10-K 1 a2018stratus10-k.htm 10-K Document


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K
 
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 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: 000-19989
stratuslogoprinta15.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)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common Stock, par value $0.01 per share
 
The NASDAQ Stock Market
Securities registered pursuant to Section 12(g) of the Act:  None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. o Yes þ No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. o Yes þ No
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 o No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).    þ Yes o No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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.     
o Large accelerated filer                                      Accelerated filer þ
o Non-accelerated filer                                  Smaller reporting company þ o 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.    o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    o Yes þ No
The aggregate market value of common stock held by non-affiliates of the registrant was $150.6 million on June 30, 2018.
Common stock issued and outstanding was 8,164,370 shares on February 28, 2019, and 8,153,370 shares on June 30, 2018.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of our proxy statement for our 2019 annual meeting of stockholders are incorporated by reference into Part III (Items 10, 11, 12, 13 and 14) of this report.



STRATUS PROPERTIES INC.
TABLE OF CONTENTS
 
Page
 
 
              Executive Officers of the Registrant
 
 
 
 
 
 
 
 
 

 
 
 
 



PART I

Items 1. and 2.  Business and Properties.

Except as otherwise described herein or the context otherwise requires, all references to “Stratus,” “we,” “us” and “our” in this Form 10-K refer to Stratus Properties Inc. and all entities owned or controlled by Stratus Properties Inc. All of our periodic reports filed with or furnished to the United States (U.S.) Securities and Exchange Commission (SEC) pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports are available, free of charge, through our website, www.stratusproperties.com, or by submitting a written request via mail to Stratus Investor Relations, 212 Lavaca St., Suite 300, Austin, Texas, 78701. These reports and amendments are available through our website or by request as soon as reasonably practicable after we electronically file or furnish such material with or to the SEC.

All references to “Notes” herein refer to the Notes to Consolidated Financial Statements located in Part II, Item 8. of this Form 10-K.

Overview

We are a diversified real estate company with headquarters in Austin, Texas. Our company was incorporated under the laws of the State of Delaware on March 11, 1992. We are engaged primarily in the acquisition, entitlement, development, management, operation and sale of commercial, and multi-family and single-family residential real estate properties, real estate leasing, and the operation of hotel and entertainment businesses located in the Austin, Texas area and other select, fast-growing markets in Texas. Our development portfolio consists of approximately 1,800 acres of commercial and multi- and single-family residential projects under development or undeveloped and held for future use. Our W Austin Hotel and our ACL Live and 3TEN ACL Live entertainment venues, are located in downtown Austin and are central to the city’s world renowned, vibrant music scene. See “Operations” below and Note 9 for discussion of our four operating segments - real estate operations, leasing operations, hotel and entertainment.

We generate revenues and cash flows from the sale of our developed properties, rental income from our leased properties and from our hotel and entertainment operations. Developed property sales can include an individual tract of land that has been developed and permitted for residential use, a developed lot with a residence already built on the lot or condominium units at our W Austin Residences. We may sell properties under development, undeveloped properties or leased properties if opportunities arise that we believe will maximize overall asset value as part of our business strategy. See “Business Strategy” in Part II, Items 7. and 7A. for further discussion.

Operations
A description of our four operating segments follows.
Real Estate Operations. The acreage under development and undeveloped as of December 31, 2018, that comprise our real estate operations is presented in the following table. Acreage under development includes real estate for which infrastructure work over the entire property has been completed, is currently being completed or is able to be completed and for which necessary permits have been obtained. The undeveloped acreage shown in the table below is presented according to anticipated uses for multi-family units, single-family lots and commercial development based upon our understanding of the properties’ existing entitlements. However, because of the nature and cost of the approval and development process and uncertainty regarding market demand for a particular use, there is no assurance that the undeveloped acreage will ever be developed. Undeveloped acreage (i.e., development work is not currently in progress on such property) includes real estate that can be sold “as is.”

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Acreage Under Development
 
Undeveloped Acreage
 
 
 
Single Family
 
Multi-
family
 
Commercial
 
Total
 
Single
Family
 
Multi-
family
 
Commercial
 
Total
 
Total
Acreage
Austin:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Barton Creek
4

 
19

 

 
23

 
512

 
266

 
394

 
1,172

 
1,195

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

 

 

 

 

 

 
45

 
45

 
45

Kingwood Place

 

 
54

 
54

 

 

 

 

 
54

New Caney

 

 

 

 

 

 
38

 
38

 
38

Camino Real, San Antonio

 

 

 

 

 

 
2

 
2

 
2

Total
4

 
34

 
54

 
92

 
554

 
287

 
858

 
1,699

 
1,791

 
Revenue from our real estate operations segment accounted for 19 percent of our total revenue for 2018 and 14 percent for 2017.

The following table summarizes the estimated development potential, including 284 multi-family units and 143,767 square feet of commercial space currently under development, of our acreage as of December 31, 2018:
 
 
 
 
 
 
 
Single Family
 
Multi-family
 
Commercial
 
(lots)
 
(units)
 
(gross square feet)
Barton Creek
173

 
1,626

 
1,588,081

Lakeway
100

 

 

Circle C

 
296

 
674,942

Lantana

 

 
380,621

Magnolia

 

 
351,000

New Caney

 

 
180,496

Kingwood Place

 

 
143,767

Jones Crossing

 

 
104,750

Other
1

 
6

 

Total
274

 
1,928

 
3,423,657


Leasing Operations. Our principal leasing operations at December 31, 2018, consisted of (1) 38,316 square feet of office space, including 9,000 square feet occupied by our corporate office, and 18,327 square feet of retail space at the W Austin Hotel & Residences, (2) a 22,366-square-foot retail building representing the first phase of Barton Creek Village, (3) a 44,493-square-foot retail complex at West Killeen Market, (4) a 154,117-square-foot retail space at Jones Crossing, (5) a 99,379-square-foot mixed-use development representing the first phase of Lantana Place, (6) the Santal Phase I multi-family project, a garden-style apartment complex consisting of 236 units, and (7) the Santal Phase II multi-family project, a garden-style apartment complex consisting of 212 units. In February 2017, we sold The Oaks at Lakeway and the Barton Creek Village bank building (see Note 10).

Revenue from our leasing operations segment accounted for 12 percent of our total revenue for 2018 and 10 percent for 2017.

Hotel. The W Austin Hotel, which is part of the W Austin Hotel & Residences, includes 251 luxury rooms and suites, a full service spa, gym, pool and 9,750 square feet of meeting space. We have an agreement with W Hotel Management Inc., a subsidiary of Starwood Hotels & Resorts Worldwide, Inc., which is a subsidiary of Marriott International, Inc., for the management of hotel operations at the W Austin Hotel.

Revenue from our hotel segment accounted for 43 percent of our total revenue for 2018 and 47 percent for 2017.

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Entertainment. The entertainment space at the W Austin Hotel & Residences is occupied by Austin City Limits Live at the Moody Theater (ACL Live) and includes a live music and entertainment venue and production studio with a maximum capacity of approximately 3,000 people. In addition to hosting concerts and private events, ACL Live is the home of Austin City Limits, a television program showcasing popular music legends. ACL Live hosted 240 events in 2018 with estimated attendance of 285,900, compared with 224 events in 2017 with estimated attendance of 297,100. As of February 28, 2019, ACL Live has events booked through December 2020. The ACL Live entertainment space is promoted through the broadcast of Austin City Limits by KLRU, a local public television station. In 2018, ACL Live extended its agreement with KLRU and Austin City Limits for an additional ten years. Entertainment revenue also includes revenues associated with events hosted at the 3TEN ACL Live venue, which is located on the site of the W Austin Hotel & Residences. 3TEN ACL Live opened in 2016 and has a capacity of approximately 350 people. The 3TEN ACL Live venue hosted 216 events in 2018 with estimated attendance of 38,100, compared with 228 events in 2017 with estimated attendance of 40,600. As of February 28, 2019, 3TEN ACL Live has events booked through December 2019.

Revenue from our entertainment segment accounted for 26 percent of our total revenue for 2018 and 29 percent for 2017.

For further information about our operating segments see “Results of Operations” in Part II, Items 7. and 7A. See Note 9 for a summary of our revenues, operating income and total assets by operating segment.

Properties

Our properties are primarily located in the Austin, Texas area, but include properties in other select markets in Texas. Our Austin-area properties include the following:

Barton Creek
Our Amarra Drive, Santal and Barton Creek Village properties are located in the Barton Creek community, which is a 4,000-acre upscale community located southwest of downtown Austin.

Amarra Drive.  Amarra Drive is a subdivision featuring lots ranging from one to over five acres. In 2008, we completed the development of Amarra Drive Phase II, which consists of 35 lots on 51 acres. We sold three lots in 2018 and one lot in 2017. As of December 31, 2018, nine developed Phase II lots remained unsold.

In 2015, we completed the development of Amarra Drive Phase III, which consists of 64 lots on 166 acres. We sold nine lots in 2018 and six lots in 2017. As of December 31, 2018, 29 developed Phase III lots remained unsold.

In March 2018, we entered into a contract, which was amended in March 2019, pursuant to which we agreed to sell 2 Amarra Drive Phase II lots and 12 Amarra Drive Phase III lots to a homebuilder for a total of $9.5 million. In accordance with the contract, as amended, the parties are required to close on the sale of these lots ratably before March 31, 2020. If the purchaser fails to close on the sale of 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. In 2018, in accordance with the contract, we sold two Amarra Drive Phase II lots and two Amarra Drive Phase III lots for $2.7 million. Subsequent to December 31, 2018, and through March 15, 2019, in accordance with the contract, we sold two additional Amarra Drive Phase III lots for $1.2 million.

As of March 15, 2019, two Amarra Drive Phase III lots were under contract, in addition to the remaining eight Amarra Drive Phase III lots subject to the contract discussed above.

The Villas at Amarra Drive (Amarra Villas) townhome project is a 20-unit development for which we completed sitework in 2015. The townhomes average approximately 4,400 square feet and are being marketed as “lock and leave” properties, with golf course access and cart garages. Construction of the first five townhomes was completed during 2017 and an additional two townhomes were completed in 2018. We sold four townhomes in 2018 and one townhome in 2017. Subsequent to December 31, 2018, and through March 15, 2019, we closed on the sale of one townhome for $1.7 million and one additional townhome was under contract. We anticipate beginning construction of the next five Amarra Villas townhomes during the second quarter of 2019.


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Santal. Santal is a garden-style luxury apartment complex located in Section N, which is part of the upscale, highly populated Barton Creek community. As of December 31, 2018, the Santal Phase I multi-family project, consisting of 236 units, was 95 percent leased. Construction of the 212-unit Santal Phase II, located directly adjacent to Santal Phase I, began during September 2017. The first Phase II units became available for occupancy in August 2018 and we have substantially completed construction of the remaining units. As of December 31, 2018, 33 percent of the total Phase II units were leased. We currently plan to evaluate a sale or refinancing of 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.

Barton Creek Village. The first phase of Barton Creek Village includes a 22,366-square-foot retail building and a 3,085-square-foot bank building. In February 2017, we sold the 3,085-square-foot bank building and an adjacent undeveloped 4.1 acre tract of land for $3.1 million (see Note 10). Occupancy of Barton Creek Village was approximately 54 percent as of December 31, 2018, and leasing activities for the vacant space are ongoing. We intend to explore opportunities to sell Barton Creek Village in 2019, subject to market conditions and leasing progress.

Circle C community
We own over 1,200 acres in the Circle C community, which is a master planned community located in Austin, Texas.

In 2002, the city of Austin (the City) granted final approval of a development agreement (the Circle C settlement), which firmly established all essential municipal development regulations applicable to our Circle C properties until 2032. See Note 8 for a summary of incentives we received in connection with the Circle C settlement.

We are developing the Circle C community based on the entitlements secured in the Circle C settlement. The Circle C settlement, as amended in 2004, permits development of 1.16 million square feet of commercial space, 504 multi-family units and 830 single-family residential lots.
 
The Saint Mary. In June 2018, we obtained financing for, and commenced construction of The Saint Mary, a 240-unit luxury garden-style apartment project located in the Circle C community. The project remains on schedule and within budget, and the first units are expected to be available for occupancy in third-quarter 2019, with project completion currently expected by the end of 2019. See Note 2 for further discussion of project financing.

Meridian. Meridian is an 800-lot residential development at the Circle C community. Development of the final phase of Meridian, which consisted of 57 one-acre lots, was completed in 2014. We sold the last 12 lots in 2017.

As of December 31, 2018, our Circle C community had remaining entitlements for 674,942 square feet of commercial space and 296 multi-family units, including The Saint Mary multi-family development.

In January 2019, Circle C Land, L.P., a wholly owned subsidiary of Stratus, completed the sale of a CVS store ground lease for a subdivided retail pad located in the Circle C community for $3.2 million. Stratus used proceeds from the sale to repay $2.5 million of its Comerica Bank credit facility.

Lantana

In third-quarter 2018, 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. The anchor tenant, Moviehouse & Eatery, opened in May 2018. As of December 31, 2018, we had signed leases for 71 percent of the retail space and tenant improvement work is progressing. We also entered into a ground lease with a hotel operator in connection with its development of an AC Hotel by Marriott, which is anticipated to commence construction in second-quarter 2019.

The W Austin Hotel & Residences

In 2006, we acquired a two-acre city block in downtown Austin for $15.1 million to develop a multi-use project. In 2008, we entered into a joint venture with Canyon-Johnson Urban Fund II, L.P. (Canyon-Johnson) for the development of the W Austin Hotel & Residences. In 2015, we completed the purchase of Canyon-Johnson’s approximate 58 percent interest in the joint venture.


