10-Q 1 strsq3201810-q.htm 10-Q Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
 
SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2018
 
or
[  ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
 
SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from to
 
Commission File Number: 001-37716
 
stratuslogoprintaa17.jpg
Stratus Properties Inc.
(Exact name of registrant as specified in its charter)
Delaware
72-1211572
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer Identification No.)
 
 
212 Lavaca St., Suite 300
 
Austin, Texas
78701
(Address of principal executive offices)
(Zip Code)
 
(512) 478-5788
(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.
þ Yes   ¨ No
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 (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   þ Yes   ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer  ¨     
 
 
Accelerated filer   þ
Non-accelerated filer ¨ 
Smaller reporting company þ
 
 
Emerging growth company ¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   ¨ Yes þ No
On October 31, 2018, there were issued and outstanding 8,164,370 shares of the registrant’s common stock, par value $0.01 per share.







PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

STRATUS PROPERTIES INC.
CONSOLIDATED BALANCE SHEETS (Unaudited)
(In Thousands)

 
September 30,
2018
 
December 31,
2017
ASSETS
 
 
 
Cash and cash equivalents
$
21,182

 
$
14,611

Restricted cash
25,910

 
24,779

Real estate held for sale
18,980

 
22,612

Real estate under development
136,645

 
118,484

Land available for development
23,947

 
14,804

Real estate held for investment, net
234,796

 
188,390

Deferred tax assets
12,542

 
11,461

Other assets
14,054

 
10,852

Total assets
$
488,056

 
$
405,993

 
 
 
 
LIABILITIES AND EQUITY
 
 
 
Liabilities:
 
 
 
Accounts payable
$
20,976

 
$
22,809

Accrued liabilities, including taxes
10,428

 
13,429

Debt
293,739

 
221,470

Deferred gain
9,926

 
11,320

Other liabilities
12,620

 
9,575

Total liabilities
347,689

 
278,603

 
 
 
 
Commitments and contingencies

 

 
 
 
 
Equity:
 
 
 
Stockholders’ equity:
 
 
 
Common stock
93

 
93

Capital in excess of par value of common stock
186,024

 
185,395

Accumulated deficit
(42,220
)
 
(37,121
)
Common stock held in treasury
(21,260
)
 
(21,057
)
Total stockholders’ equity
122,637

 
127,310

Noncontrolling interests in subsidiaries
17,730

 
80

Total equity
140,367

 
127,390

Total liabilities and equity
$
488,056

 
$
405,993


The accompanying Notes to Consolidated Financial Statements (Unaudited) are an integral part of these consolidated financial statements.


2


STRATUS PROPERTIES INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME (Unaudited)
(In Thousands, Except Per Share Amounts)

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2018
 
2017
 
2018
 
2017
Revenues:
 
 
 
 
 
 
 
Real estate operations
$
2,100

 
2,923

 
$
10,273

 
$
9,108

Leasing operations
2,813

 
1,923

 
7,148

 
6,015

Hotel
8,172

 
7,738

 
27,087

 
27,817

Entertainment
4,838

 
4,638

 
14,490

 
16,375

Total revenues
17,923

 
17,222

 
58,998

 
59,315

Cost of sales:
 
 
 
 
 
 
 
Real estate operations
2,279

 
2,204

 
9,405

 
8,048

Leasing operations
1,227

 
1,091

 
3,732

 
3,749

Hotel
6,625

 
6,676

 
20,803

 
21,277

Entertainment
4,008

 
3,666

 
11,412

 
12,298

Depreciation
2,171

 
2,031

 
6,166

 
5,928

Total cost of sales
16,310

 
15,668

 
51,518

 
51,300

General and administrative expenses
2,650

 
2,220

 
8,646

 
8,462

Profit participation in sale of The Oaks at Lakeway

 

 

 
2,538

Gain on sale of assets

 
(24,306
)
 

 
(25,421
)
Total
18,960

 
(6,418
)
 
60,164

 
36,879

Operating (loss) income
(1,037
)
 
23,640

 
(1,166
)
 
22,436

Interest expense, net
(2,150
)
 
(1,577
)
 
(5,451
)
 
(5,060
)
Gain on interest rate derivative instruments
56

 
54

 
314

 
136

Loss on early extinguishment of debt

 

 

 
(532
)
Other income, net
17

 
6

 
39

 
24

(Loss) income before income taxes and equity in unconsolidated affiliates' income (loss)
(3,114
)
 
22,123

 
(6,264
)
 
17,004

Equity in unconsolidated affiliates' income (loss)
210

 
(5
)
 
204

 
(24
)
Benefit from (provision for) income taxes
532

 
(7,810
)
 
961

 
(6,227
)
Net (loss) income and total comprehensive (loss) income
(2,372
)
 
14,308

 
(5,099
)
 
10,753

Total comprehensive income attributable to noncontrolling interests in subsidiaries

 

 

 
(8
)
Net (loss) income and total comprehensive (loss) income attributable to common stockholders
$
(2,372
)
 
$
14,308

 
$
(5,099
)
 
$
10,745

 
 
 
 
 
 
 
 
Basic net (loss) income per share attributable to common stockholders
$
(0.29
)
 
$
1.76

 
$
(0.63
)
 
$
1.32

Diluted net (loss) income per share attributable to common stockholders
$
(0.29
)
 
$
1.75

 
$
(0.63
)
 
$
1.32

 
 
 
 
 
 
 
 
Weighted average common shares outstanding:
 
 
 
 
 
 
 
Basic
8,156

 
8,128

 
8,149

 
8,119

Diluted
8,156

 
8,172

 
8,149

 
8,169

 
 
 
 
 
 
 
 
Dividends declared per share of common stock
$

 
$

 
$

 
$
1.00


The accompanying Notes to Consolidated Financial Statements (Unaudited) are an integral part of these consolidated financial statements.

3


STRATUS PROPERTIES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In Thousands)

 
Nine Months Ended
 
September 30,
 
2018
 
2017
Cash flow from operating activities:
 
 
 
Net (loss) income
$
(5,099
)
 
$
10,753

Adjustments to reconcile net (loss) income to net cash used in operating activities:
 
 
 
Depreciation
6,166

 
5,923

Cost of real estate sold
5,780

 
5,086

Gain on sale of assets

 
(25,421
)
Gain on interest rate derivative contracts
(314
)
 
(136
)
Loss on early extinguishment of debt

 
532

Debt issuance cost amortization and stock-based compensation
1,389

 
1,227

Equity in unconsolidated affiliates' (income) loss
(204
)
 
24

Increase (decrease) in deposits
1,242

 
(145
)
Deferred income taxes
(1,081
)
 
(1,264
)
Purchases and development of real estate properties
(28,900
)
 
(11,196
)
Municipal utility district reimbursement

 
2,172

Increase in other assets
(2,965
)
 
(160
)
Decrease in accounts payable, accrued liabilities and other
(2,607
)
 
(320
)
Net cash used in operating activities
(26,593
)
 
(12,925
)
 
 
 
 
Cash flow from investing activities:
 
 
 
Capital expenditures
(53,468
)
 
(14,363
)
Proceeds from sale of assets

 
117,261

Payments on master lease obligations
(1,476
)
 
(1,653
)
Other, net
378

 
(49
)
Net cash (used in) provided by investing activities
(54,566
)

101,196

 
 
 
 
Cash flow from financing activities:
 
 
 
Borrowings from credit facility
32,436

 
45,200

Payments on credit facility
(6,112
)
 
(53,651
)
Borrowings from project loans
50,062

 
8,725

Payments on project and term loans
(3,799
)
 
(64,228
)
Cash dividend paid

 
(8,133
)
Stock-based awards net payments
(203
)
 
(234
)
Noncontrolling interests contributions
17,650

 

Financing costs
(1,173
)
 
(1,536
)
Net cash provided by (used in) financing activities
88,861

 
(73,857
)
Net increase in cash, cash equivalents and restricted cash
7,702

 
14,414

Cash, cash equivalents and restricted cash at beginning of year
39,390

 
25,489

Cash, cash equivalents and restricted cash at end of period
$
47,092

 
$
39,903


The accompanying Notes to Consolidated Financial Statements (Unaudited), which include information regarding noncash transactions, are an integral part of these consolidated financial statements.

4


STRATUS PROPERTIES INC.
CONSOLIDATED STATEMENTS OF EQUITY (Unaudited)
(In Thousands)

 
 
Stockholders’ Equity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Stock
Held in Treasury
 
Total Stockholders' Equity
 
 
 
 
 
 
Common Stock
 
Capital in Excess of Par Value
 
Accum-ulated Deficit
 
 
 
Noncontrolling Interests in Subsidiaries
 
 
 
 
Number
of Shares
 
At Par
Value
 
 
 
Number
of Shares
 
At
Cost
 
 
 
Total
Equity
Balance at June 30, 2018
 
9,277

 
$
93

 
$
185,757

 
$
(39,848
)
 
1,124

 
$
(21,260
)
 
$
124,742

 
$
7,080

 
$
131,822

Exercised and vested stock-based awards
 
11

 

 

 

 

 

 

 

 

Stock-based compensation
 

 

 
267

 

 

 

 
267

 

 
267

Noncontrolling interests contributions
 

 

 

 

 

 

 

 
10,650

 
10,650

Total comprehensive loss
 

 

 

 
(2,372
)
 

 

 
(2,372
)
 

 
(2,372
)
Balance at September 30, 2018
 
9,288

 
$
93

 
$
186,024

 
$
(42,220
)
 
1,124

 
$
(21,260
)
 
$
122,637

 
$
17,730

 
$
140,367

 
 
Stockholders’ Equity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Stock
Held in Treasury
 
Total Stockholders' Equity
 
 
 
 
 
 
Common Stock
 
Capital in Excess of Par Value
 
Accum-ulated Deficit
 
 
 
Noncontrolling Interests in Subsidiaries
 
 
 
 
Number
of Shares
 
At Par
Value
 
 
 
Number
of Shares
 
At
Cost
 
 
 
Total
Equity
Balance at June 30, 2017
 
9,243

 
$
93

 
$
185,080

 
$
(44,563
)
 
1,117

 
$
(21,057
)
 
$
119,553

 
$
83

 
$
119,636

Cash dividend
 

 

 
(94
)
 

 

 

 
(94
)
 

 
(94
)
Vested stock-based awards
 
7

 

 

 

 

 

 

 

 

Stock-based compensation
 

 

 
198

 

 

 

 
198

 

 
198

Total comprehensive income
 

 

 

 
14,308

 

 

 
14,308

 

 
14,308

Balance at September 30, 2017
 
9,250

 
$
93

 
$
185,184

 
$
(30,255
)
 
1,117

 
$
(21,057
)
 
$
133,965

 
$
83

 
$
134,048





5


STRATUS PROPERTIES INC.
CONSOLIDATED STATEMENTS OF EQUITY (Unaudited) (continued)
(In Thousands)

 
 
Stockholders’ Equity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Stock
Held in Treasury
 
Total Stockholders' Equity
 
 
 
 
 
 
Common Stock
 
Capital in Excess of Par Value
 
Accum-ulated Deficit
 
 
 
Noncontrolling Interests in Subsidiaries
 
 
 
 
Number
of Shares
 
At Par
Value
 
 
 
Number
of Shares
 
At
Cost
 
 
 
Total
Equity
Balance at December 31, 2017
 
9,250

 
$
93

 
$
185,395

 
$
(37,121
)
 
1,117

 
$
(21,057
)
 
$
127,310

 
$
80

 
$
127,390

Exercised and vested stock-based awards
 
38

 

 

