Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
 
SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2016
 
or
[  ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
 
SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from to
 
Commission File Number: 001-37716
 
stratuslogoprintaa03.jpg
Stratus Properties Inc.
(Exact name of registrant as specified in its charter)
Delaware
72-1211572
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer Identification No.)
 
 
212 Lavaca St., Suite 300
 
Austin, Texas
78701
(Address of principal executive offices)
(Zip Code)
 
(512) 478-5788
(Registrant's telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
þ Yes   ¨ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   þ Yes   ¨ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨        Accelerated filer þ         Non-accelerated filer ¨          Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   ¨ Yes þ No

On October 31, 2016, there were issued and outstanding 8,098,140 shares of the registrant’s common stock, par value $0.01 per share.

Table of Contents



STRATUS PROPERTIES INC.
TABLE OF CONTENTS
 
 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


Table of Contents


PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

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

 
September 30,
2016
 
December 31,
2015
ASSETS
 
 
 
Cash and cash equivalents
$
16,240

 
$
17,036

Restricted cash
10,682

 
8,731

Real estate held for sale
21,526

 
25,944

Real estate under development
111,491

 
139,171

Land available for development
13,733

 
23,397

Real estate held for investment, net
240,614

 
186,626

Deferred tax assets
28,156

 
15,329

Other assets
15,407

 
13,871

Total assets
$
457,849

 
$
430,105

 
 
 
 
LIABILITIES AND EQUITY
 
 
 
Liabilities:
 
 
 
Accounts payable
$
7,930

 
$
14,182

Accrued liabilities, including taxes
23,088

 
10,356

Debt
285,358

 
260,592

Other liabilities
10,247

 
8,301

Total liabilities
326,623

 
293,431

 
 
 
 
Commitments and contingencies

 

 
 
 
 
Equity:
 
 
 
Stockholders’ equity:
 
 
 
Common stock
92

 
91

Capital in excess of par value of common stock
192,788

 
192,122

Accumulated deficit
(40,969
)
 
(35,144
)
Common stock held in treasury
(20,760
)
 
(20,470
)
Total stockholders’ equity
131,151

 
136,599

Noncontrolling interests in subsidiaries
75

 
75

Total equity
131,226

 
136,674

Total liabilities and equity
$
457,849

 
$
430,105


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


2
Table of Contents


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

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Revenues:
 
 
 
 
 
 
 
Hotel
$
8,268

 
$
8,521

 
$
29,501

 
$
31,194

Entertainment
4,190

 
4,159

 
13,236

 
13,463

Commercial leasing
2,567

 
787

 
6,761

 
4,311

Real estate operations
6,155

 
6,210

 
9,858

 
10,920

Total revenues
21,180

 
19,677

 
59,356

 
59,888

Cost of sales:
 
 
 
 
 
 
 
Hotel
6,891

 
6,782

 
22,248

 
23,159

Entertainment
3,713

 
3,423

 
10,532

 
10,514

Commercial leasing
1,390

 
516

 
3,295

 
2,216

Real estate operations
4,075

 
4,459

 
8,173

 
8,580

Depreciation
2,189

 
2,063

 
5,854

 
6,713

Total cost of sales
18,258

 
17,243

 
50,102

 
51,182

General and administrative expenses
2,497

 
2,187

 
9,718

 
6,308

Gain on sales of assets
—

 
(20,729
)
 
—

 
(20,729
)
Total
20,755

 
(1,299
)
 
59,820

 
36,761

Operating income (loss)
425

 
20,976

 
(464
)
 
23,127

Interest expense, net
(2,579
)
 
(855
)
 
(6,894
)
 
(2,736
)
Gain (loss) on interest rate derivative instruments
174

 
(918
)
 
(301
)
 
(986
)
Loss on early extinguishment of debt
—

 
—

 
(837
)
 
—

Other income, net
6

 
15

 
14

 
304

(Loss) income before income taxes and equity in unconsolidated affiliates' (loss) income
(1,974
)
 