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The W Austin Hotel & Residences consists of a 251-room luxury hotel, 159 residential condominium units, 38,316 square feet of leasable office space, including 9,000 square feet occupied by our corporate office, 18,327 square feet of retail space, including 3TEN ACL Live, and entertainment space occupied by ACL Live. During 2018, we sold one W Austin Hotel & Residences condominium unit, and as of December 31, 2018, one condominium unit remained unsold.

The Oaks at Lakeway
We own approximately 35 acres of undeveloped property in the greater Austin area, which is zoned for residential, hotel and civic uses. See Note 10 for discussion of our sale of The Oaks at Lakeway.

Our other Texas properties and development projects include:

Magnolia

In 2014, we acquired 124 acres in the greater Houston area to develop the Magnolia project, an H-E-B, L.P. (HEB)-anchored retail project planned for 351,000 square feet of commercial space. Planning and infrastructure work by the city of Magnolia is complete, road expansion by the Texas Department of Transportation has been completed, and we expect to begin construction in late 2019. The HEB grocery store is currently expected to open in August 2020.

West Killeen Market

In 2015, we acquired approximately 21 acres in Killeen, Texas, to develop the West Killeen Market project, an HEB-anchored retail project with 44,493 square feet of commercial space and three pad sites adjacent to a 90,000 square-foot HEB grocery store. Construction at West Killeen Market began in August 2016 and was completed in June 2017. The HEB grocery store opened in April 2017. As of December 31, 2018, leases for 68 percent of the space at West Killeen Market had been executed, all current tenants are currently open for business and leasing activities for the vacant space are ongoing. We intend to explore opportunities to sell West Killeen Market in 2019, subject to leasing progress and market conditions.

Jones Crossing

In 2017, we acquired a 72-acre tract of land in College Station, Texas, for Jones Crossing, an HEB-anchored, mixed-use project. Construction of the first phase of the retail component of the Jones Crossing project began in September 2017 and was completed in third-quarter 2018. The HEB grocery store opened in September 2018, and, as of December 31, 2018, we had signed leases for 87 percent of the retail space, including the HEB grocery store.

Kingwood Place

In August 2018, we purchased a 54-acre tract of land in Kingwood, Texas to be developed as Kingwood Place, an HEB-anchored, 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, with 41,000 square feet of retail space, 6 retail pads and an 11-acre parcel planned for approximately 300 multi-family units. Construction began in December 2018 and, as of December 31, 2018, we had signed leases for 77 percent of the retail space, including the HEB grocery store. The HEB grocery store is currently anticipated to open in November 2019. See Note 2 for further discussion of project financing.

New Caney

In October 2018, we purchased a 38-acre tract of land, in partnership with HEB, 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 include restaurants and retail services, totaling approximately 145,000 square feet (inclusive of the HEB grocery store), 5 pad sites and a 10-acre multi-family parcel. We finalized the lease for the HEB grocery store in March 2019, and upon execution of this lease, we acquired HEB’s interests in the partnership for approximately $5 million. We currently plan to commence construction of the New Caney project no earlier than 2021.

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Competition
 
We operate in highly competitive industries, namely the real estate development, leasing, hotel and entertainment industries. In the real estate development industry, we compete with numerous public and private developers of varying sizes, ranging from local to national in scope. As a result, we may be competing for investment opportunities, financing and potential buyers with developers that may possess greater financial, marketing or other resources than we have. Our prospective customers generally have a variety of choices of new and existing residences and sites when considering a purchase. We attempt to differentiate our properties primarily on the basis of design, quality, uniqueness, amenities, location and our developer reputation.

The leasing industry is highly fragmented among individuals, partnerships and public and private entities, with no single entity or person dominating the industry. Although we may compete against large sophisticated owners and operators, owners and operators of any size can effectively compete for prospective tenants. We compete for tenants primarily on the basis of property location, rent charged, design and amenities of the property.

In the hotel industry, competition is generally based on quality and consistency of rooms, availability of restaurant and meeting facilities and services, attractiveness of location, price and other factors. Management believes that we compete favorably in these areas. Our W Austin Hotel competes with other hotels and resorts in our geographic market, including hotels owned locally and facilities owned by national and international chains. According to a report published by the City of Austin's hotel and motel association, between 2010 (when the W Austin Hotel first opened) and 2018, the Austin central business district hotel room count has increased from 6,226 rooms to 10,660 rooms, an increase of 71 percent.

In the entertainment industry, we compete with other venues in Austin, Texas, and venues in other markets for artists likely to perform in the Austin, Texas region. Touring artists have several alternatives to our venue when scheduling tours. Some of our competitors in venue management have a greater number of venues in certain markets and may have greater financial resources in those markets. We differentiate our entertainment businesses by providing a quality live music experience and promoting our ACL Live entertainment space through the broadcast of Austin City Limits by KLRU, a local public television station.

See Part I, Item 1A. “Risk Factors” for further discussion.

Credit Facility and Other Financing Arrangements

Obtaining and maintaining adequate financing is a critical component of our business. For information about our credit facility and other financing arrangements, see “Capital Resources and Liquidity - Credit Facility and Other Financing Arrangements” in Part II, Items 7. and 7A. and Note 5.

Regulation and Environmental Matters

Our real estate investments are subject to extensive local, city, county and state rules and regulations regarding permitting, zoning, subdivision, utilities and water quality as well as federal rules and regulations regarding air and water quality and protection of endangered species and their habitats. Such regulation has delayed and may continue to delay development of our properties and may result in higher development and administrative costs. See Part I, Item 1A. “Risk Factors” for further discussion.

We have made, and will continue to make, expenditures for the protection of the environment with respect to our real estate development activities. Emphasis on environmental matters will result in additional costs in the future. Based on an analysis of our operations in relation to current and presently anticipated environmental requirements, we currently do not anticipate that these costs will have a material adverse effect on our future operations or financial condition.


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Employees

At December 31, 2018, we had a total of 140 employees, 49 of which were full-time employees, located at our Austin, Texas headquarters. We believe we have a good relationship with our employees, none of whom are represented by a union. Since 1996, certain services necessary for our business and operations, including certain administrative, financial reporting and other services, have been performed by FM Services Company (FM Services) pursuant to a services agreement. FM Services is a wholly owned subsidiary of Freeport-McMoRan Inc. Either party may terminate the services agreement at any time upon 60 days notice or earlier upon mutual written agreement.

Item 1A.  Risk Factors

This report contains “forward-looking statements” within the meaning of U.S. federal securities laws. Forward-looking statements are all statements other than statements of historical facts, such as 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, leasing activities, timeframes for development, construction and completion of our projects, capital expenditures, liquidity and capital resources, and other plans and objectives of management for future operations and activities.

We undertake no obligation to update any forward-looking statements. We caution readers that forward-looking statements are not guarantees of future performance and our 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 the following:

Risks Relating to our Business and Industries

We need significant amounts of cash to service our debt. If we are unable to generate sufficient cash to service our debt, our liquidity, financial condition and results of operations could be negatively affected.

Our industry is capital-intensive and requires significant up-front expenditures to secure land and pursue development and construction on such land. Our business strategy requires us to rely on cash flow from operations and our debt agreements as our primary sources of funding for our liquidity needs. We have also, from time to time, relied on project-level equity financing of our subsidiaries. As of December 31, 2018, our outstanding debt totaled $295.5 million and our cash and cash equivalents totaled $19.0 million. Our level of indebtedness could have significant consequences. For example, it could:

Increase our vulnerability to adverse changes in economic and industry conditions;

Require us to dedicate a substantial portion of our cash flow from operations and proceeds from asset sales to pay or provide for our indebtedness, thus reducing the availability of cash flows to fund working capital, capital expenditures, acquisitions, investments, dividends and other general corporate purposes;

Limit our flexibility to plan for, or react to, changes in our business and the markets in which we operate;

Force us to dispose of one or more of our properties, possibly on unfavorable terms;

Place us at a competitive disadvantage to our competitors that have less debt; and

Limit our ability to borrow money to fund our working capital, capital expenditures, debt service requirements and other financing needs.

Our ability to make scheduled debt service payments or to refinance our indebtedness, depends on our future operating and financial performance, which is subject to economic, financial, competitive and other factors beyond our control. Our business may not continue to generate cash flow from operations in the future sufficient to service our debt and make necessary capital expenditures. Historically, much of our debt has been renewed or refinanced in the ordinary course of business. Any deterioration of current economic conditions in our areas of operations could impact our ability to refinance our debt and obtain renewals on favorable terms or at all. In the future we may not be able to obtain sufficient external sources of liquidity on attractive terms, if at all, or otherwise renew, extend or refinance a significant portion of our outstanding debt scheduled to become due in the near future. There can be no

7


assurance that we will maintain cash reserves and generate sufficient cash flow from operations in an amount sufficient to enable us to service our debt or to fund our other liquidity needs. Any of these occurrences may have a material adverse effect on our liquidity, financial condition and results of operations. For example, our inability to extend, repay or refinance our debt when it becomes due, including upon a default or acceleration event, could force us to sell properties on unfavorable terms or ultimately result in foreclosure on properties pledged as collateral, which could result in a loss of our investment and harm our reputation. In addition, any difficulty in obtaining sufficient capital for planned development expenditures could also cause project delays, which could increase our costs.

Our current financing arrangements contain, and our future financing arrangements likely will contain, certain financial and restrictive covenants relating to our operations and the failure to comply with such covenants could result in a default that accelerates the required payment of such debt.

The terms of the agreements governing our indebtedness include restrictive covenants and require that certain financial ratios be maintained. For example, the minimum stockholders’ equity covenant contained in several of our debt agreements requires us to maintain total stockholders’ equity of no less than $110.0 million. At December 31, 2018, our total stockholders’ equity was $124.0 million. In addition, several of our debt agreements include a requirement that we maintain a net asset value, as defined in the agreements, of $125 million, and certain of our debt agreements include a requirement that we maintain a promissory note debt-to-gross asset value, as defined in the agreement, of less than 50 percent. As of December 31, 2018, we were in compliance with all financial covenants or had received waivers from lenders for noncompliance (see Note 5). Our Comerica credit facility and other debt arrangements contain several significant limitations restricting our ability to, among other things:

Borrow additional money or issue guarantees;

Pay dividends or other distributions to shareholders;

Make loans, advances or other investments;

Create liens on assets;

Sell assets;

Enter into sale-leaseback transactions;

Enter into transactions with affiliates; and

Engage in mergers or consolidations.

Failure to obtain necessary bank consents or to comply with any of the restrictions or covenants in our loan documents could result in a default that may, if not cured or waived, accelerate the payment under our debt obligations which would likely have a material adverse effect on our liquidity, financial condition and results of operations. Certain of our debt arrangements have cross-default or cross-acceleration provisions. When present, these provisions could have a wider impact on liquidity than might otherwise arise from a default or acceleration of a single debt instrument. We cannot assure you that we could adequately address any such defaults, cross-defaults or acceleration of our debt payment obligations in a sufficient or timely manner, or at all. Our ability to comply with our covenants will depend upon our future economic performance. These covenants may adversely affect our ability to finance our future operations, satisfy our capital needs or engage in other business activities that may be desirable or advantageous to us. See Note 5 for additional discussion of our restrictive covenants.

In order to maintain compliance with the covenants in our debt agreements and carry out our business plan, we may need to raise additional capital through equity transactions, including project-level equity financing of our subsidiaries or obtain waivers or modifications of covenants from our lenders. Such additional funding may not be available on acceptable terms, if at all, when needed. We also may need to incur additional indebtedness in the future in the ordinary course of business to fund our development projects and our operations. There can be no assurance that such additional financing will be available when needed or, if available, offered on acceptable terms. If new debt is added to our current debt levels, the risks described above could intensify.


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Increases in interest rates will increase our interest expense and may adversely affect our cash flow, and changes in how LIBOR, the London interbank offered rate, is determined, or the potential replacement of LIBOR with an alternative reference rate, may adversely affect our interest expense.

We have incurred, and may in the future incur, additional indebtedness that bears interest at a variable rate. Our consolidated debt at December 31, 2018 was $295.5 million, of which 51 percent was variable-rate debt. An increase in interest rates would increase our interest expense and increase the cost of refinancing existing debt and issuing new debt, which would adversely affect our cash flow. In addition, if we need to repay existing debt during periods of rising interest rates, we could be required to liquidate one or more of our investments at times that may not permit realization of the maximum return on such investments. The effect of prolonged interest rate increases could adversely impact our ability to make purchases and develop properties. We may seek to manage our exposure to interest rate volatility by using interest rate hedging arrangements, such as interest rate swap agreements. These agreements involve certain additional risks.

LIBOR is widely used as a reference for setting the interest rate on loans globally. We have used LIBOR as a reference rate in our promissory notes, loans, credit facilities, and other debt agreements such that the interest due to our creditors pursuant to these loans is calculated using LIBOR. LIBOR, in its current form, is currently scheduled to be phased out by the end of 2021. Before LIBOR ceases to exist, we may need to renegotiate our debt agreements that utilize LIBOR as a factor in determining the interest rate to replace LIBOR with a new standard, which has yet to be established. The full consequences of these developments cannot be predicted, but they could result in higher interest obligations than under the current form of LIBOR.

We are vulnerable to concentration risks because our operations are primarily located in the Austin, Texas area.