 

 

 

 

 

 

Stock-based compensation
 

 

 
629

 

 

 

 
629

 

 
629

Tender of shares for stock-based awards
 

 

 

 

 
7

 
(203
)
 
(203
)
 

 
(203
)
Noncontrolling interests contributions
 

 

 

 

 

 

 

 
17,650

 
17,650

Total comprehensive loss
 

 

 

 
(5,099
)
 

 

 
(5,099
)
 

 
(5,099
)
Balance at September 30, 2018
 
9,288

 
$
93

 
$
186,024

 
$
(42,220
)
 
1,124

 
$
(21,260
)
 
$
122,637

 
$
17,730

 
$
140,367

 
 
Stockholders’ Equity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Stock
Held in Treasury
 
Total Stockholders' Equity
 
 
 
 
 
 
Common Stock
 
Capital in Excess of Par Value
 
Accum-ulated Deficit
 
 
 
Noncontrolling Interests in Subsidiaries
 
 
 
 
Number
of Shares
 
At Par
Value
 
 
 
Number
of Shares
 
At
Cost
 
 
 
Total
Equity
Balance at December 31, 2016
 
9,203

 
$
92

 
$
192,762

 
$
(41,143
)
 
1,105

 
$
(20,760
)
 
$
130,951

 
$
75

 
$
131,026

Adjustment for cumulative effect of change in accounting for stock-based compensation
 

 

 

 
143

 

 

 
143

 

 
143

Cash dividend
 

 

 
(8,221
)
 

 

 

 
(8,221
)
 

 
(8,221
)
Exercised and vested stock-based awards
 
47

 
1

 
62

 

 

 

 
63

 

 
63

Stock-based compensation
 

 

 
581

 

 

 

 
581

 

 
581

Tender of shares for stock-based awards
 

 

 

 

 
12

 
(297
)
 
(297
)
 

 
(297
)
Total comprehensive income
 

 

 

 
10,745

 

 

 
10,745

 
8

 
10,753

Balance at September 30, 2017
 
9,250

 
$
93

 
$
185,184

 
$
(30,255
)
 
1,117

 
$
(21,057
)
 
$
133,965

 
$
83

 
$
134,048


The accompanying Notes to Consolidated Financial Statements (Unaudited) are an integral part of these consolidated financial statements.



6


STRATUS PROPERTIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1.
GENERAL
The accompanying unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2017, included in Stratus Properties Inc.’s (Stratus) Annual Report on Form 10-K (Stratus 2017 Form 10-K) filed with the United States (U.S.) Securities and Exchange Commission. The information furnished herein reflects all adjustments that are, in the opinion of management, necessary for a fair statement of the results for the interim periods reported. With the exception of the accounting for the deferred gain on the 2017 sale of The Oaks at Lakeway, all such adjustments are, in the opinion of management, of a normal recurring nature. Operating results for the nine-month period ended September 30, 2018, are not necessarily indicative of the results that may be expected for the year ending December 31, 2018.

2.
EARNINGS PER SHARE
Stratus’ basic net (loss) income per share of common stock was calculated by dividing the net (loss) income attributable to common stockholders by the weighted-average shares of common stock outstanding during the period. A reconciliation of net (loss) income and weighted-average shares of common stock outstanding for purposes of calculating diluted net (loss) income per share (in thousands, except per share amounts) follows:
 
 
 
 
 
 
 
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2018
 
2017
 
2018
 
2017
 
Net (loss) income
$
(2,372
)
 
$
14,308

 
$
(5,099
)
 
$
10,753

 
Net income attributable to noncontrolling interests in subsidiaries

 



 
(8
)
 
Net (loss) income attributable to Stratus common stockholders
$
(2,372
)
 
$
14,308

 
$
(5,099
)
 
$
10,745

 
 
 
 
 
 
 
 
 
 
Basic weighted-average shares of common stock outstanding
8,156

 
8,128

 
8,149

 
8,119

 
 
 
 
 
 
 
 
 
 
Add shares issuable upon exercise or vesting of dilutive stock options and restricted stock units (RSUs)a

 
44

 

 
50

 
 
 
 
 
 
 
 
 
 
Diluted weighted-average shares of common stock outstanding
8,156

 
8,172

 
8,149

 
8,169

 
 
 
 
 
 
 
 
 
 
Basic net (loss) income per share attributable to common stockholders
$
(0.29
)
 
$
1.76

 
$
(0.63
)
 
$
1.32

 
 
 
 
 
 
 
 
 
 
Diluted net (loss) income per share attributable to common stockholders
$
(0.29
)
 
$
1.75

 
$
(0.63
)
 
$
1.32

 
 
 
 
 
 
 
 
 
 
a.
Excludes approximately 97 thousand shares of common stock for third-quarter 2018, 30 thousand shares for third-quarter 2017, 96 thousand shares for the first nine months of 2018 and 23 thousand shares for the first nine months of 2017 associated with restricted stock units and outstanding stock options that were anti-dilutive.

3.
RELATED PARTY TRANSACTIONS
The Saint Mary, L.P.
On June 19, 2018, The Saint Mary, L.P., a Texas limited partnership and a subsidiary of Stratus, completed a series of financing transactions to develop The Saint Mary, a 240-unit luxury, garden-style apartment project in the Circle C community in Austin, Texas. The financing transactions included (1) a $26 million construction loan with Texas Capital Bank, National Association (see Note 6 for further discussion) and (2) an $8.0 million private placement. The Saint Mary, L.P. issued, in a private placement exempt from registration under federal and state securities laws, Class B limited partnership interests to a limited number of investors (the Saint Mary Class B limited partners), for $8.0 million (the Saint Mary Offering) resulting in the Saint Mary Class B limited partners owning an aggregate 49.1 percent equity interest in The Saint Mary, L.P.

In accordance with the terms of the Saint Mary Offering, Circle C Land, L.P., a Texas limited partnership and a subsidiary of Stratus and the sole Class A limited partner of The Saint Mary, L.P. (Circle C) purchased Class B limited partnership interests representing a 6.1 percent equity interest in The Saint Mary, L.P. for $1.0 million. Upon completion of the Saint Mary Offering, Stratus holds, in aggregate, a 57 percent indirect equity interest in The Saint Mary, L.P. Additionally, among the participants in the Saint Mary Offering, LCHM Holdings, LLC, a related party as a result of its greater than 5 percent beneficial ownership of Stratus’ common stock (LCHM), purchased Saint Mary

7


Class B limited partnership interests representing a 6.1 percent equity interest in The Saint Mary, L.P. for $1.0 million.

In connection with the Saint Mary Offering, The Saint Mary GP, L.L.C., a Texas limited liability company (the Saint Mary General Partner) and a subsidiary of Stratus, Circle C, and the Saint Mary Class B limited partners entered into an Amended and Restated Limited Partnership Agreement (the Saint Mary Partnership Agreement) effective as of June 18, 2018. The Saint Mary Partnership Agreement includes the following key provisions:

The Saint Mary, L.P. will be managed by the Saint Mary General Partner, and The Saint Mary, L.P. will pay the Saint Mary General Partner, or another affiliate of Stratus, an asset management fee of $210,000 per year beginning one year after construction of The Saint Mary begins.
The Saint Mary, L.P. will pay the Saint Mary General Partner, or another affiliate of Stratus, a development management fee of approximately $1.4 million for the overall coordination and management of the development and construction of The Saint Mary.
Circle C contributed an approximate 14.35 acre tract of land upon which The Saint Mary will be developed and constructed and $0.7 million of cash.
The partners are entitled to preferred returns, which change after certain returns are achieved as specified in the Saint Mary Partnership Agreement.

Stratus has performed evaluations and concluded that The Saint Mary, L.P. is a variable interest entity and that Stratus is the primary beneficiary. Stratus will continue to evaluate which entity is the primary beneficiary of The Saint Mary, L.P. in accordance with applicable accounting guidance. As of September 30, 2018, Stratus’ consolidated balance sheet includes the following assets and liabilities of The Saint Mary, L.P. (in thousands):
 
 
September 30, 2018
Assets:
 
 
Cash and cash equivalents
 
$
11

Restricted cash
 
6,001

Real estate held under development
 
6,550

Other assets
 
748

Total assets
 
$
13,310

Liabilities:
 
 
Accounts payable
 
$
1,466

Accrued liabilities, including taxes
 
16

Total liabilities
 
1,482

Net assets
 
$
11,828


Stratus Kingwood Place, L.P.
On August 3, 2018, Stratus Kingwood Place, L.P., a Texas limited partnership and a subsidiary of Stratus (the Kingwood, L.P.), completed a $10.7 million private placement, approximately $7 million of which, combined with a $6.75 million loan from Comerica Bank, was used to purchase a 54-acre tract of land located in Kingwood, Texas for $13.5 million, for the development, subject to obtaining a construction loan and building permits, of Kingwood Place, a new H-E-B, L.P. (HEB)-anchored mixed-use development project (Kingwood Place). The development plan for Kingwood Place includes a 103,000-square-foot HEB store, 41,000 square feet of retail space, 6 retail pads, and an 11-acre parcel planned for approximately 300 multi-family units. The Kingwood, L.P. issued, in a private placement exempt from registration under federal and state securities laws, Class B limited partnership interests to a limited number of investors (the Kingwood Class B limited partners), for $10.7 million (the Kingwood Offering), representing approximately 70 percent of the projected partnership equity. Among the participants in the Kingwood Offering, LCHM purchased Kingwood Class B limited partnership interests initially representing an 8.8 percent equity interest in the Kingwood, L.P. for $1.0 million.

In connection with the Kingwood Offering, Stratus Northpark, L.L.C., a Texas limited liability company, a subsidiary of Stratus and the general partner of the Kingwood, L.P. (the Kingwood General Partner), Stratus Properties Operating Co., L.P., a Delaware limited partnership, also a subsidiary of Stratus (the Class A limited partner), and the Kingwood Class B limited partners entered into an Amended and Restated Limited Partnership Agreement (the Kingwood Partnership Agreement) effective as of August 3, 2018. The Kingwood Partnership Agreement includes the following key provisions:


8


The Kingwood, L.P. will be managed by the Kingwood General Partner, and the Kingwood, L.P. will pay the Kingwood General Partner, or another affiliate of Stratus, an asset management fee of $283,000 per year beginning one year after construction of Kingwood Place begins.
The Kingwood, L.P. will pay the Kingwood General Partner, or another affiliate of Stratus, a development management fee equal to four percent of the construction costs for Kingwood Place for the overall coordination and management of the development and construction of Kingwood Place.
The partners are entitled to preferred returns, which change after certain returns are achieved as specified in the Kingwood Partnership Agreement.

Stratus has performed evaluations and concluded that the Kingwood, L.P. is a variable interest entity and that Stratus is the primary beneficiary. Stratus will continue to evaluate which entity is the primary beneficiary of the Kingwood, L.P. in accordance with applicable accounting guidance. As of September 30, 2018, Stratus’ consolidated balance sheet includes the following assets and liabilities of the Kingwood, L.P. (in thousands):
 
 
September 30, 2018
Assets:
 
 
Cash and cash equivalents
 
$
3,197

Real estate held under development
 
15,080

Total assets
 
$
18,277

Liabilities:
 
 
Accounts payable
 
$
213

Accrued liabilities, including taxes
 
171

Debt
 
6,664

Total liabilities
 
7,048

Net assets
 
$
11,229


4.
DISPOSITIONS
The Oaks at Lakeway. On February 15, 2017, Stratus sold The Oaks at Lakeway to FHF I Oaks at Lakeway, LLC for $114.0 million in cash. Net cash proceeds were $50.8 million after repayment of the Lakeway construction loan. Stratus used a portion of these net cash proceeds to pay indebtedness outstanding under the Comerica Bank credit facility. The parties entered into three master lease agreements at closing: (1) one covering unleased in-line retail space, with a 5-year term, (2) one covering four unleased pad sites, three of which have 10-year terms, and one of which has a 15-year term, and (3) one covering the hotel pad with a 99-year term. As specified conditions are met, primarily consisting of the tenant executing a lease, commencing payment of rent and taking occupancy, leases will be assigned to the purchaser and the corresponding property will be removed from the master lease, reducing Stratus' master lease payment obligations. Stratus' master lease payment obligation, which currently approximates $180 thousand per month, is expected to decline over time until leasing is complete and all leases are assigned to the purchaser.

