a golf course, and 3,674 acres of land.
Financial performance and position
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Rental and other property revenue | $31.6 | $30.8 | $63.4 | $60.0 |
| Reported net operating income | $4.8 | $4.6 | $9.3 | $7.9 |
| Net income (loss) attributable to ARL | ($10.9) | $2.5 | ($16.6) | ($0.7) |
| Net income (loss) applicable to common shares | ($11.2) | $2.4 | ($17.2) | ($1.3) |
| Diluted loss per share from continuing operations | ($0.72) | $0.16 | ($1.11) | ($0.08) |
Reported net operating income was approximately 15.3% of revenue in Q2 and 14.7% for the first half; this is the filing’s reported measure, not a separately defined margin measure. Six-month property operating costs rose to $31.7 million and depreciation and amortization to $12.7 million.
- Cash flow, first half: Operating activities provided $0.5 million, down from $34.4 million. Investing used $23.2 million versus $50.8 million; financing provided $65.7 million versus $20.3 million. Cash and cash equivalents ended the period at $58.3 million, compared with $17.5 million at December 31, 2016. Restricted cash was $37.6 million.
- Balance sheet: Total assets were $1,232.7 million, up from $1,174.9 million at year-end. Total liabilities were $1,074.6 million and shareholders’ equity $158.1 million. Notes and interest payable were $826.3 million; bonds and bond interest payable were $104.5 million. The notes-payable disclosure separately reports $830.7 million including accrued interest and net deferred borrowing costs; debt categories should not be added without reconciling presentation.
- Liquidity and interest: First-half cash interest paid was $28.1 million. Management said anticipated excess property cash flow in 2017 would not be enough to discharge all obligations as due and expected to rely on asset sales, refinancing, extensions, and additional borrowing.
Material changes and notable items
- Revenue increased 2.4% in Q2 and 5.6% for the first half year over year, primarily reflecting apartment portfolio growth. The company said acquisitions and dispositions over the prior year resulted in a net increase of 203 apartment units.
- Despite higher revenue and reported net operating income, higher financing costs and a new foreign-exchange loss drove the period losses. Mortgage and loan interest expense rose to $17.3 million in Q2 and $34.1 million for the first half, from $14.0 million and $28.2 million, respectively.
- The indirect subsidiary Southern Properties Capital issued Israeli-shekel-denominated Series A bonds in 2017. The bonds carry a stated 7.3% rate and 9.25% effective yield; principal and interest are payable in shekels. The company recorded a noncash foreign-currency transaction loss of $3.4 million in Q2 and $3.7 million for the first half. A further bond sale of about $6.7 million occurred July 12, 2017.
- No income-producing properties were sold in the first half, compared with sales and gains in 2016. The company acquired four development land parcels for $12.9 million and sold 10.82 acres for $1.6 million, recording a loss of less than $0.1 million for the first half.
- Development continued: seven apartment projects were in development at June 30. The company reported $24.4 million of construction or predevelopment disbursements during the first half and $26.7 million of construction and development spending in cash flows.
Outlook, risks, and contingencies
- No quantified earnings or operating guidance was provided. Management’s liquidity plan depends on property operations, sales of land or income-producing real estate, debt refinancing or extension, and additional secured borrowing.
- Management disclosed mortgages on properties previously sold to a related party but accounted for as subject to sales contracts; loan makers were in default, primarily for nonpayment, and were discussing settlement or cure with lenders. Some land mortgages were also being modified or extended.
- Related-party exposure is significant: more than 80% of ARL stock was held by related-party entities; net mortgage loans and accrued interest receivable from related parties were $105.5 million. The company cautioned that related-party transactions may not be on arm’s-length terms. Advisory fees to a related party were $5.5 million for the first half.
- ARL guaranteed a $39.1 million mezzanine loan to Unified Housing Foundation; the borrower was reported in covenant compliance. ARL also guaranteed a note with a $19.9 million outstanding balance related to LK-Four Hickory and maintained reserves for potential obligations.
- Management described real estate, leasing, financing, interest-rate, development, and property-sale risks. Of $830.7 million in notes payable, $39 million was variable-rate debt; a 100-basis-point increase was estimated to raise annual interest costs by $0.4 million. Management reported disclosure controls were effective and no material quarterly change in internal control over financial reporting.
- Other disclosed legal matters include a claim against ARL alleging it was an unlawful transferee of assets, with an alter-ego claim also added; management said it believes ARL has no liability in the underlying Clapper litigation. The filing also describes litigation involving Dynex and a separate historical German project investment for which recovery is uncertain.
Important facts for investors to verify
- Debt maturities, extensions, covenant status, and the company’s ability to refinance or raise cash given management’s statement that operating cash flow will not cover all obligations due.
- Collection prospects and collateral values for related-party notes receivable, including UHF/FBH loans, and the adequacy of the existing allowance for doubtful accounts.
- Shekel exchange-rate exposure and the eventual cash cost of bond principal and interest, alongside the stated and effective bond rates.
- Status and potential exposure from defaulted mortgages, guarantees, litigation, and related-party property transactions.
- Cash conversion and development funding needs, particularly the sharp year-over-year decline in operating cash flow and ongoing apartment construction commitments.