Our real estate operations are primarily, and our hotel and entertainment venue operations are entirely, located in Austin, Texas. While our real estate operations have expanded to include select markets in Texas outside of Austin, including College Station, Kingwood, Magnolia, West Killeen and New Caney, the geographic concentration of the majority of our operations we may have under development at a given time means that our operations are more vulnerable to local economic, regulatory, and other conditions (such as local periods of economic slowdown or recession, business layoffs or downsizing, industry slowdowns, relocations of businesses, increases in real estate and other taxes and the cost of complying with governmental regulations or increased regulation) and adverse project-specific risks than those of larger, more diversified companies. The performance of the Austin economy and our other select markets in Texas greatly affects our sales and consequently the underlying values of our properties. We cannot assure you that these markets will continue to grow or that underlying real estate fundamentals will continue to be favorable. Our geographic concentration may create increased vulnerability during regional economic downturns, which can significantly affect our financial condition and results of operations. See “Overview - Real Estate Market Conditions” in Part II, Items 7. and 7A. for more information.

The success of our business is significantly related to general economic conditions and, accordingly, our business could be harmed by any slowdown or deterioration in the economy.

Periods of economic uncertainty, weakness or recession; significantly rising interest rates; declining employment levels; declining demand for real estate; declining real estate values; conditions which negatively shape public perception of travel, including travel-related accidents, the financial condition of the airline, automotive and other transportation-related industries; or the public perception that any of these events or conditions may occur or be present, may negatively affect our business. These economic conditions can result in a general decline in acquisition, disposition and leasing activity, demand for hotel rooms and related lodging services, a general decline in the value of real estate and in rents, which in turn reduces revenue derived from property sales and leases and hotel operations as well as revenues associated with development activities. These conditions can also lead to a decline in property sales prices as well as a decline in funds invested in existing commercial real estate and related assets and properties planned for development. Other factors that could influence demand in our industries include increases in fuel costs, conditions in the real estate and mortgage markets, interest rates, labor costs, access to credit on reasonable terms, geopolitical issues and other macroeconomic factors. In addition, during periods of economic slowdown and recession, many consumers have historically reduced their discretionary spending, and our hotel and entertainment businesses depend on discretionary consumer and corporate spending. A reduction in consumer spending historically is accompanied by a decrease in hotel occupancy rates and attendance at live entertainment, sporting and leisure events, which may result in reductions in ticket sales, sponsorship opportunities and our ability to generate revenue with our hotel and entertainment businesses.

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During an economic downturn, investment capital is usually constrained and it may take longer for us to dispose of real estate investments. As a result, the value of our real estate investments may be reduced increasing the risk for asset impairments and write-offs and we could realize losses or diminished profitability. If economic and market conditions decline, our business performance and profitability could deteriorate. If this were to occur, we could fail to comply with certain financial covenants in our debt agreements, which would force us to seek waivers or amendments with our lenders. No assurance can be given that we would be able to obtain any necessary waivers or amendments on satisfactory terms, if at all.

Adverse weather conditions or natural disasters could adversely affect our business, financial condition and results of operations.

Our financial condition and results of operations may be adversely affected by weather conditions, including natural disasters, in or near our areas of operations. For our real estate operations, adverse weather may delay development or damage property resulting in substantial repair or replacement costs to the extent not covered by insurance, cause shortages and price increases in labor or raw materials, reduce property values, or a loss of revenue, each of which could have a material adverse effect on our business, financial condition and results of operations. Our competitors may be affected differently by such changes in weather conditions or natural disasters depending on the location of their supplies or operations. Because of weather conditions, we may be required to cancel or reschedule an event to another available day, which would increase our costs for the event and could negatively affect the attendance at the event, as well as concession and merchandise sales, which could adversely affect our financial condition and results of operations.

Our insurance coverage on our properties may be inadequate to cover any losses we may incur.

We maintain insurance on our properties, including business interruption, property, liability, fire and extended coverage. However, there are certain types of losses, generally of a catastrophic nature, such as floods or acts of war or terrorism that may be uninsurable or not economical to insure. We use our discretion when determining amounts, coverage limits and deductibles for insurance. These terms are determined based on retaining an acceptable level of risk at a reasonable cost. This may result in insurance coverage that in the event of a substantial loss would not be sufficient to pay the full current market value or current replacement cost of our lost investment. Inflation, changes in building codes and ordinances, environmental considerations and other factors also may make it unfeasible to use insurance proceeds to replace a building or other facility after it has been damaged or destroyed. Under such circumstances, the insurance proceeds we receive may be inadequate to restore our economic position in a property. In addition, we may become liable for injuries and accidents occurring during the construction process that are underinsured. A significant uninsured loss could materially and adversely affect our business, liquidity, financial condition and results of operations.

The loss of certain key senior management personnel could negatively affect our business.

We depend on the experience and knowledge of our two executive officers and other key personnel who have been instrumental in setting our strategic direction and executing on our business strategy, have extensive market knowledge and relationships and exercise substantial influence over our operational, financing, development and construction activities. Among the reasons that these individuals are important to our success is that each has a regional industry reputation that attracts business and investment opportunities and assists us in negotiations with lenders, existing and potential tenants, community stakeholders and industry personnel. Our Chairman, President and Chief Executive Officer has been employed by the company since its inception in 1992. He has served as President since August 1996, Chief Executive Officer since May 1998 and Chairman of the Board of Directors (Board) since August 1998. Our Senior Vice President and Chief Financial Officer has been employed by the company since 2009. The loss of any of our key senior management personnel could negatively affect our business.


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Our business may be adversely affected by information technology disruptions and the failure to maintain the integrity of guest, employee or company data could result in harm to our reputation, and result in a loss of business and/or subject us to costs, fines, investigations, enforcement actions, or lawsuits.

Many of our business and operational processes are dependent on traditional and emerging technology systems to conduct day-to-day operations and lower costs. As our dependence on information systems, including those of third party service providers and vendors such as our hotel operator, third party ticket sales, or third party hotel bookings, grows, we become more vulnerable to an increasing threat of continually evolving cybersecurity risks. Cybersecurity incidents are increasing in frequency and magnitude. These incidents may include, but are not limited to, installation of malicious software, phishing, credential attacks, unauthorized access to data and other electronic security breaches that could lead to disruptions in systems, unauthorized release of confidential or otherwise protected information and the corruption of data. Our systems are also vulnerable to damage or interruption from fire, floods, power loss, telecommunications failures, computer viruses, break-ins, and similar events. These or similar occurrences could also lead to interruptions or delays in the operation of our systems resulting in business impact, including loss of business.

We and our hotel operator rely on the availability of information technology systems to operate our business. Our reliance on computer, Internet-based and mobile systems and communications and the frequency and sophistication of efforts by hackers to gain unauthorized access or prevent authorized access to such systems have greatly increased in recent years. The integrity and protection of guest, employee and company data, as well as the continuous operation of our systems, are critical to our business. Efforts to hack or breach security measures, disruptions or failures of systems or software to operate as designed or intended, viruses, “ransomware” or other malware, operator error, or inadvertent releases of data may materially impact our information systems and records and those of our hotel operator. A significant theft, loss, loss of access to, or fraudulent use of guest, employee, or company data could adversely impact our reputation and could result in a loss of business, as well as remedial and other expenses, fines, litigation, investigations, enforcement actions, or lawsuits. In addition, any disruption in the functioning of our hotel manager’s reservation systems could adversely affect our performance and results.
We have experienced targeted and non-targeted cybersecurity incidents in the past and may experience them in the future. While these cybersecurity incidents did not result in any material loss to us or interrupt our day-to-day operations, there can be no assurance that we will not experience any such losses in the future. We believe we have implemented appropriate measures to mitigate potential risks. However, given the unpredictability of the timing and the evolving nature and scope of information technology disruptions, the various procedures and controls we use to monitor and protect against these threats and to mitigate our potential risks to such threats may not be sufficient in preventing cybersecurity incidents from materializing. Further, as cybersecurity threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate vulnerabilities to cybersecurity threats.

Failure to succeed in new markets may limit our growth.

We have acquired in the past, and we may acquire in the future if appropriate opportunities arise, properties that are outside of Austin, Texas, our primary market. For example, we have properties in College Station, Kingwood, Magnolia, West Killeen and New Caney. Any success we have experienced in Austin in the past, does not indicate future success in these new markets. Our historical experience in existing markets does not ensure that we will be able to operate successfully in new markets. Entering into new markets exposes us to a variety of risks, including difficulty evaluating local market conditions and local economies, developing new business relationships in the area, competing with other companies that already have an established presence in the area, hiring and retaining key personnel, evaluating quality tenants in the area, and a lack of familiarity with local governmental and permitting procedures. Furthermore, expansion into new markets may divert management time and other resources away from our current primary market. As a result, we may not be successful in expanding into new markets, which could adversely impact our financial condition, results of operations, cash flow, cash available for distribution, and ability to service our debt obligations.


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Part of our business strategy is dependent on maintaining strong relationships with key anchor tenants and our inability to do so could adversely affect our business. In addition, our key anchor tenants may have interests that differ from ours, which could adversely affect us.

We have formed strategic relationships with key anchor tenants as part of our overall strategy for particular development projects and may enter into other similar arrangements in the future. For example, our West Killeen Market, Jones Crossing, Kingwood Place, Magnolia and New Caney mixed-use development projects are each anchored by an HEB grocery. Any deterioration in our relationship with HEB or our inability to form strategic relationships with key anchor tenants or enter into other similar arrangements in the future could adversely affect our business.

While key anchor tenants bring local credibility, enhance our ability to attract other tenants or customers to the area or offer other competitive attributes, they may have the ability to exert influence over our development projects through restrictive lease covenants (such as exclusive use covenants or prohibited use covenants) that restrict our rights or have economic or business interests or goals that are inconsistent with ours or that are influenced by factors unrelated to our business. We may also be subject to reputational harm or the value of our properties may be adversely affected if the reputation or financial position of any of our key anchor tenants deteriorates.

Risks Relating to Real Estate Operations

There can be no assurance that all of the properties in our active development pipeline will be completed in their entirety in accordance with the anticipated timing or cost, or that we will achieve the results we expect from the development of such properties, which could materially and adversely affect our financial condition, results of operations.

We currently have several active development projects, including Lantana Place, Jones Crossing, Kingwood Place, Santal Phase II, The Saint Mary and Amarra Villas. The development of the projects in our active development pipeline is subject to numerous risks, many of which are outside of our control. The cost necessary to complete the development of our active development pipeline could be materially higher than we anticipate. In addition, we could decide not to undertake construction on one or more of the projects in our development pipeline if our pre-leasing or financing efforts are unsuccessful. Furthermore, if we are delayed in the completion of any development project, tenants may have the right to terminate pre-development leases, which could materially and adversely affect the financial viability of the project. In addition, even if we decide to commence construction on a project, we can provide no assurances that we will complete any of the projects in our active development pipeline on the anticipated schedule or within the budget, or that, once completed, the properties in our development pipeline will achieve the results that we expect. If the development of the projects in our development pipeline is not completed in accordance with our anticipated timing or at the anticipated cost, or the properties fail to achieve the financial results we expect, it could have a material adverse effect on our financial condition, results of operations and cash flows.

The real estate business is highly competitive and many of our competitors are larger and financially stronger than we are.

The real estate business is highly competitive. We compete with a large number of companies and individuals that have significantly greater financial, sales, marketing and other resources than we have. Our competitors include local developers who are committed primarily to particular markets and also national developers who acquire and develop properties throughout the United States. Competition may increase the demand for the types of properties in which we typically invest and, therefore, reduce the number of suitable investment opportunities available to us and increase the purchase prices for such properties. In addition, a downturn in the real estate industry could significantly increase competition among developers. Increased competition could cause us to increase our selling incentives, lose existing or potential tenants, offer more substantial rent abatements, tenant improvement allowances, early termination rights, below-market renewal options, or other incentives in order to retain tenants when our tenants' leases expire, and reduce our prices. An oversupply of real estate properties available for sale or lease, as well as the potential significant discounting of prices by some of our competitors, may adversely affect our results of operations.


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Our results of operations, cash flows and financial condition are greatly affected by the performance of the real estate industry.

Revenue from our real estate operations segment accounted for 19 percent of our total revenue for the fiscal year ended December 31, 2018. The U.S. real estate industry is highly cyclical and is affected by changes in global, national and local economic conditions and events such as general employment and income levels, availability of financing, interest rates, consumer confidence and spending, and overbuilding of or decrease in demand for residential and commercial real estate. Our real estate activities are subject to numerous factors beyond our control, including local real estate market conditions (both where our properties are located and in areas where our potential customers reside), substantial existing and potential competition, general national, regional and local economic, political and social conditions, fluctuations in interest rates and mortgage availability, over-building in our markets, a decline in brick-and-mortar retail industry, changes in demographic conditions, changes in tenant preferences and changes in government regulations or requirements, including tax law changes. Any of the foregoing factors could result in a reduction or cancellation of sales and/or lower gross margins for sales. Lower than expected sales could have a material adverse effect on the level of our profits and the timing and amounts of our cash flows.

Real estate investments often cannot easily be converted into cash and market values may be adversely affected by these economic circumstances, market fundamentals, and competitive and demographic conditions. Because of the effect these factors have on real estate values, it is difficult to predict the level of future sales or sales prices that will be realized for individual assets. In addition, validating third party pricing for illiquid assets may be more subjective than more liquid assets. We cannot predict whether we will be able to sell any property for the price or on the terms set by us or whether any price or other terms offered by a prospective purchaser would be acceptable to us. We also cannot predict the length of time needed to find a willing purchaser and to close the sale of a property. To the extent we are unable to sell any properties for our book value, we may be required to take a non-cash impairment charge or loss on the sale, either of which would reduce our net income or increase our net loss. See "Critical Accounting Policies" in Part II, Items 7. and 7A. for more information.