Stratus agreed to guarantee the obligations of its selling subsidiary under the sales agreement, up to a liability cap of two percent of the purchase price. This cap does not apply to Stratus' obligation to satisfy the selling subsidiary's indemnity obligations for its broker commissions or similar compensation or Stratus' liability in guaranteeing the selling subsidiary's obligations under the master leases. To secure its obligations under the master leases, Stratus has provided a $1.5 million irrevocable letter of credit with a three-year term.

At the date of sale, Stratus allocated the purchase price for The Oaks at Lakeway between two performance obligations based on the relative fair values of each. The first performance obligation, to deliver the completed and leased portion of the property, was performed on the date of sale. The second performance obligation was to complete construction of the remaining buildings and leasing of the vacant space. The obligations under master leases were considered variable consideration and are recorded as reductions to the contract liability. The hotel pad was leased to a hotel operator under a ground lease at the date of sale. However, the hotel tenant had not commenced rent payments or construction of the hotel. At the date of the sale, primarily because of the uncertainty related to the hotel tenant’s performance under its ground lease, the probability-weighted estimate of the obligations under the master leases reduced the sale consideration such that no gain was recognized on the sale.

Once the hotel tenant began paying rent in May 2017 and obtained construction financing and commenced construction of the hotel in August 2017, the probability-weighted estimate of Stratus’ obligations under the master leases was significantly reduced, and a gain of $24.3 million related to the first performance obligation was recognized in third-quarter 2017. A contract liability of $9.9 million is presented as a deferred gain in the

9


consolidated balance sheets at September 30, 2018, compared with $11.3 million at December 31, 2017. The reduction in the deferred gain balance primarily reflects master lease payments. The contract liability, as reduced by future master lease payments, will be recognized as additional gain as Stratus fulfills the remaining performance obligation.

Upon the sale of The Oaks at Lakeway, HEB earned a profit participation of $2.5 million (of which $2.2 million was paid at closing), which is presented separately in the consolidated statements of comprehensive (loss) income.

Barton Creek Village. On February 28, 2017, Stratus completed the sale of its 3,085-square-foot bank building and an adjacent undeveloped 4.1 acre tract of land in Barton Creek, for $3.1 million and recorded a gain on the sale of $1.1 million. In connection with the sale, a $2.1 million paydown was made on the Barton Creek Village term loan.

5.
FAIR VALUE MEASUREMENTS
Fair value accounting guidance includes a hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 inputs) and the lowest priority to unobservable inputs (Level 3 inputs).

The carrying value for certain Stratus financial instruments (i.e., cash and cash equivalents, restricted cash, accounts payable and accrued liabilities) approximates fair value because of their short-term nature and generally negligible credit losses.

A summary of the carrying amount and fair value of Stratus' other financial instruments follows (in thousands):
 
September 30, 2018
 
December 31, 2017
 
Carrying
Value
 
Fair
Value
 
Carrying
Value
 
Fair
Value
Assets:
 
 
 
 
 
 
 
Interest rate swap agreement
$
179

 
$
179

 
$

 
$

Liabilities:
 
 
 
 
 
 
 
Debt
$
293,739

 
$
297,246

 
$
221,470

 
$
224,632

Interest rate swap agreement

 

 
134

 
134


Debt. Stratus' debt is recorded at cost and is not actively traded. Fair value is estimated based on discounted future expected cash flows at estimated current market interest rates. Accordingly, Stratus' debt is classified within Level 2 of the fair value hierarchy. The fair value of debt does not represent the amounts that will ultimately be paid upon the maturities of the loans.

Interest Rate Swap Agreement. The interest rate swap does not qualify for hedge accounting and changes in its fair value are recorded in the consolidated statements of comprehensive (loss) income. Stratus evaluated the counterparty credit risk associated with the interest rate swap agreement, which is considered a Level 3 input, but did not consider such risk to be significant. Therefore, the interest rate swap agreement is classified within Level 2 of the fair value hierarchy.

6.
DEBT AND EQUITY
Debt. The components of Stratus' debt are as follows (in thousands):
 
September 30, 2018
 
December 31, 2017
 
Goldman Sachs loan
$
143,753

 
$
145,195

 
Comerica Bank credit facility
52,089

 
25,765

 
Santal Phase I construction loan
32,597

 
31,864

 
Barton Creek Village term loan
3,308

 
3,375

 
Amarra Villas credit facility
5,261

 
5,247

 
West Killeen Market construction loan
6,421

 
5,378

 
Jones Crossing construction loan
11,153

 
4,646

 
Lantana Place construction loan
16,114

 

 
Santal Phase II construction loan
16,379

 

 
Kingwood Place loan
6,664

 

 
Total debta
$
293,739

 
$
221,470

 

10


a.
Includes net reductions for unamortized debt issuance costs of $2.4 million at September 30, 2018, and $2.1 million at December 31, 2017.

As discussed in Note 3, on August 3, 2018, Kingwood, L.P. entered into a one year, $6.75 million loan with Comerica Bank to purchase a 54-acre tract of land located in Kingwood, Texas, for the development, subject to obtaining a construction loan and building permits, of Kingwood Place. The loan bears interest at the London Interbank Offered Rate (LIBOR) plus 4.0 percent. Borrowings on the Kingwood Place loan are secured by the Kingwood project, and are guaranteed by Stratus. The Kingwood Place loan contains the same financial covenants in place on Stratus’ Comerica Bank Credit Facility, including a requirement that Stratus maintains a net asset value of $125 million and an aggregate promissory note debt-to-gross asset value of less than 50 percent.

On June 29, 2018, Stratus entered into a loan agreement with Comerica Bank to modify, increase and extend Stratus’ Comerica Bank credit facility, which was scheduled to mature on November 30, 2018. The new loan agreement provides for (1) an increase in the revolving credit facility from $45.0 million to $60.0 million, (2) a $7.5 million sublimit for letters of credit issuance and (3) an extension of the maturity date from November 30, 2018, to June 29, 2020. Advances under the credit facility bear interest at the annual LIBOR plus 4.0 percent. The Comerica Bank credit facility is secured by substantially all of Stratus' assets, except for properties that are encumbered by separate debt financing. The loan agreement contains financial covenants usual and customary for loan agreements of this nature, including a requirement that Stratus maintains a net asset value of $125 million and an aggregate promissory note debt-to-gross asset value of less than 50 percent. As of September 30, 2018, Stratus had $3.8 million available under its $60.0 million Comerica Bank revolving line of credit, with $4.1 million of letters of credit committed against the credit facility.

As discussed in Note 3, on June 19, 2018, Stratus entered into a $26 million construction loan with Texas Capital Bank (The Saint Mary construction loan) to finance the initial phase of The Saint Mary. Stratus will fully guaranty The Saint Mary construction loan. The repayment guaranty will be reduced to 50 percent upon issuance of a certificate of occupancy for The Saint Mary and will be eliminated when the project debt service coverage ratio equals or exceeds 1.25:1.0. Interest is variable at the one-month LIBOR plus 3.0 percent. Payments of interest only will be due and payable monthly, and outstanding principal is payable at maturity of June 19, 2021. Outstanding amounts will be secured by The Saint Mary and all subsequent improvements. The construction loan agreement and related document contain affirmative and negative covenants usual and customary for loan agreements of this nature. Stratus may extend the maturity of this loan for up to two additional 12-month periods if certain conditions are met, including debt service coverage ratio thresholds. As of September 30, 2018, no amounts were drawn on The Saint Mary construction loan.

For a description of Stratus' other debt, refer to Note 6 in the Stratus 2017 Form 10-K.

Interest Expense and Capitalization. Interest costs (before capitalized interest) totaled $4.3 million in third-quarter 2018, $3.1 million in third-quarter 2017, $11.4 million for the first nine months of 2018 and $9.3 million for the first nine months of 2017. Stratus' capitalized interest costs totaled $2.1 million in third-quarter 2018, $1.5 million in third-quarter 2017, $6.0 million for the first nine months of 2018 and $4.3 million for the first nine months of 2017, primarily related to development activities at Barton Creek.

Equity. Stratus' Comerica Bank credit facility requires the bank's prior written consent to pay a dividend on Stratus' common stock. On March 15, 2017, Stratus' Board of Directors (the Board), after receiving written consent from Comerica Bank, declared a special cash dividend of $1.00 per share ($8.1 million), which was paid on April 18, 2017, to stockholders of record on March 31, 2017. The special cash dividend was declared after the Board’s consideration of the results of the sale of The Oaks at Lakeway. Comerica Bank’s consent to the payment of this special dividend is not indicative of the bank’s willingness to consent to the payment of future dividends. The declaration of future dividends is at the discretion of the Board, subject to the restrictions under Stratus' Comerica Bank credit facility, and will depend on Stratus' financial results, cash requirements, projected compliance with covenants in its debt agreements, outlook and other factors deemed relevant by the Board.

7.
PROFIT PARTICIPATION INCENTIVE PLAN
On July 11, 2018, the Stratus Compensation Committee of the Board (the Committee) unanimously adopted the Stratus Profit Participation Incentive Plan (the Plan), which provides participants with economic incentives tied to the success of the development projects designated by the Committee as approved projects under the Plan. Under the Plan, 25 percent of the profit for each approved project following a capital transaction (as defined in the Plan) will be set aside in a pool. The Committee will allocate participation interests in each pool to select executi

11


ves, other employees and consultants determined to be instrumental in the success of the project. The profit is equal to the net proceeds to Stratus from a capital transaction after Stratus has received a return of its costs and expenses and any capital contributions and a preferred return of 10 percent per year on the approved project. Provided the applicable service conditions are met, each participant is eligible to earn a bonus equal to his or her allocated participation interest in the applicable profit pool. Bonuses under the Plan are payable in cash prior to March 15th of the year following the capital transaction, unless the participant is an executive officer, in which case annual cash payouts under the Plan are limited to no more than four times the executive officer’s base salary, and any amounts due under the Plan in excess of that amount will be converted to an equivalent number of stock-settled restricted stock units with a one-year vesting period.

If a capital transaction has not occurred prior to the third anniversary of the date an approved project is substantially complete (a valuation event), the Committee will obtain a third-party appraisal of the approved project as of the valuation event. Based on the appraised value, the Committee will determine if any profit would have been generated after applying the hurdles described above, and if so, the amount of any bonus that would have been attributable to each participant. Any such amount will convert into an equivalent number of stock-settled restricted stock units that will vest in annual installments over a three-year period, provided that the participant satisfies the applicable service conditions.

On August 2, 2018, the Committee designated seven existing development projects as approved projects under the Plan, and allocated participation interests in each pool to certain executives, employees and consultants. As of September 30, 2018, one of those approved projects was substantially complete.