19,218

 
(8,482
)
 
19,709

Equity in unconsolidated affiliates' (loss) income
(3
)
 
(280
)
 
70

 
(398
)
Benefit from (provision for) income taxes
318

 
(5,197
)
 
2,587

 
(5,244
)
(Loss) income from continuing operations
(1,659
)
 
13,741

 
(5,825
)
 
14,067

Income from discontinued operations, net of taxes
—

 
—

 
—

 
3,218

Net (loss) income
(1,659
)
 
13,741

 
(5,825
)
 
17,285

Net income attributable to noncontrolling interests in subsidiaries
—

 
(3,493
)
 
—

 
(5,414
)
Net (loss) income attributable to common stockholders
$
(1,659
)
 
$
10,248

 
$
(5,825
)
 
$
11,871

 
 
 
 
 
 
 
 
Basic and diluted net (loss) income per share attributable to common stockholders:
 
 
 
 
 
 
 
Continuing operations
$
(0.20
)
 
$
1.27

 
$
(0.72
)
 
$
1.07

Discontinued operations
—

 
—

 
—

 
0.40

 
$
(0.20
)
 
$
1.27

 
$
(0.72
)
 
$
1.47

 
 
 
 
 
 
 
 
Weighted-average shares of common stock outstanding:
 
 
 
 
 
 
 
Basic
8,094

 
8,063

 
8,086

 
8,055

Diluted
8,094

 
8,094

 
8,086

 
8,085


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

3
Table of Contents


STRATUS PROPERTIES INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME (Unaudited)
(In Thousands)

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
Net (loss) income
$
(1,659
)
 
$
13,741

 
$
(5,825
)
 
$
17,285

 
 
 
 
 
 
 
 
Other comprehensive income, net of taxes:
 
 
 
 
 
 
 
Gain on interest rate swap agreement
—

 
438

 
—

 
457

Other comprehensive income
—

 
438

 
—

 
457

 
 
 
 
 
 
 
 
Total comprehensive (loss) income
(1,659
)
 
14,179

 
(5,825
)
 
17,742

Total comprehensive income attributable to noncontrolling interests
—

 
(3,666
)
 
—

 
(5,592
)
Total comprehensive (loss) income attributable to common stockholders
$
(1,659
)
 
$
10,513

 
$
(5,825
)
 
$
12,150

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



4
Table of Contents


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

 
Nine Months Ended
 
September 30,
 
2016
 
2015
Cash flow from operating activities:
 
 
 
Net (loss) income
$
(5,825
)
 
$
17,285

Adjustments to reconcile net (loss) income to net cash provided by operating activities:
 
 
 
Depreciation
5,854

 
6,713

Cost of real estate sold
4,546

 
4,935

Loss on early extinguishment of debt
837

 
—

Gain on sales of assets
—

 
(20,729
)
Loss on interest rate derivative contracts
301

 
986

Debt issuance cost amortization and stock-based compensation
1,233

 
1,177

Gain on sale of 7500 Rialto, net of tax
—

 
(3,218
)
Equity in unconsolidated affiliates' (income) loss
(70
)
 
398

Deposits
1,054

 
1,267

Deferred income taxes
(12,827
)
 
1,470

Purchases and development of real estate properties
(10,919
)
 
(20,591
)
Municipal utility district reimbursement
12,302

 
5,307

Increase in other assets
(2,675
)
 
(3,519
)
Increase in accounts payable, accrued liabilities and other
7,071

 
11,863

Net cash provided by operating activities
882

 
3,344

 
 
 
 
Cash flow from investing activities:
 
 
 
Capital expenditures
(24,820
)
 
(37,383
)
Net proceeds from sales of assets
—

 
43,266

Other, net
(19
)
 
6

Net cash (used in) provided by investing activities
(24,839
)

5,889

 
 
 
 
Cash flow from financing activities:
 
 
 