Our operations are subject to an intensive regulatory approval process and opposition from environmental and special interest groups, either or both of which could cause delays and increase the costs of our development efforts or preclude such developments entirely.

Real estate projects must generally comply with local land development regulations and may need to comply with state and federal regulations. Before we can develop a property, we must obtain a variety of approvals from local and state governments with respect to such matters as zoning and other land use entitlements and issues, and subdivision, site planning and environmental issues under applicable regulations. Some of these approvals are discretionary. Obtaining all of the necessary permits and entitlements to develop a parcel of land is often difficult, costly and may take several years, or more, to complete. In some situations, we may be unable to obtain the necessary permits and/or entitlements to proceed with a real estate development or may be required to alter our plans for the development. Because government agencies and special interest groups have in the past expressed concerns about our development plans in or near Austin and in the future may express similar concerns in or near Austin and in our other select markets in Texas, our ability to develop these properties and realize future income from our properties could be delayed, reduced, prevented or made more expensive. In addition, any failure to comply with these laws or regulations could result in capital or operating expenditures or the imposition of significant financial penalties or restrictions on our operations that could adversely affect present and future operations or our ability to sell, and thereby, our financial condition, results of operations, and cash flows.

Several special interest groups have in the past opposed our plans in the Austin area and have taken various actions to partially or completely restrict development in some areas, including areas where some of our most valuable properties are located. We have actively opposed these actions. However, because of the regulatory environment that has existed in the Austin area and the opposition of these special interest groups, there can be no assurance that an unfavorable ruling would not have a significant long-term adverse effect on the overall value of our property holdings.


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Our operations are subject to environmental regulation, which can change at any time and could increase our costs.

Real estate development is subject to state and federal environmental regulations and to possible interruption or termination because of environmental considerations, including, without limitation, air and water quality and protection of endangered species and their habitats. In addition, in those cases where an endangered or threatened species is involved and agency rulemaking and litigation are ongoing, the outcome of such rulemaking and litigation can be unpredictable, and at any time can result in unplanned or unforeseeable restrictions on or even the prohibition of development in identified environmentally sensitive areas.

Certain of the Barton Creek and Lantana properties include nesting territories for the golden-cheeked warbler, a federally listed endangered species. In 1995, we received a permit from the U.S. Wildlife Service pursuant to the Endangered Species Act, which to date has allowed the development of the Barton Creek and Lantana properties free of restrictions under the Endangered Species Act related to the maintenance of habitat for the golden-cheeked warbler.

Additionally, in April 1997, the U.S. Department of Interior listed the Barton Springs salamander as an endangered species after a federal court overturned a March 1997 decision by the Department of Interior not to list the Barton Springs salamander based on a conservation agreement between the State of Texas and federal agencies. The listing of the Barton Springs salamander has not affected, nor do we anticipate it will affect, our Barton Creek and Lantana properties for several reasons, including the results of technical studies and the U.S. Fish and Wildlife Service 10(a) permit obtained by us in 1995. The development permitted by the 2002 Circle C settlement with the city of Austin has been reviewed and approved by the U.S. Fish and Wildlife Service and, as a result, we also do not anticipate that the 1997 listing of the Barton Springs salamander will affect our Circle C properties.

In January 2013, the U.S. Department of the Interior announced that it had conducted an economic assessment of the potential designation of critical habitat for four species of Central Texas salamanders. Although this potential designation of habitat has not affected, nor do we anticipate that it will affect, our Barton Creek, Lantana or Circle C properties for several reasons, including prior studies and approvals and our existing U.S. Fish and Wildlife Service 10(a) permit obtained in 1995, future endangered species listings or habitat designations could impact development of our properties.

Under various federal, state and local laws and regulations relating to the environment, as a current or former owner or operator of real property, we may be liable for costs and damages resulting from the presence or discharge of hazardous or toxic substances, waste or petroleum products at, on, in, under or migrating through, whether generated from our property or other property, including costs to investigate and clean up such contamination and liability for harm to natural resources. The costs of removal or remediation, and the impact on the development potential and development timeline could be substantial. These laws often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of any hazardous or toxic substances. Environmental laws also may impose restrictions on the manner in which a property may be used or businesses may be operated, and these restrictions may require substantial expenditures. Environmental laws provide for sanctions in the event of noncompliance and may be enforced by governmental agencies or, in certain circumstances, by private parties. Certain environmental laws and common law principles could be used to impose liability for release of and exposure to hazardous substances, including asbestos and other airborne contaminants. In addition, third parties may seek recovery from owners or operators of real properties for personal injury or property damage associated with exposure to released hazardous substances. The cost of defending against claims of liability, of compliance with environmental regulatory requirements, of remediating any contaminated property, or of paying personal injury claims could materially adversely affect our business, assets or results of operations and, consequently, amounts available for distributions to our shareholders.

From time to time, the Environmental Protection Agency and similar federal, state or local agencies review land developers’ compliance with environmental laws and may levy fines and penalties for failure to strictly comply with applicable environmental laws or impose additional requirements for future compliance as a result of past failures. Any such actions taken with respect to us may increase our costs and result in project delays. We are making, and will continue to make, expenditures with respect to our real estate development for the protection of the environment. Emphasis on environmental matters will result in additional costs in the future. New environmental regulations or changes in existing regulations or their enforcement may be enacted and such new regulations or changes may require significant expenditures by us. The recent trend toward stricter standards in environmental legislation and regulations is likely to continue and could have a material adverse effect on our operating costs.

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Risks Relating to Leasing Operations

Unfavorable changes in market and economic conditions could negatively affect occupancy or rental rates, which could negatively affect our financial condition and results of operations.

A decline in the real estate market and economic conditions could significantly affect rental rates. Occupancy and rental rates in our market, in turn, could significantly affect our profitability and our ability to satisfy our financial obligations. The risks that could affect conditions in our market include the following:

Local conditions, such as an oversupply of office and retail space, a decline in the demand for office and retail space or increased competition from other available office and retail buildings;

The inability or unwillingness of tenants to pay their current rent or rent increases; and

Declines in market rental rates.

Additionally, tenants at our retail properties face continual competition in attracting customers from various on-line and other competitors. Our competitors and those of our tenants could have a material adverse effect on our ability to lease space in our retail properties, maintain occupancy levels and on the rents we can charge or the concessions we can grant. Further, as new technologies emerge, the relationship among customers, retailers, and shopping centers are evolving on a rapid basis. If we are unable to adapt to such new technologies and relationships on a timely basis, our financial performance will be adversely impacted.

We cannot predict with certainty whether any of these conditions will occur or whether, and to what extent, they will have an adverse effect on our operations.

Risks Relating to Hotel Operations

We are subject to the business, financial and operating risks common to the hotel industry, any of which could reduce our revenues and adversely affect our financial condition and results of operations.

Revenue from our hotel segment accounted for 43 percent of our total revenue for the fiscal year ended December 31, 2018. Business, financial and operating risks common to the hotel industry include:

Changes in desirability of geographic regions or travel patterns of customers and geographic concentration of our operations and customers;

Changes and volatility in general economic conditions;

Decreases in the demand for hotel rooms and related lodging services, including a reduction in business travel as a result of alternatives to in-person meetings (including virtual meetings hosted online or over private teleconferencing networks) or because of general economic conditions;

Increases in fixed costs, including increases in commercial property taxes;

Decreased corporate or governmental travel-related budgets and spending, as well as cancellations, deferrals or renegotiations of group business such as industry conventions;

Negative public perception of corporate travel-related activities;

The effect of internet intermediaries and other new industry entrants on pricing and our increasing reliance on technology;

The costs and administrative burdens associated with complying with applicable laws and regulations in the U.S., including health, safety and environmental laws, rules and regulations and other governmental and regulatory actions and obtaining and maintain necessary licenses and permits to operate;

Spending more than budgeted amounts to make necessary improvements or renovations;


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Changes in operating costs including, but not limited to, energy, water, labor (including the effect of labor shortages, unionization and minimum wage increases), food, workers’ compensation and health-care, insurance and unanticipated costs related to force majeure events and their consequences;

Decreased airline capacities and routes;

Seasonality of the hotel industry and the Austin market;

Attractiveness of properties and services to consumers; and

Cyclical over-building in the hotel industry.

External perception of the W Austin Hotel could negatively affect our results of operations.

Starwood manages hotel operations at the W Austin Hotel. Our ability to attract and retain guests depends, in part, upon the external perceptions and market recognition of Starwood and the quality of the W Austin Hotel and its services. We may be required to spend money periodically to keep the property well maintained, modernized and refurbished. The reputation of the W Austin Hotel may be negatively affected if Starwood fails to act responsibly or comply with regulatory requirements in a number of areas, such as safety and security, sustainability, responsible tourism, environmental management, human rights and support for the local communities where Starwood manages and/or owns properties. The considerable increase in the use of social media over recent years has greatly expanded the potential scope and scale, and increased the rapidity of the dissemination of negative publicity that could be generated by any adverse incident or failure on the part of hotel operators. An adverse incident involving associates or guests and any media coverage resulting therefrom may cause a loss of consumer confidence in the Starwood brand which could negatively affect our results of operations.

Our revenues, profits or market share could be harmed if we are unable to compete effectively in the hotel industry in Austin.

The hotel industry in Austin is highly competitive. The W Austin Hotel competes for customers with other hotel and resort properties in Austin, ranging from national and international hotel brands to independent, local and regional hotel operators. We compete based on a number of factors, including quality and consistency of rooms, restaurant, bar and meeting facilities and services, attractiveness of location and price, and other amenities. Some of our competitors may have substantially greater marketing and financial resources than we do, and if we are unable to successfully compete in these areas, our operating results could be adversely affected.

Historically, the Austin market has had a limited number of high-end hotel accommodations. However, hotel capacity is being expanded by other hotel operators in Austin, including several properties in close proximity to the W Austin Hotel in downtown Austin. This increase in competition as well as the anticipated opening of additional hotel rooms in downtown Austin during 2019, is expected to further impact future hotel revenues. As new rooms come on-line, increased competition could lead to an excess supply of hotel rooms in the Austin market, thereby causing Starwood to increase promotional incentives for hotel guests and/or reduce rates. Increased competition in the Austin market from new hotels or hotels that have recently undergone expansion or renovation could have an adverse effect on occupancy, average daily rate and revenue per available room.

Additionally, some of our hotel rooms are booked through third-party internet travel intermediaries as well as lesser-known online travel service providers. Furthermore, travelers can book stays on websites that facilitate the short-term rental of homes and apartments from owners, thereby providing an alternative to hotel rooms. Increased internet bookings could have an adverse effect on occupancy, average daily rate and revenue per available room.


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Risks Relating to Entertainment Businesses

We face intense competition in the live music industry, and we may not be able to maintain or increase our current revenue, which could adversely affect our business, financial condition and results of operations.

Revenue from our entertainment businesses accounted for 26 percent of our total revenue for the fiscal year ended December 31, 2018. Our entertainment businesses compete in a highly competitive industry, and we may not be able to maintain or increase our current revenue as a result of such competition. The live music industry competes with other forms of entertainment for consumers’ discretionary spending and within this industry we compete with other venues to book artists. Our competitors compete with us for key personnel who have relationships with popular music artists and that have a history of being able to book such artists for concerts and tours. These competitors may engage in more extensive development efforts, undertake more far-reaching marketing campaigns, adopt more aggressive pricing policies and make more attractive offers to existing and potential artists. Our competitors may develop services, advertising options or music venues that are equal or superior to those we provide or that achieve greater market acceptance and brand recognition than we achieve. It is possible that new competitors may emerge and rapidly acquire significant market share.

Other variables related to our entertainment businesses that could adversely affect our financial performance by, among other things, leading to decreases in overall revenue, the number of sponsors, event attendance, ticket prices and fees or profit margins include:

An increased level of competition for advertising dollars, which may lead to lower sponsorships as we attempt to retain advertisers or which may cause us to lose advertisers to our competitors offering better programs that we are unable or unwilling to match;

Unfavorable fluctuations in operating costs, which we may be unwilling or unable to pass through to our customers via ticket prices;

Competitors’ offerings that may include more favorable terms than we do in order to obtain events for the venues they operate;

Event, tour and artist cancellations;

Our ability to anticipate and respond to changes in consumer preferences and to offer events that appeal to them;

Technological changes and innovations that we are unable to adopt or are late in adopting that offer more attractive entertainment alternatives than we or other live entertainment providers currently offer, which may lead to a reduction in attendance at live events, a loss of ticket sales or lower ticket fees;

Other entertainment options available to our audiences that we do not offer;

General economic conditions which could cause our consumers to reduce discretionary spending;

Unfavorable changes in labor conditions which may require us to spend more to retain and attract key employees;

Interruptions in our computer, communications, information and ticketing systems and infrastructures and data loss or other breaches of our network security; and

Occurrence and threat of extraordinary events, such as terrorist attacks, intentional or unintentional mass-casualty incidents such as active shooter incidents, public health concerns such as contagious disease outbreaks, weather conditions, natural disasters or similar events that may require us to cancel or reschedule an event.