Because of uncertainty in estimating future market conditions and development plans and costs for approved projects, the timing and amount of bonus awards under the Plan cannot currently be reliably determined. As such, no amounts have been recorded for bonus awards under the Plan as of September 30, 2018. Stratus will record estimates of such amounts for an approved project when they can be reliably determined, which is currently expected to be at the time a capital transaction is announced or when a valuation event occurs.

8.
INCOME TAXES
Stratus’ accounting policy for and other information regarding its income taxes is further described in Notes 1 and 7 in the Stratus 2017 Form 10-K.

Stratus had deferred tax assets (net of deferred tax liabilities) totaling $12.5 million at September 30, 2018, and $11.5 million at December 31, 2017. Stratus’ income tax benefit for the first nine months of 2018 includes a deferred tax benefit of $1.1 million, partly offset by income tax expense of $0.1 million. Stratus’ future results of operations may be negatively impacted by an inability to realize a tax benefit for future tax losses or for items that will generate additional deferred tax assets.

The difference between Stratus' consolidated effective income tax rate for the first nine months of 2018 and the first nine months of 2017, and the U.S. Federal statutory income tax rate of 21 percent for 2018 and 35 percent for 2017, was primarily attributable to the Texas state margin tax.

9.
BUSINESS SEGMENTS
Stratus currently has four operating segments: Real Estate Operations, Leasing Operations, Hotel and Entertainment.

The Real Estate Operations segment is comprised of Stratus’ real estate assets (developed, under development and available for development), which consists of its properties in Austin, Texas (the Barton Creek community, including portions of Santal Phase II; the Circle C community, including The Saint Mary; the Lantana community, including Lantana Place; and one condominium unit at the W Austin Hotel & Residences); in Lakeway, Texas located in the greater Austin area (Lakeway); in College Station, Texas (Jones Crossing); and in Magnolia, Texas (Magnolia) and Kingwood, Texas (Kingwood Place), both located in the greater Houston area.

The Leasing Operations segment includes the office and retail space at the W Austin Hotel & Residences, a retail building in Barton Creek Village, Santal Phase I, the West Killeen Market in Killeen, Texas, and portions of the Santal Phase II, Lantana Place and Jones Crossing projects.

The Hotel segment includes the W Austin Hotel located at the W Austin Hotel & Residences in downtown Austin, Texas.

12



The Entertainment segment includes ACL Live, a live music and entertainment venue and production studio, and 3TEN ACL Live, both at the W Austin Hotel & Residences. In addition to hosting concerts and private events, ACL Live is the home of Austin City Limits, a television program showcasing popular music legends. The Entertainment segment also includes revenues and costs associated with events hosted at other venues.

Stratus uses operating income or loss to measure the performance of each segment. General and administrative expenses, which primarily consist of employee salaries, wages and other costs, are managed on a consolidated basis and are not allocated to Stratus' operating segments. The following segment information reflects management determinations that may not be indicative of what the actual financial performance of each segment would be if it were an independent entity.

Revenues From Contracts with Customers. Stratus' revenues from contracts with customers for the third quarters and the first nine months of 2018 and 2017 follow (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Real Estate Operations:
 
 
 
 
 
 
 
Developed property sales
$
2,025

 
$
2,860

 
$
10,036

 
$
8,436

Undeveloped property sales

 

 

 
544

Commissions and other
75

 
63

 
237

 
128

 
2,100

 
2,923

 
10,273

 
9,108

Leasing Operations:
 
 
 
 
 
 
 
Rental revenue
2,813

 
1,923

 
7,148

 
6,015

 
2,813

 
1,923

 
7,148

 
6,015

Hotel:
 
 
 
 
 
 
 
Rooms, food and beverage
7,554

 
7,143

 
25,156

 
26,054

Other
618

 
595

 
1,931

 
1,763

 
8,172

 
7,738

 
27,087

 
27,817

Entertainment:
 
 
 
 
 
 
 
Event revenue
4,154

 
4,010

 
12,532

 
14,520

Other
684

 
628

 
1,958

 
1,855

 
4,838

 
4,638

 
14,490

 
16,375

 
 
 
 
 
 
 
 
Total Revenues from Contracts with Unaffiliated Customers
$
17,923

 
$
17,222

 
$
58,998

 
$
59,315


Financial Information by Business Segment. The following segment information was prepared on the same basis as Stratus’ consolidated financial statements (in thousands).
 
Real Estate
Operationsa
 
Leasing Operations
 
Hotel
 
Entertainment
 
Eliminations and Otherb
 
Total
Three Months Ended September 30, 2018:
 
 
 
 
 
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
 
 
 
 
Unaffiliated customers
$
2,100

 
$
2,813

 
$
8,172

 
$
4,838

 
$

 
$
17,923

Intersegment
8

 
227

 
72

 
21

 
(328
)
 

Cost of sales, excluding depreciation
2,279

 
1,235

 
6,639

 
4,154

 
(168
)
 
14,139

Depreciation
65

 
863

 
886

 
391

 
(34
)
 
2,171

General and administrative expenses

 

 

 

 
2,650

 
2,650

Operating (loss) income
$
(236
)
 
$
942

 
$
719

 
$
314

 
$
(2,776
)
 
$
(1,037
)
Capital expenditures and purchases and development of real estate properties
$
21,201

 
$
10,334

 
$
128

 
$
24

 
$

 
$
31,687

Total assets at September 30, 2018
183,857

 
157,706

 
102,069

 
36,377

 
8,047

 
488,056


13


 
 
 
 
 
 
 
 
 
 
 
 
 
Real Estate
Operationsa
 
Leasing Operations
 
Hotel
 
Entertainment
 
Eliminations and Otherb
 
Total
Three Months Ended September 30, 2017:
 
 
 
 
 
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
 
 
 
 
Unaffiliated customers
$
2,923

 
$
1,923

 
$
7,738

 
$
4,638

 
$

 
$
17,222

Intersegment
115

 
222

 
57

 
17

 
(411
)
 

Cost of sales, excluding depreciation
2,204

 
1,100

 
6,678

 
3,799

 
(144
)
 
13,637

Depreciation
57

 
739

 
886

 
384

 
(35
)
 
2,031

General and administrative expenses

 

 

 

 
2,220

 
2,220

Gain on sales of assets

 
(24,306
)
c 

 

 

 
(24,306
)
Operating income (loss)
$
777

 
$
24,612

 
$
231

 
$
472

 
$
(2,452
)
 
$
23,640

Capital expenditures and purchases and development of real estate properties
$
3,222

 
$
9,066

 
$
15

 
$
182

 
$

 
$
12,485

Total assets at September 30, 2017
183,643

 
71,041

 
103,560

 
36,888

 
15,332

 
410,464


Nine Months Ended September 30, 2018:
 
 
 
 
 
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
 
 
 
 
  Unaffiliated customers
$
10,273

 
$
7,148

 
$
27,087

 
$
14,490

 
$

 
$
58,998

  Intersegment
24

 
703

 
194

 
79

 
(1,000
)
 

Cost of sales, excluding depreciation
9,405

d 
3,756

 
20,861

 
11,850

 
(520
)
 
45,352

Depreciation
190

 
2,234

 
2,675

 
1,171

 
(104
)
 
6,166

General and administrative expenses

 

 

 

 
8,646

 
8,646

Operating income (loss)
$
702

 
$
1,861

 
$
3,745

 
$
1,548

 
$
(9,022
)
 
$
(1,166
)
Capital expenditures and purchases and development of real estate properties
$
28,900

 
$
52,619

 
$
464

 
$
385

 
$

 
$
82,368

Nine Months Ended September 30, 2017:
 
 
 
 
 
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
 
 
 
 
  Unaffiliated customers
$
9,108

 
$
6,015

 
$
27,817

 
$
16,375

 
$

 
$
59,315

  Intersegment
136

 
653

 
230

 
142

 
(1,161
)
 

Cost of sales, excluding depreciation
8,048

 
3,773

 
21,323

 
12,756

 
(528
)
 
45,372

Depreciation
171

 
2,070

 
2,654

 
1,137

 
(104
)
 
5,928

General and administrative expenses

 

 

 

 
8,462

 
8,462

Profit participation

 
2,538

 

 

 

 
2,538

Gain on sales of assets

 
(25,421
)
c 

 

 

 
(25,421
)
Operating income (loss)
$
1,025

 
$
23,708

 
$
4,070

 
$
2,624

 
$
(8,991
)
 
$
22,436

Capital expenditures and purchases and development of real estate properties
$
11,196

 
$
13,845

 
$
273

 
$
245

 
$

 
$
25,559

a.
Includes sales commissions and other revenues together with related expenses.
b.
Includes consolidated general and administrative expenses and eliminations of intersegment amounts.
c.
Includes $24.3 million associated with recognition of a portion of the deferred gain on the sale of The Oaks at Lakeway.
d.
Includes $0.4 million of reductions to cost of sales associated with collection of prior-years' assessments of properties in Barton Creek.

10.
NEW ACCOUNTING STANDARDS
Revenue Recognition. In May 2014, the Financial Accounting Standards Board (FASB) issued a new Accounting Standards Update (ASU) related to revenue recognition. Stratus adopted this standard effective January 1, 2018, under the modified retrospective approach applied to contracts that remain in force at the adoption date. The adoption of this standard did not result in any changes to Stratus' revenue recognition policies or processes (refer to Note 1 of Stratus' 2017 Form 10-K for disclosure of Stratus' revenue recognition policy) except as follows:

Revenue or gains on sales of real estate are recognized when control of the asset has been transferred to the buyer if collection of substantially all of the consideration to which Stratus will be entitled is probable and Stratus has satisfied all other performance obligations under the contract. Consideration is allocated among multiple performance obligations or distinct nonfinancial assets to be transferred to the buyer based on relative fair value.


14


Financial Instruments. In January 2016, FASB issued an ASU that amends the guidance on the classification and measurement of financial instruments. This ASU makes limited changes to prior guidance and amends certain disclosure requirements. Stratus adopted this ASU effective January 1, 2018, and such adoption did not have a material impact on its financial statements.

Leases. In February 2016, FASB issued an ASU that will require lessees to recognize most leases on the balance sheet. This ASU allows lessees to make an accounting policy election to not recognize a lease asset and liability for leases with a term of 12 months or less and do not have a purchase option that is expected to be exercised. For public entities, this ASU is effective for interim and annual reporting periods beginning after December 15, 2018, with early adoption permitted. In July 2018, FASB issued a practical expedient allowing for entities to apply the provisions of the updated lease guidance at the January 1, 2019, effective date, without adjusting the comparative periods presented. Stratus continues to review the impact of the new guidance on its financial reporting and disclosures, including the impact of the College Station ground lease.

Statement of Cash Flows: Restricted Cash. In November 2016, FASB issued an ASU that changes the classification and presentation of restricted cash and restricted cash equivalents on the statement of cash flows. The ASU requires that a statement of cash flows include the change during the period in the total of cash, cash equivalents and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. Stratus adopted this ASU effective January 1, 2018, and adjusted its consolidated statement of cash flows for the nine months ended September 30, 2017, to include restricted cash (Stratus has no restricted cash equivalents) with cash and cash equivalents.