Borrowings from credit facility
24,000

 
55,826

Payments on credit facility
(19,120
)
 
(20,857
)
Borrowings from project loans
174,342

 
60,202

Payments on project and term loans
(154,584
)
 
(36,081
)
Purchase of noncontrolling interest
—

 
(61,991
)
Stock-based awards net (payments) proceeds, including excess tax benefit
(146
)
 
1,722

Noncontrolling interests distributions
—

 
(4,244
)
Financing costs
(1,331
)
 
(265
)
Net cash provided by (used in) financing activities
23,161

 
(5,688
)
Net (decrease) increase in cash and cash equivalents
(796
)
 
3,545

Cash and cash equivalents at beginning of year
17,036

 
29,645

Cash and cash equivalents at end of period
$
16,240

 
$
33,190


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

5
Table of Contents


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

 
 
Stockholders’ Equity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Accum-
ulated
Other
Compre-
hensive
Loss
 
Common Stock
Held in Treasury
 
Total Stockholders' Equity
 
 
 
 
 
 
Common Stock
 
Capital in Excess of Par Value
 
Accum-ulated Deficit
 
 
 
 
Noncontrolling Interests in Subsidiaries
 
 
 
 
Number
of Shares
 
At Par
Value
 
 
 
 
Number
of Shares
 
At
Cost
 
 
 
Total
Equity
Balance at December 31, 2015
 
9,160

 
$
91

 
$
192,122

 
$
(35,144
)
 
$
—

 
1,093

 
$
(20,470
)
 
$
136,599

 
$
75

 
$
136,674

Exercised and issued stock-based awards
 
43

 
1

 
(1
)
 
—

 
—

 
—

 
—

 
—

 
—

 
—

Stock-based compensation
 
—

 
—

 
523

 
—

 
—

 
—

 
—

 
523

 
—

 
523

Tax benefit for stock-based awards

 
—

 
—

 
144

 
—

 
—

 
—

 
—

 
144

 
—

 
144

Tender of shares for stock-based awards
 
—

 
—

 
—

 
—

 
—

 
12

 
(290
)
 
(290
)
 
—

 
(290
)
Total comprehensive loss
 
—

 
—

 
—

 
(5,825
)
 
—

 
—

 
—

 
(5,825
)
 
—

 
(5,825
)
Balance at September 30, 2016
 
9,203

 
$
92

 
$
192,788

 
$
(40,969
)
 
$
—

 
1,105

 
$
(20,760
)
 
$
131,151

 
$
75

 
$
131,226


Balance at December 31, 2014
 
9,116

 
$
91

 
$
204,269

 
$
(47,321
)
 
$
(279
)
 
1,081

 
$
(20,317
)
 
$
136,443

 
$
38,643

 
$
175,086

Exercised and issued stock-based awards
 
42

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Stock-based compensation
 
2

 
—

 
421

 
—

 
—

 
—

 
—

 
421

 
—

 
421

Tax benefit for stock-based awards
 
—

 
—

 
1,866

 
—

 
—

 
—

 
—

 
1,866

 
—

 
1,866

Tender of shares for stock-based awards
 
—

 
—

 
—

 
—

 
—

 
12

 
(153
)
 
(153
)
 
—

 
(153
)
Noncontrolling interests distributions
 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(4,244
)
 
(4,244
)
Purchase of noncontrolling interest in consolidated subsidiary, net of taxes
 
—

 
—

 
(14,453
)
 
—

 
—

 
—

 
—

 
(14,453
)
 
(39,920
)
 
(54,373
)
Total comprehensive income
 
—

 
—

 
—

 
11,871

 
279

 
—

 
—

 
12,150

 
5,592

 
17,742

Balance at September 30, 2015
 
9,160

 
$
91

 
$
192,103

 
$
(35,450
)
 
$
—

 
1,093

 
$
(20,470
)
 
$
136,274

 
$
71

 
$
136,345


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



6
Table of Contents


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

1.
GENERAL
The accompanying unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2015, included in Stratus Properties Inc.’s (Stratus) Annual Report on Form 10-K (Stratus 2015 Form 10-K) filed with the United States Securities and Exchange Commission. In the opinion of management, the accompanying consolidated financial statements reflect all adjustments (consisting only of normal recurring items) considered necessary for a fair statement of the results for the interim periods reported. Operating results for the three-month and nine-month periods ended September 30, 2016, are not necessarily indicative of the results that may be expected for the year ending December 31, 2016.