Additionally, our entertainment operations are seasonal. The results of operations from our entertainment segment vary from quarter to quarter and year to year, and the financial performance in certain quarters or years may not be indicative of, or comparable to, our financial performance in subsequent quarters or years.


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Personal injuries and accidents may occur in connection with our live music events, which could subject us to personal injury or other claims and increase our expenses, as well as reduce attendance at our live music events, causing a decrease in our revenue.

There are inherent risks involved with producing live music events. As a result, personal injuries and accidents have, and may, occur from time to time, which could subject us to claims and liabilities for personal injuries. Incidents in connection with our live music events at ACL Live could also result in claims or reduce attendance at our events, which could cause a decrease in our revenue or reduce our operating income. We maintain insurance policies that provide coverage for personal injuries sustained by persons at our venues or events or accidents in the ordinary course of business, and there can be no assurance that such insurance will be adequate at all times and in all circumstances.

Risks Relating to Ownership of Shares of Our Common Stock

Our common stock is thinly traded; therefore, our stock price may fluctuate more than the stock market as a whole.

As a result of the thin trading market for shares of our common stock, our stock price may fluctuate significantly more than the stock market as a whole or the stock prices of similar companies. Without a larger public float, shares of our common stock will be less liquid than the shares of common stock of companies with broader public ownership, and as a result, the trading prices for shares of our common stock may be more volatile. Among other things, trading of a relatively small volume of shares of our common stock may have a greater effect on the trading price than would be the case if our public float were larger.

Anti-takeover provisions in our charter documents and Delaware law may make an acquisition of us more difficult.

Anti-takeover provisions in our charter documents and Delaware law may make an acquisition of us more difficult. These provisions:

Provide for a classified Board serving staggered three-year terms;

Authorize the Board to issue preferred stock without stockholder approval and to designate the rights, preferences and privileges of each class; if issued, such preferred stock would increase the number of outstanding shares of our capital stock and could include terms that may deter an acquisition of us;

Establish advance notice requirements for nominations to the Board or for proposals that can be presented at stockholder meetings;

Limit who may call stockholder meetings or act by written consent; and

Require a supermajority stockholder vote for certain transactions with a 20% stockholder, subject to certain exceptions.

These provisions may discourage potential takeover attempts, discourage bids for our common stock at a premium over market price or adversely affect the market price of, and the voting and other rights of the holders of, our common stock. These provisions could also discourage proxy contests and make it more difficult for stockholders to elect directors other than the candidates nominated by our Board.

In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which may prohibit large stockholders from consummating a merger with, or acquisition of, us. These provisions may deter an acquisition of us that might otherwise be attractive to our stockholders.


18


We may not pay dividends on our common stock or repurchase shares of our common stock.

Holders of our common stock are only entitled to receive dividends when and if they are declared by our Board. Further, our Comerica credit facility prohibits us from paying a dividend on our common stock without the bank’s prior written consent. Although we declared a special cash dividend on our common stock in March 2017 after receiving written consent from Comerica Bank, we are not required to do so and we may not pay special cash dividends in the future. Comerica’s consent to the payment of a dividend in March 2017 is not indicative of the bank’s willingness to consent to the payment of future dividends. Additionally, our Comerica credit facility contains a restrictive covenant limiting common stock repurchases to $1.0 million in the aggregate during the term of the facility. Any repurchases of our common stock in excess of $1.0 million would require a waiver from Comerica. The declaration of future dividends and share repurchases, which is subject to our Board's discretion and the restrictions under our Comerica credit facility, will depend on our financial results, cash requirements, projected compliance with covenants in our debt agreements, outlook and other factors deemed relevant by our Board.

Item 1B. Unresolved Staff Comments

None.

Item 3.  Legal Proceedings

We are from time to time involved in legal proceedings that arise in the ordinary course of our business. We do not believe, based on currently available information, that the outcome of any legal proceeding will have a material adverse effect on our financial condition or results of operations. We maintain liability insurance to cover some, but not all, potential liabilities normally incident to the ordinary course of our business as well as other insurance coverage customary in our business, with such coverage limits as management deems prudent.

Item 4. Mine Safety Disclosures

Not applicable.

Executive Officers of the Registrant
Certain information as of February 28, 2019, regarding our executive officers is set forth in the following table and accompanying text. Each of our executive officers serves at the discretion of our Board of Directors.
Name
 
Age
 
Position or Office
William H. Armstrong III
 
54
 
Chairman of the Board, President and Chief Executive Officer
Erin D. Pickens
 
57
 
Senior Vice President and Chief Financial Officer

Mr. Armstrong has been employed by us since our inception in 1992. Mr. Armstrong has served as President since August 1996, Chief Executive Officer since May 1998 and Chairman of the Board since August 1998.

Ms. Pickens has served as our Senior Vice President since May 2009 and as our Chief Financial Officer since June 2009. Ms. Pickens previously served as Executive Vice President and Chief Financial Officer of Tarragon Corporation from November 1998 until April 2009, and as Vice President and Chief Accounting Officer from September 1996 until November 1998 and Accounting Manager from June 1995 until August 1996 for Tarragon and its predecessors.


19


PART II

Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Common Stock

Our common stock trades on The Nasdaq Stock Market (NASDAQ) under the symbol “STRS.” As of February 28, 2019, there were 312 holders of record of our common stock.    

Common Stock Dividends

The declaration of dividends is at the discretion of our Board of Directors (the Board); however, our ability to pay dividends is restricted by the terms of our Comerica credit facility, which prohibits us from paying a dividend on or repurchasing shares of our common stock without the bank’s prior written consent. In March 2017, we announced that our Board, after receiving written consent from Comerica Bank, declared a special cash dividend of $1.00 per share that was paid on April 18, 2017, to stockholders of record on March 31, 2017. The dividend was declared after the Board’s consideration of the results of our sale of The Oaks at Lakeway. Comerica’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, which is subject to our Board’s discretion and the restrictions under our Comerica credit facility, will depend on our financial results, cash requirements, projected compliance with covenants in our debt agreements, outlook and other factors deemed relevant by our Board. See Part I, Item 1A. "Risk Factors" for further discussion.

Unregistered Sales of Equity Securities

None.

Issuer Purchases of Equity Securities

The following table sets forth information with respect to shares of our common stock that we repurchased under the Board-approved open market share purchase program during the three months ended December 31, 2018.
Period
 
Total Number of Shares Purchased
 
Average Price Paid Per Share
 
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programsa
 
Maximum Number of Shares That May Yet Be Purchased Under the Plans or Programsa
October 1 to 31, 2018
 

 
$

 

 
991,695

November 1 to 30, 2018
 

 

 

 
991,695

December 1 to 31, 2018
 

 

 

 
991,695

Total
 

 
$

 

 
991,695

a.
In November 2013, the Board approved an increase in our open-market share purchase program, initially authorized in 2001, for up to 1.7 million shares of our common stock. The program does not have an expiration date.
As stated above, our Comerica credit facility requires lender approval of any common stock repurchases in excess of $1.0 million.

20


Items 7. and 7A. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Quantitative and Qualitative Disclosures About Market Risk

OVERVIEW

In Management’s Discussion and Analysis of Financial Condition and Results of Operations, “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 and the related discussion of “Business and Properties” and “Risk Factors” included elsewhere in this Form 10-K. 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 located in Part II, Item 8. “Financial Statements and Supplementary Data.”

We are a diversified real estate company with headquarters in Austin, Texas. We are engaged primarily in the acquisition, entitlement, development, management, operation and sale of commercial and multi-family and single-family residential real estate properties, real estate leasing, and the operation of hotel and entertainment businesses located in the Austin, Texas area and other select, fast-growing markets in Texas. We generate revenues and cash flows from the sale of our developed properties, rental income from our leased properties and from our hotel and entertainment operations. See "Operations" in Part I, Items 1 and 2, and Note 9 for further discussion of our four operating segments and “Business Strategy” for a discussion of our business strategy.

BUSINESS STRATEGY

Our development portfolio consists of approximately 1,800 acres of commercial, multi-family and single-family residential projects under development or undeveloped and held for future use. Our W Austin Hotel and our ACL Live and 3TEN ACL Live entertainment venues, are located in downtown Austin and are central to the city's world renowned, vibrant music scene.

Our primary business objective is to create value for stockholders by methodically developing and enhancing the value of our properties and then selling them profitably. Our full cycle development program of acquiring properties, securing and maintaining development entitlements, developing and stabilizing, and then preparing them for sale or refinancing is a key element of our strategy. We currently have projects in each of these stages as described below in “Development Activities - Residential” and “Development Activities - Commercial.”

We believe that Austin and other select, fast-growing markets in Texas continue to be desirable locations. Many of our developments are in locations where development approvals have historically been subject to regulatory constraints, which has made it difficult to obtain entitlements. Our Austin properties, which are located in desirable areas with significant regulatory constraints, are entitled and have utility capacity for full buildout. As a result, we believe that through strategic planning, development and marketing, we can maximize and fully realize their value.

Our development plans require significant additional capital, which we may pursue through joint ventures or other arrangements. Our business strategy requires us to rely on cash flow from operations and debt financing as our primary sources of funding for our liquidity needs. We have also, from time to time, relied on project-level equity financing of our subsidiaries. We have formed strategic relationships as part of our overall strategy for particular development projects and may enter into other similar arrangements in the future.

During 2018, we made significant progress in advancing our development projects as we:
(1) completed construction of the 154,117-square-foot first phase of the retail component of Jones Crossing, an H-E-B, L.P. (HEB)-anchored mixed-use development project in College Station, Texas, totaling approximately 259,000 square feet, including the 106,000-square-foot HEB grocery store, which opened on schedule in September 2018,
(2) 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,
(3) obtained project financing and commenced construction of The Saint Mary, a 240-unit multi-family development in the Circle C community,

21


(4) purchased a 54-acre tract of land, obtained project financing and commenced construction of Kingwood Place, an HEB-anchored mixed-use development project in Kingwood, Texas, totaling approximately 144,000 square feet of retail lease space,
(5) in partnership with HEB, purchased a 38-acre tract of land in New Caney, Texas, for the future development of an HEB-anchored, mixed-use project,
(6) substantially completed construction of Santal Phase II, a 212-unit garden style, multi-family project located directly adjacent to the previously completed Santal Phase I in the upscale, highly populated Barton Creek community, and
(7) advanced development plans for Magnolia, an HEB-anchored retail development project in Magnolia, Texas, which includes 351,000 square feet of total tenant leasing space and 1,200 multi-family units.

GENERAL

Developed property sales can include an individual tract of land that has been developed and permitted for residential use, a developed lot with a residence 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 strategy.

Our acreage under development and undeveloped as of December 31, 2018, is presented in the following table.
 
 
 
 
Acreage Under Development
 
Undeveloped Acreage
 
 
 
 
Single Family
 
Multi-family
 
Commercial
 
Total
 
Single
Family
 
Multi-
family
 
Commercial
 
Total
 
Total
Acreage
Austin:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Barton Creek
 
4

 
19

 

 
23

 
512

 
266

 
394

 
1,172

 
1,195

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
 

 

 

 

 

 

 
45

 
45

 
45

Kingwood Place
 

 

 
54

 
54

 

 

 

 

 
54

New Caney
 

 

 

 

 

 

 
38

 
38

 
38

Camino Real, San Antonio
 

 

 

 

 

 

 
2

 
2

 
2

Total
 
4

 
34

 
54

 
92

 
554

 
287

 
858

 
1,699

 
1,791


Our single-family residential holdings at December 31, 2018, are principally in southwest Austin, Texas, and include developed lots and townhomes, townhomes under development in Barton Creek and a condominium unit at the W Austin Residences. Our multi-family and commercial holdings at December 31, 2018, consist of the first phase of Barton Creek Village, Santal Phase I and Phase II, the office and retail space at the W Austin Hotel & Residences, Lantana Place, Phases I and II of Jones Crossing, West Killeen Market, Kingwood Place, The Saint Mary and New Caney. See “Development Activities - Residential” and “Development Activities - Commercial” below for further discussion.

The W Austin Hotel & Residences is located on a two-acre city block in downtown Austin and contains a 251-room luxury hotel, 159 residential condominium units and office, retail and entertainment space. The hotel is managed by W Hotel Management, Inc. a subsidiary of Starwood Hotels & Resorts Worldwide, Inc., which is a subsidiary of Marriott International, Inc. The entertainment space, occupied by Austin City Limits Live at the Moody Theater (ACL Live) and 3TEN ACL Live, includes a live music and entertainment venue and production studio. The 3TEN ACL Live venue, which opened in March 2016, has a capacity of approximately 350 people and is designed to be more intimate than ACL Live, which can accommodate approximately 3,000 people.

In 2018, our revenues totaled $87.6 million and our net loss attributable to common stockholders totaled $4.0 million, compared with revenues of $80.3 million and net income attributable to common stockholders of $3.9 million for 2017. Revenues increased in 2018, compared with 2017, primarily as a result of higher revenues from developed lot sales and our Leasing segment.

22


Our results for 2018 include equity in unconsolidated affiliates income of $1.15 million ($0.9 million to net loss attributable to common stockholders), primarily related to Crestview Station, and a net tax charge of $0.2 million associated with U.S. tax reform. Our results for 2017 include pre-tax gains on the sale of assets totaling $25.5 million ($16.4 million to net income attributable to common stockholders), primarily associated with recognition of a majority of the gain on the sale of The Oaks at Lakeway in February 2017, and a bank building and an adjacent undeveloped 4.1 acre tract of land in Barton Creek (see Note 10). Our results for 2017 also included a tax charge of $7.6 million associated with U.S. tax reform, and a charge of $2.5 million ($1.6 million to net income attributable to common stockholders) for profit participation costs and a loss of $0.5 million ($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.