The impact of adopting this ASU for the nine months ended September 30, 2017, follows (in millions):
 
 
Previously Reported
 
Impact of Adoption
 
Current Presentation
Net increase in cash, cash equivalents and restricted cash
 
$
2,555

 
$
11,859

 
$
14,414

Cash, cash equivalents and restricted cash at beginning of year
 
13,597

 
11,892

 
25,489

Cash, cash equivalents and restricted cash at end of period
 
$
16,152

 
$
23,751

 
$
39,903

 
 
 
 
 
 
 

11. SUBSEQUENT EVENTS
In October 2018, Stratus, in partnership with HEB, purchased a 38-acre tract of land for approximately $9.5 million in New Caney, Texas, for the future development of an HEB-anchored, mixed-use project. Stratus and HEB entered into a new partnership agreement in which each party owns a 50 percent interest in the partnership and each funded half of the land purchase. Subject to completion of development plans, Stratus currently expects the New Caney project will be anchored by an HEB grocery store, and will include approximately 145,000 square feet of retail space (inclusive of the HEB grocery store), 5 pad sites, and a 10-acre multi-family parcel. Upon completion of certain pre-development work, which is currently underway, Stratus intends to enter into a lease with HEB, at which time Stratus will acquire HEB’s interest in the partnership for the amount of HEB’s investment. Stratus is reviewing its plans for timing of commencement of construction, which Stratus currently expects to be in approximately three years.

Stratus evaluated events after September 30, 2018, and through the date the financial statements were issued, and determined any events or transactions occurring during this period that would require recognition or disclosure are appropriately addressed in these financial statements.

15


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

OVERVIEW

In Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A), “we,” “us,” “our” and "Stratus" refer to Stratus Properties Inc. and all entities owned or controlled by Stratus Properties Inc. You should read the following discussion in conjunction with our consolidated financial statements, related MD&A and discussion of our business and properties included in our Annual Report on Form 10-K for the year ended December 31, 2017 (2017 Form 10-K) filed with the United States (U.S.) Securities and Exchange Commission (SEC). The results of operations reported and summarized below are not necessarily indicative of future operating results, and future results could differ materially from those anticipated in forward-looking statements (refer to “Cautionary Statement” for further discussion). All subsequent references to “Notes” refer to Notes to Consolidated Financial Statements (Unaudited) located in Part I, Item 1. “Financial Statements” of this Form 10-Q, unless otherwise stated.
We are a diversified real estate company engaged primarily in the acquisition, entitlement, development, management, operation and sale of commercial, hotel, entertainment, and multi-family and single-family residential real estate properties, primarily located in the Austin, Texas area, and also including projects in certain other select markets in Texas. We generate revenues and cash flows from the sale of developed properties, rental income from our leased properties and from our hotel and entertainment operations. See Note 9 for further discussion of our operating segments.
Developed property sales can include an individual tract of land that has been developed and permitted for residential use, a developed lot with a home already built on it or condominium units at the W Austin Residences. We may sell properties under development, undeveloped properties or leased properties, if opportunities arise that we believe will maximize overall asset values as part of our business plan. See "Business Strategy" below.
Our acreage under development and undeveloped as of September 30, 2018, is presented in the following table.
 
 
Under Development
 
Undeveloped
 
 
 
 
Single
Family
 
Multi-
family
 
Commercial
 
Total
 
Single
family
 
Multi-family
 
Commercial
 
Total
 
Total
Acreage
Austin:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Barton Creek
 
4

 
32

 

 
36

 
512

 
266

 
394

 
1,172

 
1,208

Circle C
 

 
15

 

 
15

 

 
21

 
216

 
237

 
252

Lantana
 

 

 

 

 

 

 
39

 
39

 
39

Other
 

 

 

 

 
7

 

 

 
7

 
7

Lakeway
 

 

 

 

 
35

 

 

 
35

 
35

Magnolia
 

 

 

 

 

 

 
124

 
124

 
124

Jones Crossing
 

 

 

 

 

 

 
48

 
48

 
48

Kingwood Place
 

 

 
54

 
54

 

 

 

 

 
54

Camino Real, San Antonio
 

 

 

 

 

 

 
2

 
2

 
2

Total
 
4

 
47

 
54

 
105

 
554

 
287

 
823

 
1,664

 
1,769

In third-quarter 2018, our revenues totaled $17.9 million and our net loss attributable to common stockholders totaled $2.4 million, compared with revenues of $17.2 million and net income attributable to common stockholders of $14.3 million for third-quarter 2017. During the first nine months of 2018, our revenues totaled $59.0 million and our net loss attributable to common stockholders totaled $5.1 million, compared with revenues of $59.3 million and net income attributable to common stockholders of $10.7 million for the first nine months of 2017.
The increase in revenues in third-quarter 2018, compared with third-quarter 2017, primarily reflects increased revenue from the Leasing Operations segment, partially offset by lower developed property sales. The decrease in revenues for the first nine months of 2018, compared with the first nine months of 2017, primarily reflects lower revenues from the Entertainment and Hotel segments, partially offset by higher revenue from the Leasing Operations segment and developed property sales.
The results for third-quarter 2017 and the first nine months of 2017 include a gain on the sale of assets totaling $24.3 million ($15.7 million to net income attributable to common stockholders) associated with recognition of a

16


portion of the deferred gain on the sale of The Oaks at Lakeway. The results for the first nine months of 2017 also include a $2.5 million charge ($1.6 million to net income attributable to common stockholders) for profit participation costs and a $0.5 million loss ($0.3 million to net income attributable to common stockholders) on early extinguishment of debt, both related to our sale of The Oaks at Lakeway, partly offset by a $1.1 million gain ($0.7 million to net income attributable to common stockholders) on the sale of a bank building and an adjacent undeveloped 4.1 acre tract of land at Barton Creek.
At September 30, 2018, we had total debt of $293.7 million and total cash and cash equivalents of $21.2 million, compared with total debt of $221.5 million and cash and cash equivalents of $14.6 million at December 31, 2017. We have significant recurring costs, including property taxes, maintenance and marketing, and we believe we will have sufficient sources of debt financing and cash from operations to meet our cash requirements. See “Capital Resources and Liquidity below and “Risk Factors” included in Part 1, Item 1A. of our 2017 Form 10-K for further discussion.
BUSINESS STRATEGY

Our overall strategy has been to manage our diverse asset base of residential, commercial, hotel and entertainment real estate located in the premier Austin, Texas market and in other select, fast-growing Texas markets. We enhance the value of our residential and commercial properties by securing and maintaining development entitlements and developing and building real estate projects on these properties for sale or investment. Our hotel and entertainment venues, including ACL Live, are located in downtown Austin and are central to the city's world renowned, vibrant music scene.
We are continuing our successful program of actively developing our properties and refinancing or marketing and selling developed assets at appropriate times to maximize stockholder value. Our active development plan includes completion of both residential and commercial projects. Our portfolio consists of approximately 1,800 acres of commercial, multi-family and single-family projects under development or undeveloped and held for future use. We believe that our portfolio, along with management’s extensive experience in Austin-area real estate development, support our ability to obtain project financing and/or seek joint venture partners including for the development projects described in “Development Activities - Residential” and “Development Activities - Commercial”.
DEVELOPMENT ACTIVITIES
Residential. As of September 30, 2018, the number of our multi-family and single-family residential developed lots/units, lots under development and lots for potential development by area are shown below:
 
 
Residential Lots/Units
 
 
Developed
 
Under
Development
 
Potential Developmenta
 
Total
Barton Creek:
 
 
 
 
 
 
 
 
Amarra Drive:
 
 
 
 
 
 
 
 
Phase II
 
10

 

 

 
10

Phase III
 
32

 
4

 

 
36

Amarra Villas
 
3

 
14

 

 
17

Other townhomes
 

 

 
170

 
170

Section N multi-family:
 
 
 
 
 
 
 
 
Santal Phase I
 
236

 

 

 
236

Santal Phase II
 
64

 
148

 

 
212

Other Section N
 

 

 
1,412

 
1,412

Other Barton Creek sections
 

 

 
156

 
156

Circle C multi-family:
 
 
 
 
 
 
 
 
The Saint Mary
 

 
240

 

 
240

Tract 102
 

 

 
56

 
56

Lakeway
 

 

 
100

 
100

Other
 

 

 
7

 
7

W Austin Residences
 
1

 

 

 
1

Total Residential Lots/Units
 
346

 
406

 
1,901

 
2,653


17


a.
Our development of the properties identified under the heading “Potential Development” is dependent upon the approval of our development plans and permits by governmental agencies, including the City of Austin (the City) and other cities in our Texas markets. Those governmental agencies may not approve one or more development plans and permit applications related to such properties or may require us to modify our development plans. Accordingly, our development strategy with respect to those properties may change in the future. While we may be proceeding with approved infrastructure projects or planning activities for some of these properties, they are not considered to be “under development” for disclosure in this table until construction activities have begun.
Current Activities.
In March 2018, we entered into a contract to sell one Amarra Drive Phase II lot and eight Amarra Drive Phase III lots for a total of $5.9 million. In accordance with the contract, the parties are required to close on these lots ratably before March 1, 2019. If the purchaser fails to close on the minimum number of lots by any of the specified closing dates, we may elect to terminate the contract but would retain the related $45 thousand earnest money. During third-quarter 2018, we closed on the sale of the one Amarra Drive Phase II lot included in the agreement discussed above, and two Amarra Drive Phase III lots for a total of $2.0 million. During the first nine months of 2018, we sold two Amarra Drive Phase II lots, six Amarra Drive Phase III lots, two Amarra Villas townhomes and one W Austin Hotel Residence for a total of $10.0 million.
Subsequent to third-quarter 2018 and through November 8, 2018, we closed on the sale of one Amarra Villas townhome, one Amarra Drive Phase II lot and one Amarra Drive Phase III lot. As of November 8, 2018, one Amarra Drive Phase III lot was under contract, in addition to the remaining eight Phase III lots subject to the contract discussed above. Also as of November 8, 2018, two Amarra Villas townhomes were under contract, including one currently under construction, and are expected to close later this year.
Construction of Santal Phase II, a 212-unit garden style, multi-family project located directly adjacent to Santal Phase I in the upscale, highly populated Barton Creek community is continuing to advance on schedule and on budget. The first Phase II units became available for occupancy in August 2018 and we plan to substantially complete construction by year-end 2018. As of September 30, 2018, 28 of the Phase II units were leased and the 236-unit Phase I was 96 percent leased and stabilized. We currently plan to evaluate refinancing the combined 448-unit Santal property upon stabilization of Phase II, which is currently expected by the end of 2019, subject to market conditions and leasing progress. 
In June 2018, we obtained project financing for, and commenced construction of The Saint Mary, a 240-unit luxury garden-style apartment project in the Circle C Community. The project remains on budget, and the first units are expected to be available for occupancy in third-quarter 2019, with projected completion expected by the end of 2019. Refer to Notes 3 and 6 for further discussion.
For further discussion of our multi-family and single-family residential properties listed in the table above, see MD&A in our 2017 Form 10-K.

