AMERICAN REALTY INVESTORS, INC. FORM 10-Q

Management’s Overview

American Realty Investors, Inc. is a real estate investment company that owns a diverse portfolio of residential apartment communities, office buildings, and retail properties across the Southern United States. The company’s operations are externally managed by Pillar Income Asset Management, Inc., a related party.

The report highlights the company’s recent acquisition, disposition, financing, and development activities:

Financing Activities

• Paid off $67.5 million in Series C bonds on January 31, 2023
• Extended the maturity of a loan on Windmill Farms property to February 2024 at a revised interest rate of 7.75%
• Entered into several new construction loans to finance the development of new multifamily properties, including Alera, Merano, Bandera Ridge, and Mountain Creek
• Paid off remaining Series A and Series B bonds, resulting in a $1.7 million loss on early extinguishment of debt
• Amended the terms of UHF notes receivable to change the interest rate from fixed to floating
• Amended the cash management agreement with Pillar to change the interest rate on the related party receivable

Development Activities

• Developing 125 acres of land in Windmill Farms into approximately 470 single-family home lots over 2 years
• Entered into development agreements with Pillar to build new multifamily properties in Florida, Texas, and Texas, with total estimated costs ranging from $49.6 million to $55.3 million

Other Transactions

• Settled litigation with David M. Clapper and related entities for $23.4 million, which was recorded as a loss on real estate transactions

The report also discusses the company’s critical accounting policies, including the application of fair value measurements and the evaluation of related party transactions.

Results of Operations

The company’s net income decreased by $21.0 million in the three months ended September 30, 2024, compared to the same period in 2023. The key drivers of this decrease were:

• Increased profit from the multifamily segment due to the lease-up of the Redevelopment Property
• Decreased profit from the commercial segment due to lower occupancy at certain properties
• Decreased general, administrative, and advisory expenses, primarily due to lower legal and administrative costs associated with the repayment of bonds
• $23.4 million increase in loss on real estate transactions due to the settlement of the Clapper litigation
• $3.7 million decrease in interest income, net due to lower interest rates on the UHF notes and the Pillar Receivable
• $5.8 million increase in other income due to a decrease in income tax provision

For the nine months ended September 30, 2024, the company’s net income decreased by $21.8 million compared to the same period in 2023. The key drivers were similar to the three-month period, with the addition of:

• $4.8 million decrease in general, administrative, and advisory expenses, primarily due to lower legal costs associated with the Nixdorf litigation and reduced administrative expenses related to the bond repayment
• $7.6 million decrease in interest income, net due to lower interest rates on the UHF notes and the Pillar Receivable, partially offset by lower interest expense from the bond repayment
• Loss on early extinguishment of debt and gain on foreign currency transactions in 2023 related to the bond repayment

Liquidity and Capital Resources

The company’s principal sources of cash are property operations, proceeds from asset sales, collection of notes receivable, refinancing of existing debt, and additional borrowings. The company’s liquidity needs include funding normal operating expenses, debt service and principal repayments, capital expenditures, development costs, and potential property acquisitions.

The company believes its current cash and cash equivalents, along with cash generated from notes receivable and investments, will be sufficient to meet its cash requirements. The company may also selectively sell assets, refinance debt, and seek additional borrowings to meet its liquidity needs.

The report provides a summary of the company’s cash flows, highlighting:

• $9.0 million increase in cash provided by operating activities, primarily due to decreased interest and insurance payments
• $17.3 million increase in cash used in investing activities, primarily due to decreased development and renovation spending, offset by decreased distributions from joint ventures and lower net purchases of short-term investments
• $137.4 million decrease in cash used in financing activities, primarily due to the $131.2 million repayment of bonds in 2023

Funds From Operations (FFO)

The company uses Funds From Operations (FFO) as a supplemental measure to report its operating and financial results. FFO excludes the impact of real estate depreciation and amortization, gains or losses from property sales, and certain other adjustments.

The report provides a reconciliation of net income to FFO and FFO-adjusted, which excludes the impact of loss on extinguishment of debt and gain on foreign currency transactions.

Analysis

The key highlights from the financial report are:

1. Diversified real estate portfolio: American Realty Investors owns a mix of multifamily, office, and retail properties across the Southern United States, providing diversification and exposure to different real estate sectors.

2. Active development pipeline: The company is actively developing new multifamily properties, which should contribute to future growth and earnings. However, the development projects also require significant upfront capital investment.

3. Debt management: The company has been actively managing its debt, including repaying bonds, refinancing existing loans, and entering into new construction financing. This suggests a focus on maintaining a healthy balance sheet and managing interest rate risk.

4. Litigation settlement: The $23.4 million settlement of the Clapper litigation represents a significant one-time charge that negatively impacted the company’s financial results in 2024. The resolution of this long-standing legal dispute is likely a positive development for the company, even though it resulted in a substantial financial outlay.

5. Declining net income: The company’s net income has declined significantly in both the three-month and nine-month periods compared to the prior year. This is primarily due to the litigation settlement, decreased interest income, and lower profitability in the commercial segment. The company will need to address these headwinds to improve its financial performance going forward.

6. Liquidity and capital resources: The company appears to have a solid liquidity position, with sufficient cash and cash equivalents to meet its near-term obligations. The company’s ability to generate cash from operations, refinance debt, and selectively sell assets provides flexibility to fund its ongoing operations and development activities.

7. Funds From Operations (FFO): The company’s FFO, a widely used metric in the real estate industry, has increased compared to the prior year, suggesting improved operating performance when excluding the impact of one-time items.

Overall, the financial report highlights American Realty Investors’ efforts to actively manage its real estate portfolio, development pipeline, and capital structure. However, the company faces some near-term challenges, such as the litigation settlement and declining net income, that it will need to address to maintain its financial strength and continue delivering value to shareholders.