At December 31, 2018, we had total debt of $295.5 million (see “Debt Maturities and Other Contractual Obligations” below for further discussion) and consolidated cash of $19.0 million. 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. For discussion of operating cash flows and debt transactions see “Capital Resources and Liquidity” below.

Real Estate Market Conditions. Because of the concentration of our assets primarily in the Austin, Texas area, and in other select, fast-growing markets in Texas, market conditions in these regions significantly affect our business. Our future operating cash flows and our ability to develop and sell our properties will be dependent on the level and profitability of our real estate sales. In turn, these sales will be significantly affected by future real estate market conditions in and around Austin and the other markets in which we operate, including development costs, interest rates, the availability of credit to finance real estate transactions, demand for residential and commercial real estate, and regulatory factors including our use and development entitlements. These market conditions historically have moved in periodic cycles, and can be volatile.

In addition to the traditional influence of state and federal government employment levels on the local economy, the Austin-Round Rock, Texas area (Austin-Round Rock) has been influenced by growth in the technology sector. Large, high-profile technology companies have expanded their profile in Austin-Round Rock recently as the technology sector has clustered in this market. The Austin-Round Rock-area population increased by 29 percent from 2009 through 2017, largely because of growing interest in Austin’s local job market. Median family income levels in the Austin-Round Rock area increased by 22 percent during the period from 2009 through 2017. The expanding economy resulted in rising demands for residential housing, commercial office space and retail services. From 2009 through 2017, sales tax receipts in the city of Austin (the City) rose by 57 percent, an indication of the increase in business activity during the period.


23


The following chart compares Austin-Round Rock’s five-county median family income and metro area population for 1999, 2009 and the most current information available for 2017 (actual) and 2018 (estimate), based on United States (U.S.) Census Bureau data and Austin-Round Rock’s data.
chart-32321a7915aa5804adc.jpg
Based on the City’s fiscal year of October 1 through September 30, the chart below compares the City’s sales tax revenues for 1999, 2009 and 2017 (the latest period for which data is available).
chart-d68cda8328b35c06a0e.jpg
Source: Comprehensive Annual Financial Report for the City of Austin, Texas


24


Real estate development in southwest Austin, where most of our real estate under development and undeveloped real estate is located, has historically been constrained as a result of various restrictions imposed by the City. Additionally, several special interest groups have traditionally opposed development in southwest Austin. Vacancy rates as of December 31, 2018 and 2017, are noted below.
 
 
Vacancy Rates
 
Building Type
 
2018
 
2017
 
Office Buildings (Class A)
 
9.4
%
a 
8.9
%
a 
Multi-Family Buildings
 
5.5
%
b 
5.9
%
b 
Retail Buildings
 
4.4
%
b 
3.5
%
b 
a.
CB Richard Ellis: Austin MarketView
b.
Marcus & Millichap Research Services, CoStar Group, Inc.
  
CRITICAL ACCOUNTING POLICIES

Management’s discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in conformity with accounting principles generally accepted in the U.S. The preparation of these financial statements requires that we make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. We base these estimates on historical experience and on assumptions that we consider reasonable under the circumstances; however, reported results could differ from those based on the current estimates under different assumptions and/or conditions. The areas requiring the use of management’s estimates are discussed in Note 1 under the heading “Use of Estimates.” We believe that our most critical accounting policies relate to our real estate and leasing assets, deferred tax assets, income taxes and profit recognition.

Management has reviewed the following discussion of its development and selection of critical accounting estimates with the audit committee of our Board of Directors (Board).

Real Estate, Hotel, Entertainment Venue and Leasing Assets.  Real estate held for sale is stated at the lower of cost or fair value less costs to sell. The cost of real estate held for sale includes acquisition, development, construction and carrying costs and other related costs incurred through the development stage. Real estate under development and land available for development are stated at cost. Real estate held for investment, which includes the hotel and entertainment venues at the W Austin Hotel & Residences and our leasing assets, is also stated at cost, less accumulated depreciation. When events or circumstances indicate that an asset’s carrying amount may not be recoverable, an impairment test is performed. For real estate held for sale, if estimated fair value less costs to sell is less than the related carrying amount, a reduction of the asset’s carrying value to fair value less costs to sell is required. For real estate under development, land available for development and real estate held for investment, if the projected undiscounted cash flow from the asset is less than the related carrying amount, a reduction of the carrying amount of the asset to fair value is required. Measurement of an impairment loss is based on the fair value of the long-lived asset. Generally, we determine fair value using valuation techniques such as discounted expected future cash flows.

In developing estimated future cash flows for impairment testing for our real estate assets, we have incorporated our own market assumptions including those regarding real estate prices, sales pace, sales and marketing costs, and infrastructure costs. Our assumptions are based, in part, on general economic conditions, the current state of the real estate industry, expectations about the short- and long-term outlook for the real estate market, and competition from other developers in the area in which we develop our properties. These assumptions can significantly affect our estimates of future cash flows. For those properties held for sale and deemed to be impaired, we determine fair value based on appraised values, adjusted for estimated costs to sell, as we believe this is the value for which the property could be sold. We recorded no impairment losses during the two years ended December 31, 2018 (see Note 1).


25


Deferred Tax Assets. The carrying amounts of deferred tax assets are required to be reduced by a valuation allowance if, based on the available evidence, it is more likely than not that such assets will not be realized. Accordingly, we assess the need to establish valuation allowances for deferred tax assets periodically based on the more-likely-than-not realization threshold criterion. In the assessment of the need for a valuation allowance, appropriate consideration is given to all positive and negative evidence related to the realization of the deferred tax assets. This assessment considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability, the duration of statutory carryforward periods, our experience with operating loss and tax credit carryforwards not expiring unused, and tax planning alternatives. This process involves significant management judgment about assumptions that are subject to change based on variances between projected and actual operating performance and changes in our business environment or operating or financing plans.

We regularly evaluate the recoverability of our deferred tax assets, considering available positive and negative evidence, including earnings history and the forecast of future taxable income. We had deferred tax assets (net of deferred tax liabilities) totaling $11.8 million at December 31, 2018.

Income Taxes. In preparing our annual consolidated financial statements, we estimate the actual amount of income taxes currently payable or receivable as well as deferred income tax assets and liabilities attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which these temporary differences are expected to be recovered or settled. The effect on deferred income tax assets and liabilities of a change in tax rates or laws is recognized in income in the period in which such changes are enacted. Our income tax benefit (provision) includes net tax charges of $0.2 million in 2018 and $7.6 million in 2017 associated with U.S. tax reform. See Note 6 for further discussion.

Profit Recognition on Sales of Real Estate. 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. Consideration is reasonably determined and deemed likely of collection when Stratus has signed sales agreements and has determined that the buyer has demonstrated a commitment to pay. The buyer’s commitment to pay is supported by the level of its initial investment, Stratus’ assessment of the buyer’s credit standing and Stratus’ assessment of whether the buyer’s stake in the property is sufficient to motivate the buyer to honor its obligation to pay.

In February 2017, upon the sale of The Oaks at Lakeway, 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 that time. 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 (see Note 10).


26


DEVELOPMENT ACTIVITIES

Residential.  As of December 31, 2018, the number of our residential developed lots/units, lots/units under development and lot/units for potential development by area are shown below:
 
Residential Lots/Units
 
Developed
 
Under
Development
 
Potential Developmenta
 
Total
Barton Creek:
 
 
 
 
 
 
 
Amarra Drive:
 
 
 
 
 
 

Phase II
9

 

 

 
9

Phase III
29

 
4

 

 
33

Amarra Villas
2

 
13

 

 
15

 Other townhomes

 

 
170

 
170

Section N multi-family:
 
 
 
 
 
 
 
Santal Phase I
236

 

 

 
236

Santal Phase II
168

 
44

 

 
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
445

 
301

 
1,901

 
2,647

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.
Barton Creek
Amarra Drive. In 2008, we completed the development of Amarra Drive Phase II, which consists of 35 lots on 51 acres. We sold three lots for $2.0 million in 2018 and one lot for $0.6 million in 2017. As of December 31, 2018, nine developed Phase II lots remained unsold.
 
In 2015, we completed the development of Amarra Drive Phase III, which consists of 64 lots on 166 acres. We sold nine lots in 2018 for $5.9 million and six lots in 2017 for $4.1 million. As of December 31, 2018, 29 developed Phase III lots remained unsold.

In March 2018, we entered into a contract, which was amended in March 2019, pursuant to which we agreed to sell 2 Amarra Drive Phase II lots and 12 Amarra Drive Phase III lots to a homebuilder for a total of $9.5 million. In accordance with the contract, as amended, the parties are required to close on the sale of these lots ratably before March 31, 2020. If the purchaser fails to close on the sale of 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. In 2018, in accordance with the contract, we sold two Amarra Drive Phase II lots and two Amarra Drive Phase III lots for $2.7 million. Subsequent to December 31, 2018, and through March 15, 2019, in accordance with the contract, we sold two additional Amarra Drive Phase III lots for $1.2 million.

As of March 15, 2019, two Amarra Drive Phase III lots were under contract, in addition to the remaining eight Amarra Drive Phase III lots subject to the contract discussed above.

The Villas at Amarra Drive (Amarra Villas) townhome project is a 20-unit development for which we completed site work in late 2015. Construction of the first five townhomes was completed during 2017 and an additional two townhomes were completed in 2018. We sold four townhomes for $7.5 million in 2018 and one townhome for $2.2 million in 2017. Subsequent to December 31, 2018, and through March 15, 2019, we closed on the sale of one

27


townhome for $1.7 million and one additional townhome was under contract. We anticipate beginning construction of the next five Amarra Villas townhomes during the second quarter of 2019.

Section N
Santal. The Santal Phase I multi-family project, a garden-style apartment complex in the upscale, highly populated Barton Creek community, consisting of 236 units, was completed within budget in 2016. We began recognizing rental revenue, which is included in the Leasing Operations segment, in January 2016. As of December 31, 2018, 95 percent of the units were leased. Construction of the 212-unit Santal Phase II project located directly adjacent to Santal Phase I began during 2017. The first Phase II units became available for occupancy in August 2018 and we have substantially completed construction of the remaining units. As of December 31, 2018, 33 percent of the total Phase II units were leased. We currently plan to evaluate a sale or refinancing of 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.

Circle C
We are developing our properties located in the Circle C community based on the entitlements secured in our Circle C settlement with the City. Our Circle C settlement, as amended in 2004, permits development of 1.16 million square feet of commercial space, 504 multi-family units and 830 single-family residential lots. See Note 8 for a summary of incentives we received in connection with the Circle C settlement.

The Saint Mary. In June 2018, we obtained financing for, and commenced construction of The Saint Mary, a 240-unit luxury garden-style apartment project located in the Circle C community. The project remains on schedule and within budget, and the first units are expected to be available for occupancy in third-quarter 2019, with project completion currently expected by the end of 2019. See Note 2 for further discussion of project financing.

Meridian. Meridian is an 800-lot residential development at the Circle C community. Development of the final phase of Meridian, which consisted of 57 one-acre lots, was completed in 2014. We sold the last 12 lots for $3.4 million in 2017.

W Austin Residences
As of December 31, 2018, one condominium unit remained unsold.

Commercial.  As of December 31, 2018, the number of square feet of our commercial property developed, under development and our remaining entitlements for potential development (excluding the W Austin Hotel and ACL Live entertainment venue) are shown below:
 
Commercial Property
 
Developed
 
Under Development
 
Potential Development a
 
Total
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

New Caney

 

 
180,496

 
180,496

Total Square Feet
376,998

 
143,767

 
3,279,890

 
3,800,655


28


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.

Barton Creek
Barton Creek Village is a 22,366-square-foot retail building that was 54 percent occupied as of December 31, 2018, and leasing activities for the vacant space are ongoing. In February 2017, we sold a 3,085-square-foot bank building and an adjacent undeveloped 4.1 acre tract of land for $3.1 million (see Note 10). We intend to explore opportunities to sell Barton Creek Village in 2019, subject to market conditions and leasing progress.

Lantana
Lantana is a partially developed, mixed-use real-estate development project. As of December 31, 2018, we had remaining entitlements for approximately 380,621 square feet of office and retail use on 39 acres. Regional utility and road infrastructure is in place with capacity to serve Lantana at full build-out as permitted under our existing entitlements. We completed construction of the 99,379-square-foot first phase of Lantana Place in third-quarter 2018. The anchor tenant, Moviehouse & Eatery, opened in May 2018. We also entered into a ground lease with a hotel operator in connection with its development of an AC Hotel by Marriott, which is anticipated to commence construction in second-quarter 2019. We had signed leases for 71 percent of the retail space as of December 31, 2018, and tenant improvement work is progressing.

W Austin Hotel & Residences
The W Austin Hotel & Residences has 38,316 square feet of leasable office space, including 9,000 square feet occupied by our corporate office, and 18,327 square feet of retail space. As of December 31, 2018, both the office and retail space were substantially fully occupied.

Magnolia
The Magnolia project is an HEB-anchored retail project planned for 351,000 square feet of commercial space. Planning and infrastructure work by the city of Magnolia is complete, road expansion by the Texas Department of Transportation has been completed and we expect to begin construction in late 2019. The HEB grocery store is currently expected to open in August 2020.