18


Commercial. As of September 30, 2018, the number of square feet of our commercial property developed, under development and our remaining entitlements for potential development (excluding property associated with our unconsolidated joint venture with Tramell Crow Central Texas Development, Inc. relating to Crestview Station in Austin, and the W Austin Hotel and ACL Live entertainment venue) are shown below:
 
Commercial Property
 
Developed
 
Under Development
 
Potential Developmenta
 
Total
 
(in square feet)
Barton Creek:
 
 
 
 
 
 
 
Barton Creek Village
22,366

 

 

 
22,366

Entry corner

 

 
5,000

 
5,000

Amarra retail/office

 

 
83,081

 
83,081

Section N

 

 
1,500,000

 
1,500,000

Circle C

 

 
674,942

 
674,942

Lantana:
 
 
 
 
 
 
 
Lantana Place
99,379

 

 
220,621

 
320,000

Tract G07

 

 
160,000

 
160,000

W Austin Hotel & Residences:
 
 
 
 
 
 
 
Office
38,316

 

 

 
38,316

Retail
18,327

 

 

 
18,327

Magnolia

 

 
351,000

 
351,000

West Killeen Market
44,493

 

 

 
44,493

Jones Crossing
154,117

 

 
104,750

 
258,867

Kingwood Place

 
143,767

 

 
143,767

Total Square Feet
376,998

 
143,767

 
3,099,394

 
3,620,159

a.
Our development of the properties identified under the heading “Potential Development” is dependent upon the approval of our development plans and permits by governmental agencies, including the City and other cities in our Texas markets. Those governmental agencies may not approve one or more development plans and permit applications related to such properties or may require us to modify our development plans. Accordingly, our development strategy with respect to those properties may change in the future. While we may be proceeding with approved infrastructure projects or planning activities for some of these properties, they are not considered to be “under development” for disclosure in this table until construction activities have begun.
Current Activities.
We have executed leases for 68 percent of the retail space at West Killeen Market as of September 30, 2018, and all tenants are currently open for business. Leasing activities for the vacant space are ongoing. We intend to explore opportunities to sell West Killeen Market in 2019 depending on leasing progress and market conditions.

Construction of the retail component of Jones Crossing, an H-E-B, L.P., (HEB)-anchored, mixed-use development in College Station, Texas, is complete. We have signed leases for approximately 80 percent of the retail space, including the HEB lease. The HEB grocery store opened in September 2018, as scheduled. In addition, we have begun preliminary planning work on the phased 600-unit multi-family component.

We completed construction of the 99,379 square-foot first phase of Lantana Place, a mixed-use development in southwest Austin consisting of approximately 320,000 square feet of retail, hotel and office space in third-quarter 2018. The anchor tenant, Moviehouse & Eatery, opened in May 2018. We also entered into a ground lease for a Marriott A/C Hotel, which is anticipated to commence construction in early 2019. We have signed leases for 61 percent of the retail space as of September 30, 2018, and tenant improvement work is progressing.

Occupancy of the 22,366 square-foot retail complex in Barton Creek Village was approximately 70 percent as of September 30, 2018, and leasing activities for the vacant space are ongoing. We intend to market Barton Creek Village for sale in 2019, subject to market conditions and leasing progress.

19


On August 6, 2018, we purchased a 54-acre tract of land in Kingwood, Texas to be developed as Kingwood Place, a new mixed-use development project. The Kingwood project is expected to total approximately 144,000 square feet of retail lease space, anchored by a 103,000-square-foot HEB grocery store, 41,000 square feet of retail space, 6 retail pads and an 11-acre parcel planned for approximately 300 multi-family units. Site clearing is complete and construction is expected to begin in November 2018 subject to closing of construction financing. The HEB grocery store is anticipated to open in third-quarter 2019. Refer to Notes 3 and 6 for further discussion.

In October 2018, Stratus, in partnership with HEB, purchased a 38-acre tract of land for approximately $9.5 million in New Caney, Texas, for the future development of an HEB-anchored, mixed-use project. Subject to completion of development plans, we currently expect the New Caney project will be anchored by an HEB grocery store, and will include restaurants, retail services, and shop space, totaling approximately 145,000 square feet of retail space (inclusive of the HEB grocery store), 5 pad sites, and a 10-acre multi-family parcel. Refer to Note 11 for further discussion.

For further discussion of our commercial properties listed in the table above, see MD&A in our 2017 Form 10-K.

RESULTS OF OPERATIONS

We are continually evaluating the development and sale potential of our properties and will continue to consider opportunities to enter into transactions involving our properties, including possible joint ventures or other arrangements. As a result, and because of numerous other factors affecting our business activities as described herein and in our 2017 Form 10-K, our past operating results are not necessarily indicative of our future results. We use operating income or loss to measure the performance of each operating segment. Corporate, eliminations and other includes consolidated general and administrative expenses, which primarily consist of employee salaries and other costs.
The following table summarizes our results (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Operating (loss) income:
 
 
 
 
 
 
 
Real estate operations
$
(236
)
 
$
777

 
$
702

 
$
1,025

Leasing operations
942

 
24,612

 
1,861

 
23,708

Hotel
719

 
231

 
3,745

 
4,070

Entertainment
314

 
472

 
1,548

 
2,624

Corporate, eliminations and other
(2,776
)
 
(2,452
)
 
(9,022
)
 
(8,991
)
Operating (loss) income
$
(1,037
)
 
$
23,640

 
$
(1,166
)
 
$
22,436

Interest expense, net
$
(2,150
)
 
$
(1,577
)
 
$
(5,451
)
 
$
(5,060
)
Net (loss) income attributable to common stockholders
$
(2,372
)
 
$
14,308

 
$
(5,099
)
 
$
10,745

We have four operating segments: Real Estate Operations, Leasing Operations, Hotel and Entertainment (see Note 9). The following is a discussion of our operating results by segment:

Real Estate Operations
The following table summarizes our Real Estate Operations results (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Revenues:
 
 
 
 
 
 
 
Developed property sales
$
2,025

 
$
2,860

 
$
10,036

 
$
8,436

Undeveloped property sales

 

 

 
544

Commissions and other
83

 
178

 
261

 
264

Total revenues
2,108

 
3,038

 
10,297

 
9,244

Cost of sales, including depreciation
2,344

 
2,261

 
9,595

a 
8,219

Operating (loss) income
$
(236
)
 
$
777

 
$
702

 
$
1,025

 
 
 
 
 
 
 
 
a.
Includes $0.4 million of reductions to cost of sales associated with collection of prior-years' assessments of properties in Barton Creek.

20



Developed Property Sales. The following table summarizes our developed property sales (dollars in thousands):
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30,
 
2018
 
2017
 
Lots/Units
 
Revenues
 
Average Cost Per Lot/Unit
 
Lots
 
Revenues
 
Average Cost Per Lot/Unit
Barton Creek
 
 
 
 
 
 
 
 
 
 
 
Amarra Drive:
 
 
 
 
 
 
 
 
 
 
 
Phase II
1

 
$
670

 
$
211

 
1

 
$
560

 
$
193

Phase III
2

 
1,355

 
289

 
2

 
1,475

 
316

 
 
 
 
 
 
 
 
 
 
 
 
Circle C
 
 
 
 
 
 
 
 
 
 
 
Meridian

 

 

 
3

 
825

 
156

 
 
 
 
 
 
 
 
 
 
 
 
Total Residential
3

 
$
2,025

 
 
 
6

 
$
2,860

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30,
 
2018
 
2017
 
Lots/Units
 
Revenues
 
Average Cost Per Lot/Unit
 
Lots/Units
 
Revenues
 
Average Cost Per Lot/Unit
Barton Creek
 
 
 
 
 
 
 
 
 
 
 
Amarra Drive:
 
 
 
 
 
 
 
 
 
 
 
Phase II
2

 
$
1,275

 
$
210

 
1

 
$
560

 
$
193

Phase III
6

 
3,800

 
272

 
4

 
2,840

 
304

Amarra Villas
2

 
3,821

 
1,666

 
1

 
2,193

 
2,004

 
 
 
 
 
 
 
 
 
 
 
 
Circle C
 
 
 
 
 
 
 
 
 
 
 
Meridian

 

 

 
10

 
2,843

 
160

W Austin Hotel & Residences
 
 
 
 
 
 
 
 
 
 
 
Condominium Units
1

 
1,140

 
726

 

 

 

Total Residential
11

 
$
10,036

 
 
 
16

 
$
8,436

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Real Estate Revenue and Operating (Loss) Income. Revenue and operating income from our Real Estate Operations segment decreased in third-quarter 2018, compared with third-quarter 2017, primarily as a result of fewer developed property sales. Revenue and operating income from our Real Estate Operations for the first nine months of 2018 increased, compared with the first nine months of 2017, primarily as a result of higher revenues from the sales of higher priced residential units, including Amara Villas townhomes and the W Austin Hotel & Residences condominium.

Cost of Sales. Cost of sales includes cost of property sold, project operating and marketing expenses and allocated overhead costs, partly offset by reductions for certain municipal utility district (MUD) reimbursements. Cost of sales of $2.3 million for third-quarter 2018 approximated the cost of sales for third-quarter 2017. Cost of sales increased to $9.6 million for the first nine months of 2018, compared with $8.2 million for the first nine months of 2017, primarily as a result of the costs associated with the sale of two Amarra Villas townhomes and one W Austin Hotel & Residences condominium unit, which have a higher cost basis than the other properties sold.

Leasing Operations
The following table summarizes our Leasing Operations results (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Rental revenue
$
3,040

 
$
2,145

 
$
7,851

 
$
6,668

Rental cost of sales, excluding depreciation
1,235

 
1,100

 
3,756

 
3,773

Depreciation
863

 
739

 
2,234

 
2,070

Profit participation

 

 

 
2,538

Gain on sales of assets

 
(24,306
)
 

 
(25,421
)
Operating income
$
942

 
$
24,612

 
$
1,861

 
$
23,708


21


Rental Revenue. Rental revenue for 2018 primarily includes revenue from Santal Phase I, the office and retail space at the W Austin Hotel & Residences, West Killeen Market, Lantana Place and retail space at Barton Creek Village. Rental revenue for 2017 primarily included revenue from Santal Phase I, the office and retail space at the W Austin Hotel & Residences, retail space at Barton Creek Village, and The Oaks at Lakeway prior to its sale in February 2017. The increase in rental revenue in third-quarter 2018, compared with third-quarter 2017, primarily reflects activity at our recently completed retail properties, Lantana Place, Jones Crossing and West Killeen Market. The increase in rental revenue for the first nine months of 2018, compared with the first nine months of 2017, primarily reflects activity at Lantana Place, West Killeen Market, Santal Phase I and Jones Crossing, partially offset by the sale of The Oaks at Lakeway.
Rental Cost of Sales and Depreciation. Rental cost of sales and depreciation expense increased in third-quarter 2018, compared with third-quarter 2017, primarily as a result of activity at Lantana Place, Jones Crossing and the office space at the W Austin Hotel & Residences as a result of costs associated with repairs. Rental cost of sales and depreciation expense slightly increased for the first nine months of 2018, compared with the first nine months of 2017, primarily as a result of activity at West Killeen Market, Lantana Place, Jones Crossing and the office space at the W Austin Hotel & Residences as a result of costs associated with repairs, partially offset by the sale of The Oaks at Lakeway.

Operating Income. Operating income decreased in the 2018 periods, compared with the 2017 periods, primarily because operating income from the Leasing Operations segment for the 2017 periods included the recognition of a portion ($24.3 million) of the deferred gain associated with the sale of The Oaks at Lakeway (see Note 4). The first nine months of 2017 also included a $2.5 million profit participation charge associated with our sale of The Oaks at Lakeway, partly offset by a $1.1 million gain on the sale of a 3,085-square-foot bank building and an adjacent 4.1 acre undeveloped tract of land in Barton Creek.