2.
EARNINGS PER SHARE
Stratus’ basic net (loss) income per share of common stock was calculated by dividing the net (loss) income attributable to common stockholders by the weighted-average shares of common stock outstanding during the period. A reconciliation of net (loss) income and weighted-average shares of common stock outstanding for purposes of calculating diluted net (loss) income per share (in thousands, except per share amounts) follows:
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2016
 
2015
 
2016
 
2015
 
Net (loss) income
$
(1,659
)
 
$
13,741

 
$
(5,825
)
 
$
17,285

 
Net income attributable to noncontrolling interests in subsidiaries
—

 
(3,493
)
 
—

 
(5,414
)
 
Net (loss) income attributable to Stratus common stockholders
$
(1,659
)
 
$
10,248

 
$
(5,825
)
 
$
11,871

 
 
 
 
 
 
 
 
 
 
Basic weighted-average shares of common stock outstanding
8,094

 
8,063

 
8,086

 
8,055

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

a 
31

b 
—

a 
30

b 
 
 
 
 
 
 
 
 
 
Diluted weighted-average shares of common stock outstanding
8,094

 
8,094

 
8,086

 
8,085

 
 
 
 
 
 
 
 
 
 
Basic and diluted net (loss) income per share attributable to common stockholders
$
(0.20
)
 
$
1.27

 
$
(0.72
)
 
$
1.47

 
a. Excludes approximately 124 thousand shares of common stock for both the third quarter and first nine months of 2016 associated with outstanding stock options with exercise prices less than the average market price of Stratus' common stock and RSUs that were anti-dilutive.
b. Excludes approximately 22 thousand shares of common stock for third-quarter 2015 and 28 thousand shares of common stock for the first nine months of 2015 associated with RSUs that were anti-dilutive.

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

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

A summary of the carrying amount and fair value of Stratus' other financial instruments follows (in thousands):
 
September 30, 2016
 
December 31, 2015
 
Carrying
Value
 
Fair
Value
 
Carrying
Value
 
Fair
Value
Assets:
 
 
 
 
 
 
 
Interest rate cap agreement
$
—

 
$
—

 
$
1

 
$
1

Liabilities:
 
 
 
 
 
 
 
Interest rate swap agreement
946

 
946

 
646

 
646

Debt
285,358

 
288,059

 
260,592

 
263,303


7
Table of Contents


Interest Rate Cap Agreement. On September 30, 2013, Stratus’ joint venture with Canyon-Johnson Urban Fund II, L.P. (the Block 21 Joint Venture) paid $0.5 million to enter into an interest rate cap agreement that expired on September 29, 2016 (see Note 5 of the 2015 Form 10-K for further discussion).