West Killeen Market
In 2015, we acquired approximately 21 acres in Killeen, Texas, to develop the West Killeen Market project, an HEB-anchored retail project with 44,493 square feet of commercial space and three pad sites adjacent to a 90,000 square-foot HEB grocery store. Construction began in August 2016 and was completed on schedule and under budget in June 2017. The HEB grocery store opened in April 2017. As of December 31, 2018, we had executed leases for 68 percent of the retail space at West Killeen Market, all tenants are currently open for business and leasing activities for the vacant space are ongoing. We intend to explore opportunities to sell West Killeen Market in 2019, subject to leasing progress and market conditions.

Jones Crossing
Construction of the first phase of the retail component of Jones Crossing, an HEB-anchored, mixed-use development in College Station, Texas, is complete. As of December 31, 2018, we had signed leases for 87 percent of the retail space, including the HEB grocery store. The HEB grocery store opened in September 2018, as scheduled.

Kingwood Place
In August 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, with 41,000 square feet of retail space, 6 retail pads and an 11-acre parcel planned for approximately 300 multi-family units. Construction began in December 2018 and, as of December 31, 2018, we had signed leases for 77 percent of the retail space, including the HEB grocery store. The HEB grocery store is currently anticipated to open in November 2019. See Note 2 for further discussion of project financing.


29


New Caney
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 include restaurants and retail services, totaling approximately 145,000 square feet (inclusive of the HEB grocery store), 5 pad sites, and a 10-acre multi-family parcel. We finalized the lease for the HEB grocery store in March 2019, and upon execution of this lease, we acquired HEB’s interests in the partnership for approximately $5 million. We currently plan to commence construction on the New Caney project no earlier than 2021.

The Oaks at Lakeway
On February 15, 2017, we 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 (see Note 5). We 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 our master lease payment obligations. Our master lease payment obligation, which currently approximates $150 thousand per month, is expected to decline over time until leasing is complete and all leases are assigned to the purchaser.

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

At the date of sale, we 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 that time. 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 $9.3 million is presented as a deferred gain in the consolidated balance sheets at December 31, 2018, compared with $11.3 million at December 31, 2017 (see Note 10).


30


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, 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 operating results for the years ended December 31 (in thousands):
 
2018
 
2017
 
Operating income (loss):
 
 
 
 
Real estate operations
$
1,305

a 
$
522

 
Leasing operations
2,897

 
24,217

b 
Hotel
6,348

 
6,553

 
Entertainment
3,426

 
4,045

 
Corporate, eliminations and other
(11,803
)
 
(12,100
)
 
Operating income
$
2,173

 
$
23,237

 
Interest expense, net
$
(7,856
)
 
$
(6,742
)
 
Net (loss) income attributable to common stockholdersc
$
(3,982
)
d 
$
3,879

 
a.
Includes $0.4 million of reductions to cost of sales associated with collection of prior-years’ assessments of properties in Barton Creek.
b.
Includes the recognition of a gain of $24.3 million associated with the sale of The Oaks at Lakeway. Also includes a $1.1 million gain on the sale of a 3,085-square-foot bank building and an adjacent undeveloped 4.1 acre tract of land in Barton Creek. These gains were partially offset by a $2.5 million profit participation charge associated with the sale of The Oaks at Lakeway.
c.
Includes tax charges totaling $0.2 million in 2018 and $7.6 million in 2017 associated with U.S. tax reform (see Note 6).
d.
Includes $1.15 million from equity in unconsolidated affiliates’ income reflecting Stratus’ interest in Crestview Station. During 2018, Crestview Station sold its last tract of land and its multi-family entitlements.

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 for the years ended December 31 (in thousands):
 
2018
 
2017
 
Revenues:
 
 
 
 
Developed property sales
$
16,509

 
$
10,286

 
Undeveloped property sales

 
544

 
Commissions and other
322

 
314

 
Total revenues
16,831

 
11,144

 
Cost of sales, including depreciation
15,526

a 
10,609

 
Loss on sales of assets

 
13

 
Operating income
$
1,305

 
$
522

 
a.
Includes $0.4 million of reductions associated with collection of prior-years’ assessments of properties in Barton Creek.


31


Developed Property Sales.  The following table summarizes our developed property sales for the years ended December 31 (in thousands):
 
2018
 
2017
 
 
Lots/Units
 
Revenues
 
Average Cost per Lot/Unit
 
Lots/Units
 
Revenues
 
Average Cost per Lot/Unit
 
Barton Creek
 
 
 
 
 
 
 
 
 
 
 
 
Amarra Drive:
 
 
 
 
 
 
 
 
 
 
 
 
Phase II lots
3

 
$
1,970

 
$
213

 
1

 
$
560

 
$
193

 
Phase III lots
9

 
5,938

 
277

 
6

 
4,090

 
292

 
Amarra Villas
4

 
7,461

 
1,704

 
1

 
2,193

 
1,886

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Circle C
 
 
 
 
 
 
 
 
 
 
 
 
Meridian

 

 

 
12

 
3,443

 
162

 
 
 
 
 
 
 
 
 
 
 
 
 
 
W Austin Residences:
 
 
 
 
 
 
 
 
 
 
 
 
Condominium units
1

 
1,140

 
726

 

 

 

 
Total Residential
17

 
$
16,509

 
 
 
20

 
$
10,286

 
 
 

Real Estate Revenue. The increase in revenue from the Real Estate Operations segment in 2018, compared with 2017, primarily reflects higher revenues from the sales of higher priced residential units, including Amarra Villas townhomes and the W Austin Hotel & Residences condominium.

Undeveloped Property Sales. In 2017, we sold a six-acre tract of land located in the Circle C community, which had entitlements for 14,000 square feet of commercial space, for $0.5 million.

Commissions and Other.  Commissions and other primarily includes sales and leasing commissions, design fees and revenue from leasing our for-sale residential properties.

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 totaled $15.5 million in 2018 and $10.6 million in 2017. The increase in cost of sales in 2018, compared with 2017, primarily reflects costs associated with the sale of four Amarra Villas townhomes and one W Austin Hotel & Residences condominium unit, which have a higher cost basis than the other properties sold.

Cost of sales for our real estate operations also includes significant recurring costs (including property taxes, maintenance and marketing), which totaled $5.1 million in 2018 and $4.3 million in 2017.

Leasing Operations
The following table summarizes our Leasing Operations results for the years ended December 31 (in thousands):
 
2018
 
2017a
 
Rental revenue
$
11,319

 
$
8,856

 
Rental cost of sales, excluding depreciation
5,088

 
4,829

 
Depreciation
3,334

 
2,693

 
Profit participation

 
2,538

b 
Gain on sales of assets

 
(25,421
)
 
Operating income
$
2,897

 
$
24,217

 
a.
Includes the results of The Oaks at Lakeway through February 15, 2017 (see Note 10).
b.
Relates to the sale of The Oaks at Lakeway (see Note 10).

Rental Revenue.  Rental revenue primarily includes revenue from the Santal Phase I, the office and retail space at the W Austin Hotel & Residences, West Killeen Market, Lantana Place and Barton Creek Village. The increase in rental revenue in 2018, compared with 2017, primarily reflects the commencement of leases at our recently completed properties, Lantana Place, West Killeen Market, Santal Phase I and Phase II, and Jones Crossing.

Rental Cost of Sales and Depreciation.  Rental costs of sales and depreciation expense increased in 2018, compared with 2017, primarily reflecting activity at West Killeen Market, Lantana Place and Santal Phase I and Phase II, partially offset by the sale of The Oaks at Lakeway.

32


Gain on Sales of Assets. During 2017, we recorded a $25.4 million gain on the sales of assets, primarily related to the sale of The Oaks at Lakeway and a bank building and an adjacent undeveloped 4.1 acre tract of land in Barton Creek.

Hotel
The following table summarizes our Hotel results for the years ended December 31 (in thousands):
 
2018
 
2017
 
Hotel revenue
$
38,222

 
$
38,681

 
Hotel cost of sales, excluding depreciation
28,312

 
28,584

 
Depreciation
3,562

 
3,544

 
Operating income
$
6,348

 
$
6,553

 

Hotel Revenue. Hotel revenue primarily includes revenue from W Austin Hotel room reservations and food and beverage sales. Hotel revenues decreased slightly in 2018, compared with 2017, primarily as a result of a lower number of reservations made by large groups. Revenue per available room (RevPAR), which is calculated by dividing total room revenue by the average total rooms available during the year, was $245 in 2018, compared with $253 in 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 by competitors in downtown Austin during 2019 is expected to have an ongoing impact on our hotel revenues.

Entertainment
The following table summarizes our Entertainment results for the years ended December 31 (in thousands):
 
2018
 
2017
 
Entertainment revenue
$
22,691

 
$
23,232

 
Entertainment cost of sales, excluding depreciation
17,702

 
17,719

 
Depreciation
1,563

 
1,523

 
Gain on sale of assets

 
(55
)
 
Operating income
$
3,426

 
$
4,045

 

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 varies 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. Entertainment revenue decreased in 2018, compared with 2017, primarily as a result of lower event attendance.


33


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, for the years ended December 31.
 
2018
 
2017
 
ACL Live
 
 
 
 
Events:
 
 
 
 
Events hosted
240

 
224

 
Estimated attendance
285,900

 
297,100

 
Ancillary net revenue per attendee
$
41.53

 
$
40.47

 
Ticketing:
 
 
 
 
Number of tickets sold
214,130

 
221,340

 
Gross value of tickets sold (in thousands)
$
12,717

 
$
13,392

 
 
 
 
 
 
3TEN ACL Live
 
 
 
 
Events:
 
 
 
 
Events hosted
216

 
228

 
Estimated attendance
38,100

 
40,600

 
Ancillary net revenue per attendee
$
42.05

 
$
42.02

 
Ticketing:
 
 
 
 
Number of tickets sold
22,190

 
18,770

 
Gross value of tickets sold (in thousands)
$
514

 
$
430

 

Corporate, Eliminations and Other
Corporate, eliminations and other (see Note 9) includes consolidated general and administrative expenses, which primarily consist of employee salaries and other costs. Consolidated general and administrative expenses totaled $11.3 million in 2018 and $11.4 million in 2017. 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) totaled $16.0 million in 2018 and $12.6 million in 2017. The increase in interest costs in 2018, compared with 2017, primarily reflects higher average debt balances to finance development activities.

Capitalized interest totaled $8.2 million in 2018 and $5.9 million in 2017, and is primarily related to development activities at Barton Creek.

Gain on Interest Rate Derivative Instruments. We recorded gains of $0.2 million in 2018 and $0.3 million in 2017 associated with changes in the fair value of our interest rate derivative instruments.

Loss on Early Extinguishment of Debt. We recorded a loss on early extinguishment of debt of $0.5 million in 2017 associated with the repayment of The Oaks at Lakeway loan.

Other Income, Net. We recorded $1.6 million of interest income in 2017, primarily associated with reimbursements received from MUDs.

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 $1.2 million in 2018 and less than $(0.1) million in 2017. The increase in 2018 reflects profit from the sale of Crestview’s last tract of land and its multi-family entitlements.

Benefit from (Provision for) Income Taxes.  We recorded a benefit from (provision for) income taxes of $0.3 million in 2018 and $(13.9) million in 2017. Both 2018 and 2017 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 and executive compensation limitations. We had deferred tax assets (net of deferred tax liabilities) totaling $11.8 million at December 31, 2018, and $11.5 million at December 31, 2017.


34


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 unique nature and location of our assets will provide us positive cash flows over time. See “Business Strategy” for further discussion of our liquidity.

Comparison of Year-to-Year Cash Flows
Operating Activities. Cash (used in) provided by operating activities totaled $(31.9) million in 2018 and $12.8 million in 2017. The decrease in operating cash flows for 2018, compared to 2017, primarily reflects an increase in expenditures for purchases and development of real estate properties (which totaled $43.7 million in 2018 and $14.4 million in 2017) and changes in working capital accounts.

We received MUD reimbursements relating to substantially all of the infrastructure costs incurred to date in Barton Creek, including $13.8 million in 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 $(64.0) million in 2018 and $80.9 million in 2017. The year 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. Capital expenditures totaled $61.9 million for 2018, primarily related to the development of the Santal Phase II, Lantana Place, Jones Crossing and The Saint Mary projects, and $34.1 million for 2017, primarily related to the development of Lantana Place, Santal Phase II, West Killeen Market and Jones Crossing.

Stratus also made payments totaling $2.1 million in 2018 and $2.2 million in 2017 under its master lease obligations associated with the sale of The Oaks at Lakeway.

Financing Activities. Cash provided by (used in) financing activities totaled $95.4 million in 2018 and $(79.8) million in 2017. Net borrowings on the Comerica Bank credit facility totaled $24.5 million in 2018, compared with net repayments of $20.8 million in 2017. Net borrowings for 2018 were used primarily to fund development projects and capital expenditures. Net repayments for 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 $50.3 million in 2018, primarily for the Santal Phase II, Lantana Place, Kingwood Place and Jones Crossing projects, compared with net repayments of $49.0 million in 2017, primarily for The Oaks at Lakeway term loan. See Note 5 and “Credit Facility and Other Financing Arrangements” below for a discussion of our outstanding debt at December 31, 2018. The year 2018 also included $18.0 million of capital contributions from the Class B limited partners in the Kingwood Place and Saint Mary limited partnerships (see Note 2). An additional $4.6 million was received from HEB for its contribution to the purchase of the land for the future New Caney project.

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.