Hotel
The following table summarizes our Hotel results (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Hotel revenue
$
8,244

 
$
7,795

 
$
27,281

 
$
28,047

Hotel cost of sales, excluding depreciation
6,639

 
6,678

 
20,861

 
21,323

Depreciation
886

 
886

 
2,675

 
2,654

Operating income
$
719

 
$
231

 
$
3,745

 
$
4,070

Hotel Revenue. Hotel revenue primarily includes revenue from W Austin Hotel room reservations and food and beverage sales. Hotel revenues increased in third-quarter 2018, compared with third-quarter 2017, primarily reflecting higher room revenues resulting from higher occupancy during the quarter. Hotel revenues decreased during the first nine months of 2018, compared with the first nine months of 2017, primarily as a result of lower number of reservations from large groups and lower food and beverage sales. Revenue per available room (RevPAR), which is calculated by dividing total room revenue by the average total rooms available, was $214 for third-quarter 2018 and $243 for the first nine months of 2018, compared with $199 for third-quarter 2017 and $253 for the first nine months of 2017. While we remain positive on the long-term outlook of the W Austin Hotel based on continued population growth and increased tourism in the Austin market, a continued increase in competition resulting from the anticipated opening of additional hotel rooms in downtown Austin during the remainder of 2018 and 2019 is expected to have an ongoing impact on our hotel revenues.
Entertainment
The following table summarizes our Entertainment results (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Entertainment revenue
$
4,859

 
$
4,655

 
$
14,569

 
$
16,517

Entertainment cost of sales, excluding depreciation
4,154

 
3,799

 
11,850

 
12,756

Depreciation
391

 
384

 
1,171

 
1,137

Operating income
$
314

 
$
472

 
$
1,548

 
$
2,624


22


Entertainment Revenue. Entertainment revenue primarily reflects the results of operations for ACL Live, including ticket sales, revenue from private events, sponsorships, personal seat license sales and suite sales, and sales of concessions and merchandise. Entertainment revenue also reflects revenues associated with events hosted at venues other than ACL Live, including 3TEN ACL Live. Revenues from the Entertainment segment will vary from period to period as a result of factors such as the price of tickets and number of tickets sold, as well as the number and type of events hosted at ACL Live and 3TEN ACL Live. The increase in Entertainment revenue in third-quarter 2018, compared with third-quarter 2017, primarily reflects higher ticket prices at ACL Live and an increase in revenue from sponsorships and sales of suites and personal seat licenses. The decrease in Entertainment revenue for the first nine months of 2018, compared with the first nine months of 2017, primarily reflects fewer events hosted and lower event attendance.
Certain key operating statistics specific to the concert and event hosting industry are included below to provide additional information regarding our ACL Live and 3TEN ACL Live operating performance.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
ACL Live
 
 
 
 
 
 
 
Events:
 
 
 
 
 
 
 
Events hosted
49

 
43

 
151

 
160

Estimated attendance
62,323

 
61,848

 
180,942

 
208,687

Ancillary net revenue per attendee
$
32.87

 
$
35.95

 
$
40.28

 
$
40.39

Ticketing:
 
 
 
 
 
 
 
Number of tickets sold
48,436

 
56,316

 
132,568

 
152,270

Gross value of tickets sold (in thousands)
$
2,686

 
$
2,995

 
$
7,786

 
$
9,142

 
 
 
 
 
 
 
 
3TEN ACL Live
 
 
 
 
 
 
 
Events:
 
 
 
 
 
 
 
Events hosted
55

 
47

 
161

 
167

Estimated attendance
9,520

 
8,141

 
29,462

 
29,799

Ancillary net revenue per attendee
$
49.84

 
$
21.25

 
$
40.93

 
$
38.23

Ticketing:
 
 
 
 
 
 
 
Number of tickets sold
5,316

 
3,386

 
18,025

 
13,956

Gross value of tickets sold (in thousands)
$
142

 
$
89

 
$
415

 
$
302

Entertainment Cost of Sales. Entertainment cost of sales, excluding depreciation, totaled $4.2 million for third-quarter 2018, compared with $3.8 million for third-quarter 2017, primarily reflects an increase in the number of events hosted. Entertainment cost of sales, excluding depreciation, totaled $11.9 million for the first nine months of 2018, compared with $12.8 million for the first nine months of 2017, primarily reflecting a decrease in the number of events hosted at ACL Live.
Corporate, Eliminations and Other
Corporate, eliminations and other includes consolidated general and administrative expenses, which primarily consist of employee salaries and other costs. Consolidated general and administrative expenses totaled $2.7 million for third-quarter 2018 and $8.6 million for the first nine months of 2018, compared with $2.2 million for third-quarter 2017 and $8.5 million for the first nine months of 2017. The increase in general and administrative expenses in third-quarter 2018, compared to third-quarter 2017, primarily reflects increases in compensation and legal fees. Corporate, eliminations and other also includes eliminations of intersegment amounts incurred by the four operating segments.
Non-Operating Results
Interest Expense, Net. Interest costs (before capitalized interest) of $4.3 million for third-quarter 2018 and $11.4 million for the first nine months of 2018 were higher, compared with $3.1 million for third-quarter 2017 and $9.3 million for the first nine months of 2017, primarily reflecting higher average debt balances.

23


Capitalized interest totaled $2.1 million for third-quarter 2018 and $6.0 million for the first nine months of 2018, compared with $1.5 million for third-quarter 2017 and $4.3 million for the first nine months of 2017, and is primarily related to development activities at Barton Creek.
Gain on Interest Rate Derivative Instruments. We recorded gains of $0.1 million for third-quarter 2018 and $0.3 million for the first nine months of 2018, compared with $0.1 million for third-quarter 2017 and the first nine months of 2017, associated with changes in the fair values of our interest rate derivative instruments.
Loss on Early Extinguishment of Debt. We recorded losses on early extinguishment of debt of $0.5 million for the first nine months of 2017 associated with the repayment of The Oaks at Lakeway loan.
Equity in Unconsolidated Affiliates' Income (Loss). We account for our interests in our unconsolidated affiliates, primarily Crestview Station, using the equity method. Our equity in the net income (loss) of these entities totaled $210 thousand for third-quarter 2018 and $204 thousand for the first nine months of 2018, compared with $(5) thousand for third-quarter 2017 and $(24) thousand for the first nine months of 2017. The increase in the third-quarter and first nine months of 2018 reflects profit from the sale of Crestview's last tract of land in July 2018.
Benefit from (Provision for) Income Taxes. We recorded a benefit from income taxes of $0.5 million for third-quarter 2018 and $1.0 million for the first nine months of 2018, compared with a provision of $(7.8) million for third-quarter 2017 and $(6.2) million for the first nine months of 2017. Both the 2018 and 2017 periods also include the Texas state margin tax. The difference between Stratus' consolidated effective income tax rate and the U.S. Federal statutory income tax rate of 21 percent for 2018 and 35 percent for 2017 is primarily attributable to the Texas state margin tax. We had deferred tax assets (net of deferred tax liabilities) totaling $12.5 million at September 30, 2018, and $11.5 million at December 31, 2017.
CAPITAL RESOURCES AND LIQUIDITY
Volatility in the real estate market, including the markets in which we operate, can impact sales of our properties from period to period. However, we believe that the nature and location of our assets will provide us positive cash flows over time.
Comparison of Cash Flows for the Nine Months Ended September 30, 2018 and 2017
Operating Activities. Cash used in operating activities totaled $26.6 million for the first nine months of 2018, compared with $12.9 million for the first nine months of 2017. Expenditures for purchases and development of real estate properties totaled $28.9 million for the first nine months of 2018, compared with $11.2 million for the first nine months of 2017. The increase in the 2018 period primarily reflects the purchase of the Kingwood Place land.
We have received MUD reimbursements relating to substantially all of the infrastructure costs incurred to date in Barton Creek, including $2.2 million received in the first nine months of 2017. In November 2017, the city of Magnolia and the state of Texas approved the creation of a MUD, which will provide an opportunity for us to recoup approximately $26 million over the life of the project for future road and utility infrastructure costs incurred in connection with our development of the Magnolia project.
Investing Activities. Cash (used in) provided by investing activities totaled $(54.6) million for the first nine months of 2018, compared with $101.2 million for the first nine months of 2017. Capital expenditures totaled $53.5 million for the first nine months of 2018, primarily related to development of the Santal Phase II, Lantana Place, Jones Crossing and The Saint Mary projects, and $14.4 million for the first nine months of 2017, primarily related to development of the Lantana Place, West Killeen Market and Jones Crossing projects. The first nine months of 2017 included $117.3 million in proceeds from the sales of The Oaks at Lakeway and a bank building and an adjacent undeveloped 4.1 acre tract of land in Barton Creek.
Stratus also made payments under its master lease obligations associated with the sale of The Oaks at Lakeway totaling $1.5 million for the first nine months of 2018 and $1.7 million for the first nine months of 2017.
Financing Activities. Cash provided by (used in) financing activities totaled $88.9 million for the first nine months of 2018, compared with $(73.9) million for the first nine months of 2017. During the first nine months of 2018, net borrowings on the Comerica Bank credit facility totaled $26.3 million, compared with net repayments of $8.5 million for the first nine months of 2017. Net borrowings for the first nine months of 2018 were used primarily to fund development projects and capital expenditures. Net repayments in the first nine months of 2017 were primarily from the proceeds from the sale of the Oaks at Lakeway after repaying the related term loan. Net borrowings on other project and term loans totaled $46.3 million for the first nine months of 2018, primarily for the Santal Phase II,

24


Lantana Place and Jones Crossings projects, compared with net repayments of $55.5 million for the first nine months of 2017, primarily for The Oaks at Lakeway term loan. See also “Credit Facility and Other Financing Arrangements” below for a discussion of our outstanding debt at September 30, 2018. The first nine months of 2018 also included $17.7 million of capital contributions from the Class B limited partners in the Kingwood Place and Saint Mary limited partnerships (see Note 3).
On March 15, 2017, we announced that our Board, after receiving written consent from Comerica Bank, declared a special cash dividend of $1.00 per share, which was paid on April 18, 2017, to stockholders of record on March 31, 2017. The special cash dividend was declared after the Board’s consideration of the results of the sale of The Oaks at Lakeway. The declaration of future dividends is at the discretion of our Board subject to the restrictions contained in our Comerica credit facility, which prohibit us from paying a dividend on our common stock without the bank's written consent. Comerica's approval of the special dividend declared in March 2017 is not indicative of the bank's willingness to approve future dividends.
Credit Facility and Other Financing Arrangements
At September 30, 2018, we had total debt based on the principal amounts outstanding of $296.2 million, compared with $223.6 million at December 31, 2017. The principal amounts of our debt outstanding at September 30, 2018, consisted of the following:
$144.8 million under the Goldman Sachs loan.
$52.1 million under the $60.0 million Comerica Bank credit facility, which is comprised of a $60.0 million revolving line of credit, $3.8 million of which was available at September 30, 2018, net of $4.1 million of letters of credit committed against the credit facility.
$32.8 million under the construction loan with Comerica Bank to fund Phase I of the multi-family development in Section N of Barton Creek (the Santal Phase I loan).
$16.7 million under the construction loan with Comerica Bank to fund Phase II of the multi-family development in Section N of Barton Creek (the Santal Phase II loan).
$16.4 million under the construction loan with Southside Bank to finance the initial phase of Lantana Place (the Lantana Place construction loan).
$11.5 million under the construction loan with Southside Bank to finance the development and construction of Phases I and 2, the retail component, of Jones Crossing (the Jones Crossing construction loan).
$6.75 million under the loan with Comerica Bank to finance the development and construction of Kingwood Place (the Kingwood Place loan).
$6.6 million under the construction loan with Southside Bank to fund the development and construction of the West Killeen Market retail project (the West Killeen Market construction loan).
$5.3 million under the stand-alone revolving credit facility with Comerica Bank to fund the construction and development of the Amarra Villas (the Amarra Villas credit facility).
$3.4 million under the term loan with PlainsCapital Bank secured by assets at Barton Creek Village (the Barton Creek Village term loan).
Several of our financing instruments contain customary financial covenants. The Santal Phase I and Phase II loans, the Amarra Villas credit facility and the West Killeen Market construction loan include a requirement that we maintain a minimum total stockholders’ equity balance of $110.0 million. As of September 30, 2018, Stratus' total stockholders' equity was $122.6 million. The Comerica credit facility, the Goldman Sachs loan, the Lantana Place construction loan, the Jones Crossing construction loan, The Saint Mary construction loan and the Kingwood Place loan include a requirement that we maintain a net asset value, as defined in the agreements, of $125 million. The Comerica credit facility and the Kingwood Place loan also include a requirement that we maintain a promissory note debt-to-gross asset value, as defined in the agreement, of less than 50 percent. In addition, Comerica's prior written consent is required for any common stock repurchases or dividend payments. As of September 30, 2018, Stratus was in compliance with all financial covenants.