Interest Rate Swap Agreement. On December 13, 2013, Stratus' joint venture with LCHM Holdings, LLC, formerly Moffett Holdings, LLC, for the development of Parkside Village (the Parkside Village Joint Venture), entered into a 10-year interest rate swap agreement with Comerica Bank that Stratus had designated as a cash flow hedge with changes in fair value of the instrument recorded in other comprehensive income (loss). The instrument effectively converted the variable rate portion of the Parkside Village Joint Venture's loan from Comerica Bank (the Parkside Village loan) from the one-month London Interbank Offered Rate (LIBOR) to a fixed rate of 2.3 percent. In connection with the sale of the Parkside Village property on July 2, 2015, Stratus fully repaid the amount outstanding under the Parkside Village loan. Stratus assumed the interest rate swap agreement and, as a result, the instrument no longer qualifies for hedge accounting. Accordingly, the accumulated other comprehensive loss balance of $0.6 million on July 2, 2015, was reclassified to the Consolidated Statement of Operations as a loss on interest rate derivative instruments, and changes in the fair value of the instrument are being recorded in the Consolidated Statement of Operations (including a gain of $0.2 million in third-quarter 2016 and a loss of $0.3 million for the first nine months of 2016). Stratus also evaluated the counterparty credit risk associated with the interest rate swap agreement, which is considered a Level 3 input, but did not consider such risk to be significant. Therefore, the interest rate swap agreement is classified within Level 2 of the fair value hierarchy.

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

4.
DEBT
The components of Stratus' debt are as follows:
 
September 30, 2016
 
December 31, 2015
 
Goldman Sachs loan
$
147,490

 
$
—

 
Bank of America loan (BoA loan)
—

 
128,230

 
Lakeway construction loan
53,556

 
45,931

 
Comerica credit facility
38,029

 
53,149

 
Santal construction loan
30,012

 
15,874

 
Diversified Real Asset Income Fund (DRAIF) term loan
7,998

 
7,993

 
Barton Creek Village term loan
5,590

 
5,689

 
Amarra Drive credit facility
2,683

 
—

 
Magnolia loan
—

a 
3,726

 
Total debtb
$
285,358

 
$
260,592

 
a.
The term loan with Holliday Fenoglio Fowler, L.P. was paid during third-quarter 2016.
b.
Includes net reductions for unamortized debt issuance costs of $2.4 million at September 30, 2016, and $2.5 million at December 31, 2015. See Note 7 for a discussion of a change in presentation of debt issuance costs.

On January 5, 2016, Stratus completed the refinancing of the W Austin Hotel & Residences. Goldman Sachs Mortgage Company provided a $150.0 million, ten-year, non-recourse term loan (the Goldman Sachs loan) with a fixed interest rate of 5.58 percent per annum and payable monthly based on a 30-year amortization. Stratus used the proceeds from the Goldman Sachs loan to fully repay its existing obligations under the BoA loan and the $20.0 million Comerica term loan included as part of the Comerica credit facility. In connection with prepayment of the BoA loan, Stratus recorded a loss on early extinguishment of debt totaling $0.8 million.

The obligations of Stratus Block 21, LLC (Block 21), a wholly-owned subsidiary of Stratus and borrower under the Goldman Sachs loan, are secured by all assets owned from time to time by Block 21. Additionally, certain obligations of Block 21 under the Goldman Sachs loan are guaranteed by Stratus, including environmental indemnification and other customary carve-out obligations. In connection with any acceleration of the Goldman Sachs loan, Block 21 must pay a yield maintenance premium in the amount of at least three percent of the amount of indebtedness prepaid. Prepayment of the Goldman Sachs loan is not permitted except (1) for certain prepayments resulting from casualty or condemnation and (2) in whole within 90 days of the maturity date.

8
Table of Contents


On July 12, 2016, a Stratus subsidiary entered into an $8.0 million stand-alone revolving credit facility with Comerica Bank (the Amarra Drive credit facility). The proceeds of the Amarra Drive credit facility will be used for the construction of single family townhomes and related improvements at the Amarra Villas. Interest on the loan is variable at LIBOR plus 3.0 percent. The Amarra Drive credit facility matures on July 12, 2019, and is secured by assets at Stratus’ 20-unit Villas at Amarra Drive townhome project (the Amarra Villas), which had a net book value of $8.2 million at September 30, 2016. The Amarra Drive credit facility is guaranteed by Stratus and contains financial covenants including a requirement that Stratus maintain a minimum total stockholders' equity balance of $110.0 million. Principal paydowns will be made as townhomes sell, and additional amounts will be borrowed as additional townhomes are constructed. As of October 31, 2016, Stratus had $2.9 million outstanding under the Amarra Drive credit facility.