In 2013, our Board approved an increase in the 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 during 2018 or 2017. As of December 31, 2018, a total of 991,695 shares of our common stock remained available under this program. Our ability to repurchase shares of our common stock is restricted by the terms of our Comerica credit facility, which prohibits us from repurchasing shares of our common stock in excess of $1.0 million without the bank’s prior written consent.


35


Credit Facility and Other Financing Arrangements
At December 31, 2018, we had total debt of $298.4 million based on the principal amounts outstanding, compared with $223.6 million at December 31, 2017. The principal amounts of our debt outstanding at December 31, 2018, consisted of the following:

$144.2 million under the Goldman Sachs loan.

$50.2 million under the $60.0 million Comerica credit facility, which is comprised of a $60.0 million revolving line of credit, $7.6 million of which was available at December 31, 2018, net of $2.2 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 construction loan).

$20.1 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 construction loan).

$18.7 million under the construction loan with Southside Bank to finance the initial phase of Lantana Place (the Lantana Place construction loan).

$12.1 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).

$6.8 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).

$6.75 million under the construction loan with Comerica Bank to finance the development and construction of Kingwood Place (the Kingwood Place construction loan).

$3.4 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).

$3.3 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 December 31, 2018, Stratus’ total stockholders’ equity was $124.0 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 construction 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 construction 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 in excess of $1.0 million or dividend payments. The Barton Creek Village term loan includes a requirement that Stratus' subsidiary maintain a minimum debt service coverage ratio, as defined in the agreement, of 1.35 to 1.00. As of December 31, 2018, the subsidiary's minimum debt service coverage ratio calculated in accordance with the Barton Creek Village term loan agreement was 1.29 to 1.00, and it was not in compliance with this requirement. PlainsCapital Bank waived the subsidiary's obligation to comply with the minimum debt service coverage ratio from December 31, 2018, through September 30, 2019. As of December 31, 2018, Stratus was in compliance with all other financial covenants.

See Note 5 for further discussion of our outstanding debt as of December 31, 2018.


36


DEBT MATURITIES AND OTHER CONTRACTUAL OBLIGATIONS

The following table summarizes our total debt maturities based on the principal amounts outstanding as of December 31, 2018 (in thousands):
 
2019
 
2020
 
2021
 
2022
 
2023
 
Thereafter
 
Total
Goldman Sachs loan
$
2,207

 
$
2,313

 
$
2,470

 
$
2,613

 
$
2,765

 
$
131,871

 
$
144,239

Comerica credit facilitya

 
50,221

 

 

 

 

 
50,221

Santal Phase I construction loanb

 
32,790

 

 

 

 

 
32,790

Santal Phase II construction loanb

 
20,119

 

 

 

 

 
20,119

Lantana Place construction loan

 
22

 
258

 
272

 
18,110

 

 
18,662

Jones Crossing construction loan

 

 
110

 
157

 
11,863

 


12,130

West Killeen Market construction loan

 
78

 
97

 
6,591

 

 

 
6,766

Kingwood Place construction loanb

 

 

 
6,750

 

 

 
6,750

Amarra Villas credit facility
3,358

 

 

 

 

 

 
3,358

Barton Creek Village term loan
103

 
106

 
112

 
117

 
121

 
2,766

 
3,325

Total
$
5,668

 
$
105,649

 
$
3,047

 
$
16,500

 
$
32,859

 
$
134,637

 
$
298,360

 
 
 
 
 
 
 
 
 
 
 
 
 
 
a.
See Note 5 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.

We had commitments under noncancelable contracts totaling $36.9 million at December 31, 2018.

We also had guarantees related to the W Austin Hotel & Residences at December 31, 2018 (see Note 5).

NEW ACCOUNTING STANDARDS

See Note 1 for discussion of new accounting standards.

OFF-BALANCE SHEET ARRANGEMENTS

See Note 8 for discussion of our off-balance sheet arrangements.


37


CAUTIONARY STATEMENT

Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements in which we discuss factors we believe may affect our future performance. Forward-looking statements are all statements other than statements of historical fact, such as statements regarding projections or expectations related to the planning, financing, development, construction, completion and stabilization of our development projects, plans to sell or refinance properties (including, but not limited to, Amarra Drive lots, Amarra Villas townhomes, West Killeen Market, the retail building at Barton Creek Village, The Saint Mary and Santal), operational and financial performance, expectations regarding future cash flows, municipal utility district reimbursements for infrastructure costs, regulatory matters, leasing activities, estimated costs and timeframes for development and stabilization of properties, liquidity, tax rates, the impact of interest rate changes, capital expenditures, financing plans, possible joint venture, partnership, strategic relationships 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, other plans and objectives of management for future operations and development projects, future dividend payments and share repurchases. The words “anticipate,” “may,” “can,” “plan,” “believe,” “potential,” “estimate,” “expect,” “project,” "target," “intend,” “likely,” “will,” “should,” “to be” and any similar expressions are intended to identify those assertions as forward-looking statements.

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, subject to restrictions under our loan agreement with Comerica Bank, 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, the availability and terms of financing for development projects and other corporate purposes, our ability to enter into and maintain joint venture, partnership, strategic relationships or other arrangements, our ability to effect our business strategy, including our ability to sell properties at prices our Board considers acceptable, our ability to obtain various entitlements and permits, a decrease in the demand for real estate in the Austin, Texas area and other select markets in Texas where we operate, changes in economic, market and business conditions, reductions in discretionary spending by consumers and businesses, competition from other real estate developers, hotel operators and/or entertainment venue operators and promoters, challenges associated with booking events and selling tickets and event cancellations at our entertainment venues, the termination of sales contracts or letters of intent because of, among other factors, the failure of one or more closing conditions or market changes, 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 our developments or such customers’ or tenants’ failure to satisfy their purchase commitments or leasing obligations, increases in interest rates and the phase out of the London Interbank Offered Rate, declines in the market value of our assets, increases in operating costs, including real estate taxes and the cost of building materials and labor, changes in external perception of the W Austin Hotel, changes in consumer preferences, industry risks, changes in laws, regulations or the regulatory environment affecting the development of real estate, opposition from special interest groups or local governments with respect to development projects, weather-related risks, loss of key personnel, cybersecurity incidents and other factors described in more detail under the heading “Risk Factors” in Part I, Item 1A. of this Form 10-K.

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, some of which we may not be able to control. 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.



38


Item 8.  Financial Statements and Supplementary Data

MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Stratus Properties Inc.’s (the Company’s) management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting is defined in Rule 13a-15(f) or 15d-15(f) under the Securities Exchange Act of 1934 as a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:

Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the Company’s assets;
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the Company’s financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

The Company’s management, including its principal executive officer and principal financial officer, assessed the effectiveness of its internal control over financial reporting as of the end of the fiscal year covered by this annual report on Form 10-K. In making this assessment, the Company’s management used the criteria set forth in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). Based on its assessment, management concluded that, as of December 31, 2018, the Company’s internal control over financial reporting is effective based on the COSO criteria.

BKM Sowan Horan, LLP, an independent registered public accounting firm who audited the Company’s consolidated financial statements included in this Form 10-K, has issued an attestation report on the Company’s internal control over financial reporting, which is included herein.

/s/ William H. Armstrong III
/s/ Erin D. Pickens
William H. Armstrong III
Erin D. Pickens
Chairman of the Board, President
Senior Vice President
and Chief Executive Officer
and Chief Financial Officer
 
 












39


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and
Stockholders of Stratus Properties Inc.
Opinion on Internal Control over Financial Reporting
We have audited Stratus Properties Inc.’s (the Company’s) internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control-Integrated Framework (2013) issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets and the related consolidated statements of (loss) income, stockholders’ equity, and cash flows of the Company, and our report dated March 18, 2019, expressed an unqualified opinion.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ BKM Sowan Horan, LLP

Austin, Texas
March 18, 2019

40


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and
Stockholders of Stratus Properties Inc.
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Stratus Properties Inc. (the Company) as of December 31, 2018 and 2017, and the related consolidated statements of comprehensive (loss) income, stockholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2018, and the related notes (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 18, 2019, expressed an unqualified opinion.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ BKM Sowan Horan, LLP

We have served as the Company’s auditor since 2010.

Austin, Texas
March 18, 2019




41


STRATUS PROPERTIES INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Par Value)
 
 
December 31,
 
2018
 
2017
ASSETS
 
 
 
Cash and cash equivalents
$
19,004

 
$
14,611

Restricted cash
19,915

 
24,779

Real estate held for sale
16,396

 
22,612

Real estate under development
136,678

 
118,484

Land available for development
24,054

 
14,804

Real estate held for investment, net
253,074

 
188,390

Deferred tax assets
11,834

 
11,461

Other assets
15,538

 
10,852

Total assets
$
496,493

 
$
405,993

 
 
 
 
LIABILITIES AND EQUITY
 
 
 
Liabilities:
 
 
 
Accounts payable
$
20,602

 
$
22,809

Accrued liabilities, including taxes
11,914

 
13,429

Debt
295,531

 
221,470

Deferred gain
9,270

 
11,320

Other liabilities
12,525

 
9,575

Total liabilities
349,842

 
278,603

 
 
 
 
Commitments and contingencies (Notes 6, 8 and 10)

 

 
 
 
 
Equity:
 
 
 
Stockholders’ equity:
 
 
 
Common stock, par value of $0.01 per share, 150,000 shares authorized,
 
 
 
9,288 and 9,250 shares issued, respectively and
 
 
 
8,164 and 8,134 shares outstanding, respectively
93

 
93

Capital in excess of par value of common stock
186,256

 
185,395

Accumulated deficit
(41,103
)
 
(37,121
)
Common stock held in treasury, 1,124 shares and 1,117 shares
 
 
 
at cost, respectively
(21,260
)
 
(21,057
)
Total stockholders’ equity
123,986

 
127,310

Noncontrolling interests in subsidiaries
22,665

 
80

Total equity
146,651

 
127,390

Total liabilities and equity
$
496,493

 
$
405,993

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


42


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

 
Years Ended December 31,
 
2018
 
2017
Revenues:
 
 
 
Real estate operations
$
16,800

 
$
11,001

Leasing operations
10,389

 
7,981

Hotel
37,905

 
38,360

Entertainment
22,506

 
22,998

Total revenues
87,600

 
80,340

Cost of sales:
 
 
 
Real estate operations
15,277

 
10,378

Leasing operations
5,056

 
4,797

Hotel
28,160

 
28,478

Entertainment
17,089

 
17,121

Depreciation
8,571

 
7,853

Total cost of sales
74,153

 
68,627

General and administrative expenses
11,274

 
11,401

Profit participation in sale of The Oaks at Lakeway

 
2,538

Gain on sale of assets

 
(25,463
)
Total
85,427

 
57,103

Operating income
2,173

 
23,237

Interest expense, net
(7,856
)
 
(6,742
)
Gain on interest rate derivative instruments
187

 
293

Loss on early extinguishment of debt

 
(532
)
Other income, net
55

 
1,581

(Loss) income before income taxes and equity in unconsolidated affiliates’ income (loss)
(5,441
)
 
17,837

Equity in unconsolidated affiliates’ income (loss)
1,150

 
(49
)
Benefit from (provision for) income taxes
305

 
(13,904
)
Net (loss) income and total comprehensive (loss) income
(3,986
)
 
3,884

Total comprehensive loss (income) attributable to noncontrolling interests in subsidiaries
4

 
(5
)
Net (loss) income and total comprehensive (loss) income attributable to common stockholders
$
(3,982
)
 
$
3,879

 
 
 
 
Net (loss) income per share attributable to common stockholders:
 
 
 
Basic
$
(0.49
)
 
$
0.48

Diluted
$
(0.49
)
 
$
0.47

 
 
 
 
Weighted-average shares of common stock outstanding:
 
 
 
Basic
8,153

 
8,122

Diluted
8,153

 
8,171

 
 
 
 
Dividends declared per share of common stock
$

 
$
1.00

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


43


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

 
 
Years Ended December 31,
 
 
2018
 
2017
Cash flow from operating activities:
 
 
 
 
Net (loss) income
 
$
(3,986
)
 
$
3,884

Adjustments to reconcile net (loss) income to net cash (used in) provided by
 
 
 
 
operating activities:
 
 
 
 
Depreciation
 
8,571

 
7,853

Cost of real estate sold
 
10,283

 
5,774

Gain on sale of assets
 

 
(25,463
)
U.S. tax reform charge
 
215

 
7,580

Gain on interest rate derivative contracts
 
(187
)
 
(293
)
Loss on early extinguishment of debt
 

 
532

Debt issuance cost amortization and stock-based compensation
 
1,859

 
1,573

Equity in unconsolidated affiliates’ (income) loss
 
(1,150
)
 
49

Return on investment in unconsolidated affiliate
 
1,251

 

Increase (decrease) in deposits
 
507

 
(1,322
)
Deferred income taxes, excluding U.S. tax reform charge
 
(588
)
 
(1,675
)
Purchases and development of real estate properties
 
(43,660
)
 
(14,395
)
Municipal utility districts reimbursements
 

 
13,799

(Increase) decrease in other assets
 
(4,038
)
 
4,750

(Decrease) increase in accounts payable, accrued liabilities and other
 
(966
)
 
10,126

Net cash (used in) provided by operating activities
 
(31,889
)
 
12,772

 
 
 
 
 
Cash flow from investing activities:
 
 
 
 
Capital expenditures
 
(61,932
)
 
(34,079
)
Proceeds from sales of assets
 

 
117,261

Payments on master lease obligations
 
(2,112
)
 
(2,196
)
Return of investment in (investment in) unconsolidated affiliates