American Realty Investors, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Amounts are in millions of dollars unless stated otherwise. The company invests in apartments, commercial real estate, land and mortgage loans; at quarter-end it owned or had interests in 53 income-producing properties and had 10 apartment projects in development.
Financial results and position
| Metric | Q2 2018 | Q2 2017 | H1 2018 | H1 2017 |
|---|---|---|---|---|
| Rental and other property revenue | $31.6 | $31.6 | $62.7 | $63.4 |
| Net operating income | $3.6 | $4.8 | $8.5 | $9.3 |
| Net income (loss) | $6.3 | ($11.3) | $5.9 | ($17.2) |
| Net income (loss) applicable to common shares | $5.6 | ($11.2) | $4.7 | ($17.2) |
| Diluted earnings (loss) per share | $0.35 | ($0.72) | $0.30 | ($1.11) |
| Operating cash flow | — | $2.9 | ($2.4) |
Net operating income was approximately 11.4% of property revenue in Q2 2018 versus 15.3% a year earlier; for H1 it was approximately 13.6% versus 14.7%. These ratios are calculated from reported figures. At June 30, total assets were $1.349 billion, total liabilities $1.176 billion and shareholders’ equity $173.2 million. Cash and cash equivalents were $28.1 million, with $64.7 million of restricted cash. Notes and interest payable were $921.5 million on the balance sheet; bonds and interest payable were $143.9 million. The filing’s debt note reports $921.8 million of notes payable including accrued interest and deferred borrowing costs, so debt presentation differs by table.
For H1, investing cash outflow was $51.8 million, chiefly reflecting $47.5 million in construction and development and $14.6 million in new notes receivable. Financing provided $53.1 million. Cash, cash equivalents and restricted cash together were $92.8 million at period-end. Cash interest paid was $31.0 million. The weighted-average borrowing rate was 6.87%; $65.3 million of notes payable was variable-rate debt. Management estimated a 100-basis-point rate increase would add about $0.65 million to annual interest cost.
Changes and significant items
- H1 common-share income improved to $4.7 million from a $17.2 million loss, despite slightly lower property revenue. Lower property operating expenses and interest expense contributed; the reported comparison also benefited from other income, foreign-exchange gains and land-sale gains.
- Q2 other income included about $6.6 million of insurance proceeds following an “as is” sale of a hurricane-damaged property. The six-month foreign-currency gain was $7.6 million, primarily from favorable movements between the U.S. dollar and Israeli shekel on the bond program; this was an unrealized, noncash gain.
- H1 G&A rose $1.3 million to $5.3 million, mainly from higher advisor expense reimbursements and professional fees. H1 property revenue declined $0.7 million: apartment revenue increased $2.0 million while commercial revenue fell $2.7 million.
- The company sold 112.2 acres of land for $7.2 million and recorded a $1.3 million gain; it also sold a golf course and six income-producing properties. The six properties were sold to a related party for $8.5 million, with $6.4 million received in notes. Sales recognition for certain related-party land transactions remains deferred.
- Construction and development investment was $47.5 million in H1, up from $26.7 million a year earlier. The company acquired an 80-unit Baton Rouge apartment community for $12 million, financed partly with seller and other notes.
Outlook, liquidity, risks and contingencies
Management said property operations should generate excess cash flow in 2018, but not enough to discharge all obligations as they come due. It plans to pursue land and property sales, refinancing or extensions, and additional real-estate-secured borrowing. No numerical earnings or revenue guidance is provided. Southern Properties Capital issued $39.2 million of Series B bonds in February; after quarter-end it issued a further approximately $19.8 million in July. The bonds are denominated in shekels and carry currency exposure.
- Some land mortgages are being modified or extended after loan expirations. Mortgages on properties sold to related parties but still treated as subject to sales contracts were reported in default, primarily for nonpayment; discussions with lenders were ongoing.
- Related-party exposure is substantial: $55.987 million was receivable from a related party, and $104.665 million of gross notes and interest receivable was from related parties. The company is externally advised, with related entities sharing directors and officers; management cautions such transactions may not be on arm’s-length terms.
- The company is the primary guarantor of a $39.1 million mezzanine loan to Unified Housing Foundation; the borrower was in compliance with loan covenants at June 30, 2018.
- Litigation includes a Clapper-related case against ARL and others that was reinstated in June 2018 after an earlier dismissal; ARL says it will vigorously defend itself. The filing also describes a separate large judgment against former entities ART and ART Midwest, which ARL says are not obligated for its outcome. Management does not expect ordinary-course litigation to materially harm ARL, subject to the described matters.
- Other risks include real-estate market and occupancy conditions, construction delays and cost overruns, financing availability and interest rates, property sales, environmental liability and the ability to meet debt maturities. Management reported no material change to the prior annual report’s risk factors.
Key facts for investors to verify
- Near-term debt maturities, refinancing progress and the company’s ability to meet obligations given management’s stated liquidity shortfall.
- Status of defaulted mortgages, loan extensions and the treatment or eventual transfer of properties under related-party sales contracts.
- Collectability and terms of related-party receivables and notes, and governance safeguards for related-party transactions.
- Cash conversion and sustainability of reported earnings, including the effects of the $6.6 million insurance proceeds and noncash foreign-exchange gains.
- Development funding needs, project completion and stabilization, and exposure to shekel-denominated bond obligations.