On August 5, 2016, a Stratus subsidiary entered into a $9.9 million construction loan agreement with Southside Bank (the West Killeen Market loan). The proceeds of the West Killeen Market loan will be used for the construction of the West Killeen Market project. Stratus will make an initial draw on the West Killeen Market loan after certain site improvements have been completed. Interest on the loan will be variable at one-month LIBOR plus 2.75 percent, with a minimum interest rate of 3.0 percent. Payments of interest only will be made monthly during the initial 42 months of the 72-month term, followed by 30 months of monthly principal and interest payments based on a 30-year amortization. Borrowings on the West Killeen Market loan will be secured by assets at Stratus’ West Killeen Market retail project in Killeen, Texas, which had a net book value of $4.1 million at September 30, 2016, and will be guaranteed by Stratus until construction is completed and certain debt service coverage ratios are met.

On August 12, 2016, the Comerica credit facility was amended to allow Stratus and certain of its wholly owned subsidiaries to use the $7.5 million letters of credit tranche to fund Stratus’ working capital needs, including land acquisitions; however, without prior approval from Comerica, individual land acquisitions may not exceed $3.0 million. All amounts borrowed under the letters of credit tranche to fund working capital needs pursuant to the amendment must be repaid in full by March 31, 2017, at which point the amendment will terminate.

For a description of Stratus' other loans, refer to Note 7 in the Stratus 2015 Form 10-K.

Interest Expense and Capitalization. Interest expense (before capitalized interest) totaled $4.1 million for third-quarter 2016, $2.2 million for third-quarter 2015, $11.7 million for the first nine months of 2016 and $6.8 million for the first nine months of 2015. Stratus' capitalized interest costs totaled $1.5 million for third-quarter 2016, $1.4 million for third-quarter 2015, $4.8 million for the first nine months of 2016 and $4.1 million for the first nine months of 2015. Capitalized interest costs for the 2016 and 2015 periods primarily related to development activities at Barton Creek and The Oaks at Lakeway.

5.
INCOME TAXES
Stratus’ accounting policy for and other information regarding its income taxes is further described in Notes 1 and 8 in the Stratus 2015 Form 10-K.

Stratus had deferred tax assets (net of deferred tax liabilities) totaling $28.2 million at September 30, 2016, and $15.3 million at December 31, 2015. The increase in deferred tax assets of $12.8 million in 2016 is primarily associated with the anticipated closing of the sale of The Oaks at Lakeway in fourth-quarter 2016, which is expected to result in a current taxable gain which would be deferred under generally accepted accounting principles in the United States. Stratus’ income tax benefit for the third quarter of 2016 includes current income tax expense of $12.5 million offset by a deferred tax benefit of $12.8 million. Stratus’ future results of operations may be negatively impacted by an inability to realize a tax benefit for future tax losses or for items that will generate additional deferred tax assets.

The difference between Stratus' consolidated effective income tax rate for the first nine months of 2016, and the U.S. Federal statutory income tax rate of 35 percent, was primarily attributable to the state margin tax. The difference between Stratus' consolidated effective income tax rate for the first nine months of 2015, and the U.S. Federal statutory income tax rate of 35 percent, was primarily attributable to the state margin tax partially offset by the tax effect of income attributable to noncontrolling interests.

6.
BUSINESS SEGMENTS
Stratus currently has four operating segments: Hotel, Entertainment, Commercial Leasing and Real Estate Operations.


9
Table of Contents


The Hotel segment includes the W Austin Hotel located at the W Austin Hotel & Residences.

The Entertainment segment includes ACL Live, a live music and entertainment venue and production studio at the W Austin Hotel & Residences. In addition to hosting concerts and private events, this venue is the home of Austin City Limits, a television program showcasing popular music legends. The Entertainment segment also includes revenues and costs associated with events hosted at other venues, including the recently opened 3TEN ACL Live, which opened in March 2016 on the site of the W Austin Hotel & Residences, and the results of the Stageside Productions joint venture with Pedernales Entertainment LLC (see Note 2 in the Stratus 2015 Form 10-K for further discussion).