25


Stratus Kingwood Place, L.P. has secured a commitment to modify its loan agreement with Comerica Bank to increase the original commitment from $6.75 million to $32.9 million, guaranteed by us, to finance a portion of the construction of Kingwood Place. The loan modification is expected to close in November 2018.
See Note 6 in our 2017 Form 10-K for further discussion of our outstanding debt.
The following table summarizes our debt maturities based on the principal amounts outstanding as of September 30, 2018 (in thousands):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2018
 
2019
 
2020
 
2021
 
2022
 
Thereafter
 
Total
Goldman Sachs loan
$
538

 
$
2,208

 
$
2,313

 
$
2,470

 
$
2,613

 
$
134,635

 
$
144,777

Comerica Bank credit facilitya

 

 
52,089

 

 

 

 
52,089

Santal Phase I loanb

 

 
32,790

 

 

 

 
32,790

Santal Phase II loan

 

 
16,669

 

 

 

 
16,669

Lantana Place construction loan

 

 

 

 

 
16,374

 
16,374

Jones Crossing construction loan

 

 

 

 

 
11,518

 
11,518

Kingwood Place loan

 
6,750

 

 

 

 

 
6,750

West Killeen Market construction loan

 

 

 

 
6,560

 

 
6,560

Amarra Villas credit facility

 
5,308

 

 

 

 

 
5,308

Barton Creek Village term loan
28

 
104

 
109

 
114

 
119

 
2,877

 
3,351

Total
$
566

 
$
14,370

 
$
103,970

 
$
2,584

 
$
9,292

 
$
165,404

 
$
296,186

a.
See Note 6 for further information regarding Comerica Bank credit facility.
b.
We have the option to extend the maturity date for two additional twelve-month periods, subject to certain debt service coverage conditions.

CONTRACTUAL OBLIGATIONS
There have been no material changes in our contractual obligations since December 31, 2017. Refer to Part II, Items 7. and 7A. in our 2017 Form 10-K, for further information regarding our contractual obligations.
NEW ACCOUNTING STANDARDS
Refer to Note 10 for discussion of a recently adopted accounting standards update.
OFF-BALANCE SHEET ARRANGEMENTS
There have been no material changes in our off-balance sheet arrangements since December 31, 2017. See Note 9 in our 2017 Form 10-K for further information.
CAUTIONARY STATEMENT
MD&A contains forward-looking statements in which we discuss our future performance. Forward-looking statements are all statements other than statements of historical facts, such as statements regarding the implementation, projections or expectations related to the future development, construction and completion of our projects, and potential results of our active development plan, projections or expectations related to operational and financial performance or liquidity, reimbursements for infrastructure costs, financing and regulatory matters, development plans and sales of properties, including, but not limited to, Amarra Drive lots and townhomes, exploring opportunities to sell West Killeen Market and the retail complex in Barton Creek Village, evaluating refinancing of Santal Phase I and II, leasing activities, timeframes for development, capital expenditures, possible joint venture, partnership or other arrangements, our projections with respect to our obligations under the master lease agreements entered into in connection with the sale of The Oaks at Lakeway in 2017, and other plans and objectives of management for future operations and activities, and future dividend payments. The words “anticipate,” “may,” “can,” “plan,” “believe,” “potential,” “estimate,” “expect,” “project,” “intend,” “likely,” “will,” “should,” “to be” and any similar expressions and/or statements that are not historical facts are intended to identify those assertions as forward-looking statements. Nothing contained in MD&A should be construed as an offer to sell or the solicitation of an offer to buy any securities. Under our loan agreement with Comerica Bank, we are not permitted to pay dividends on common stock without Comerica’s prior written consent. The declaration of dividends is at the discretion of our Board of Directors (Board), subject to restrictions under our loan agreement with Comerica Bank,

26


and will depend on our financial results, cash requirements, projected compliance with covenants in our debt agreements, outlook and other factors deemed relevant by the Board.
We caution readers that forward-looking statements are not guarantees of future performance and actual results may differ materially from those anticipated, expected, projected or assumed in the forward-looking statements. Important factors that can cause our actual results to differ materially from those anticipated in the forward-looking statements include, but are not limited to, our ability to refinance and service our debt and the availability of financing for development projects and other corporate purposes, our ability to sell properties at prices our Board considers acceptable, a decrease in the demand for real estate in the Austin, Texas area and other select Texas markets where we operate, changes in economic and business conditions, reductions in discretionary spending by consumers and corporations, competition from other real estate developers, hotel operators and/or entertainment venue operators and promoters, the termination of sales contracts or letters of intent due to, among other factors, the failure of one or more closing conditions or market changes, the failure to attract customers for our developments or such customers' failure to satisfy their purchase commitments, our ability to secure qualifying tenants for the space subject to the master lease agreements entered into in connection with the sale of The Oaks at Lakeway in 2017 and to assign such leases to the purchaser and remove the corresponding property from the master leases, the failure to attract customers or tenants for its developments or such customers’ or tenants' failure to satisfy their purchase commitments, increases in interest rates, declines in the market value of our assets, increases in operating costs, including real estate taxes and the cost of construction materials, changes in external perception of the W Austin Hotel, changes in consumer preferences, changes in laws, regulations or the regulatory environment affecting the development of real estate, opposition from special interest groups with respect to development projects, and other factors described in more detail under the heading “Risk Factors” in Part I, Item 1A. of our 2017 Form 10-K. In addition, forward-looking statements and estimates regarding the effects of the Tax Cuts and Jobs Act, which are based on our current interpretation of this legislation and on reasonable estimates, may change as a result of new guidance issued by regulators or changes in our estimates.

Investors are cautioned that many of the assumptions upon which our forward-looking statements are based are likely to change after the forward-looking statements are made. Further, we may make changes to our business plans that could affect our results. We caution investors that we do not intend to update our forward-looking statements more frequently than quarterly notwithstanding any changes in our assumptions, business plans, actual experience, or other changes, and we undertake no obligation to update any forward-looking statements.


27


Item 3. Quantitative and Qualitative Disclosures About Market Risk.

We derive our revenue from the acquisition, entitlement, development, management, operation and sale of our commercial, hotel, entertainment and multi-family and single-family residential real estate properties. Our results of operations can vary significantly with fluctuations in the market prices of real estate, which are influenced by numerous factors, including interest rate levels. Changes in interest rates also affect interest expense on our debt.

At September 30, 2018, $148.1 million of the $296.2 million principal amount of debt outstanding bears interest at variable rates. An increase of 100 basis points in annual interest rates for this variable-rate debt would increase our annual interest costs by $1.5 million.

There have been no material changes in our market risks since December 31, 2017. For additional information on our market risks, refer to “Disclosures About Market Risks” included in Part II, Items 7. and 7A. of our 2017 Form 10-K.

Item 4. Controls and Procedures.

(a)           Evaluation of disclosure controls and procedures. Our Chief Executive Officer and Chief Financial Officer, with the participation of management, have evaluated the effectiveness of our “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this quarterly report on Form 10-Q. Based on this evaluation, they have concluded that our disclosure controls and procedures were effective as of September 30, 2018.

(b)           Changes in internal control over financial reporting. There was no change in our internal control over financial reporting that occurred during the quarter ended September 30, 2018, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION
 
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

There were no unregistered sales of equity securities during the three months ended September 30, 2018.

In November 2013, our Board approved an increase in our open-market share purchase program from 0.7 million shares to 1.7 million shares of our common stock. There were no purchases under this program in third quarter
2018. As of September 30, 2018, a total of 991,695 shares of our common stock remain available for repurchase under this program. The program does not have an expiration date.

Our Comerica Bank credit facility requires lender approval of any common stock repurchases.

For a discussion of limitations on our ability to pay dividends, see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Capital Resources and Liquidity" in Part I, Item 2. of this quarterly report on Form 10-Q.

Item 6. Exhibits.
 
 
 
 
 
 
Incorporated by Reference
Exhibit
Number
 
Exhibit Title
 
Filed with this Form 10-Q
 
Form
 
File No.
 
Date Filed
 
 
 
 
 
 
 
 
 
 
 
 
Agreement of Sale and Purchase, dated February 15, 2017, between Stratus Lakeway Center, LLC and FHF I Oaks at Lakeway, LLC.
 
 
 
8-K
 
001-37716
 
2/21/2017
 
 
 
 
 
 
 
 
 
 
 
 
Composite Certificate of Incorporation of Stratus Properties Inc.
 
 
 
8-A/A
 
000-19989
 
8/26/2010
 
 
 
 
 
 
 
 
 
 
 
 
Second Amended and Restated By-Laws of Stratus Properties Inc., as amended effective August 3, 2017.
 
 
 
10-Q
 
001-37716
 
8/9/2017

28


 
 
 
 
 
 
Incorporated by Reference
Exhibit
Number
 
Exhibit Title
 
Filed with this Form 10-Q
 
Form
 
File No.
 
Date Filed
 
 
 
 
 
 
 
 
 
 
 
 
Investor Rights Agreement by and between Stratus Properties Inc. and Moffett Holdings, LLC dated as of March 15, 2012.
 
 
 
8-K
 
000-19989
 
3/20/2012
 
 
 
 
 
 
 
 
 
 
 
 
Assignment and Assumption Agreement by and among Moffett Holdings, LLC, LCHM Holdings, LLC and Stratus Properties Inc., dated as of March 3, 2014.
 
 
 
13D
 
000-19989
 
3/5/2014
 
 
 
 
 
 
 
 
 
 
 
 
Amended and Restated Limited Partnership Agreement of Stratus Kingwood Place, L.P. entered into by and among Stratus Northpark, L.L.C., Stratus Properties Operating Co., L.P., and several Class B Limited Partners.
 
 
 
10-Q
 
001-37716
 
8/9/2018
 
 
 
 
 
 
 
 
 
 
 
 
Stratus Properties Inc. Profit Participation Incentive Plan and Form of Award Notice.

 
 
 
10-Q
 
001-37716
 
8/9/2018
 
 
 
 
 
 
 
 
 
 
 
 
Certification of Principal Executive Officer pursuant to Rule 13a-14(a)/15d-14(a).
 
X
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Certification of Principal Financial Officer pursuant to Rule 13a-14(a)/15d-14(a).
 
X
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350.
 
X
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350.
 
X
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
101.INS
 
XBRL Instance Document.
 
X
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
101.SCH
 
XBRL Taxonomy Extension Schema.
 
X
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase.
 
X
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
_______________________

* Indicates management contract or compensatory plan or arrangement.

29


SIGNATURE


Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

STRATUS PROPERTIES INC.

By: /s/ Erin D. Pickens
----------------------------------------
Erin D. Pickens
Senior Vice President and
Chief Financial Officer
(authorized signatory and
Principal Financial Officer)

Date: November 9, 2018

S-1