The Commercial Leasing segment includes the office and retail space at the W Austin Hotel & Residences, a retail building and a bank building in Barton Creek Village, a retail property at The Oaks at Lakeway and the Santal multi-family project. On July 2, 2015, Stratus completed the sales of the Parkside Village and 5700 Slaughter properties, which were included in the Commercial Leasing segment.

The Real Estate Operations segment is comprised of Stratus’ real estate assets (developed, under development and available for development), which consists of its properties in Austin, Texas (the Barton Creek community, the Circle C community, Lantana and the condominium units at the W Austin Hotel & Residences); in Lakeway, Texas (The Oaks at Lakeway) located in the greater Austin area; in Magnolia, Texas located in the greater Houston area; and in Killeen, Texas (The West Killeen Market).

Stratus uses operating income or loss to measure the performance of each segment. General and administrative expenses primarily consist of employee salaries, wages and other costs, and beginning January 1, 2016, are managed on a consolidated basis and are not allocated to Stratus' operating segments. The segment disclosures for the 2015 periods have been recast to be consistent with the presentation of general and administrative expenses in the 2016 periods. The following segment information reflects management determinations that may not be indicative of what the actual financial performance of each segment would be if it were an independent entity.

Segment data presented below were prepared on the same basis as Stratus’ consolidated financial statements (in thousands).
 
Hotel
 
Entertainment
 
Commercial Leasinga
 
Real Estate
Operationsb
 
Corporate, Eliminations and Otherc
 
Total
Three Months Ended September 30, 2016:
 
 
 
 
 
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
 
 
 
 
Unaffiliated customers
$
8,268

 
$
4,190

 
$
2,567

 
$
6,155

 
$
—

 
$
21,180

Intersegment
60

 
6

 
203

 
8

 
(277
)
 
—

Cost of sales, excluding depreciation
6,893

 
3,837

 
1,398

 
4,076

 
(135
)
 
16,069

Depreciation
873

 
378

 
920

 
55

 
(37
)
 
2,189

General and administrative expenses
—

 
—

 
—

 
—

 
2,497

d 
2,497

Operating income (loss)
$
562

 
$
(19
)
 
$
452

 
$
2,032

 
$
(2,602
)
 
$
425

Capital expenditurese
$
16

 
$
(16
)
 
$
2,385

 
$
3,290

 
$
—

 
$
5,675

Municipal utility district (MUD) reimbursements
—

 
—

 
—

 
12,302

 
—

 
12,302

Total assets at September 30, 2016
104,674

 
38,240

 
119,968

 
171,465

 
23,502

 
457,849

Three Months Ended September 30, 2015:
 

 
 
 
 

 
 

 
 

 
 

Revenues:
 
 
 
 
 
 
 
 
 
 
 
Unaffiliated customers
$
8,521

 
$
4,159

 
$
787

 
$
6,210

 
$
—

 
$
19,677

Intersegment
76

 
22

 
134

 
8

 
(240
)
 
—

Cost of sales, excluding depreciation
6,792

 
3,493

 
524

 
4,458

 
(87
)
 
15,180

Depreciation
1,494

 
323

 
222

 
58

 
(34
)
 
2,063

General and administrative expenses
—

 
—

 
—

 
—

 
2,187

 
2,187

Gain on sales of assets
—

 
—

 
(20,729
)
 
—

 
—

 
(20,729
)
Operating income (loss)
$
311

 
$
365

 
$
20,904

 
$
1,702

 
$
(2,306
)
 
$
20,976

Capital expenditurese
$
241

 
$
52

 
$
20,350

 
$
4,888

 
$
—

 
$
25,531

MUD reimbursements
—

 
—

 
—

 
5,307

 
—

 
5,307

Total assets at September 30, 2015
108,877

 
49,039

 
26,522

 
231,228

 
11,704

 
427,370


10
Table of Contents


 
 
 
 
 
 
 
 
 
 
 
 
 
Hotel
 
Entertainment
 
Commercial Leasinga
 
Real Estate
Operationsb
 
Eliminations and Otherc
 
Total
Nine Months Ended September 30, 2016:
 
 
 
 
 
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
 
 
 
 
  Unaffiliated customers
$
29,501

 
$
13,236

 
$
6,761

 
$
9,858

 
$
—

 
$
59,356

  Intersegment
220

 
90

 
564

 
24

 
(898
)
 
—

Cost of sales, excluding depreciation
22,322

 
10,869

 
3,319

 
8,174

 
(436
)
 
44,248

Depreciation
2,570

 
1,084

 
2,162

 
169

 
(131
)
 
5,854

General and administrative expenses
—

 
—

 
—

 
—

 
9,718

d 
9,718

Operating income (loss)
$
4,829

 
$
1,373

 
$
1,844

 
$
1,539

 
$
(10,049
)
 
$
(464
)
Capital expenditurese
$
277

 
$
263

 
$
24,280

 
$
10,919

 
$
—

 
$
35,739

MUD reimbursements
—

 
—

 
—

 
12,302

 
—

 
12,302


Nine Months Ended September 30, 2015:
 
 
 
 
 
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
 
 
 
 
  Unaffiliated customers
$
31,194

 
$
13,463

 
$
4,311

 
$
10,920

 
$
—

 
$
59,888

  Intersegment
217

 
124

 
386

 
58

 
(785
)
 
—

Cost of sales, excluding depreciation
23,247

 
10,666

 
2,274

 
8,580

 
(298
)
 
44,469

Depreciation
4,484

 
965

 
1,190

 
183

 
(109
)
 
6,713

General and administrative expenses
—

 
—

 
—

 
—

 
6,308

 
6,308

Gain on sales of assets
—

 
—

 
(20,729
)
 
—

 
—

 
(20,729
)
Operating income (loss)
$
3,680

 
$
1,956

 
$
21,962

 
$
2,215

 
$
(6,686
)
 
$
23,127

Income from discontinued operationsf
$
—

 
$
—

 
$
3,218

 
$
—

 
$
—

 
$
3,218

Capital expenditurese
689

 
121

 
36,573

 
20,591

 
—

 
57,974

MUD reimbursements
—

 
—

 
—

 
5,307

 
—

 
5,307

a.
Includes the results of the Parkside Village and 5700 Slaughter commercial properties through July 2, 2015.
b.
Includes sales commissions and other revenues together with related expenses.
c.
Includes consolidated general and administrative expenses and eliminations of intersegment amounts.
d.
General and administrative costs were higher in the third quarter and first nine months of 2016, compared with the third quarter and first nine months of 2015, primarily reflecting higher legal and consulting fees mainly due to $0.3 million in third-quarter 2016 and $2.8 million for the first nine months of 2016 associated with Stratus' successful proxy contest.
e.
Also includes purchases and development of residential real estate held for sale.
f.
Represents a deferred gain, net of taxes, associated with the 2012 sale of 7500 Rialto that was recognized in first-quarter 2015.

7.
NEW ACCOUNTING STANDARDS
In May 2014, the Financial Accounting Standards Board (FASB) issued an Accounting Standard Update (ASU) that provides a single comprehensive revenue recognition model, which will replace most existing revenue recognition guidance, and also requires expanded disclosures. The core principle of the model is that revenue is recognized when control of goods or services has been transferred to customers at an amount that reflects the consideration to which an entity expects to be entitled in exchange for those goods or services. For public entities, this ASU is effective for annual reporting periods beginning after December 15, 2017 (following the FASB’s August 2015 ASU providing for a one-year deferral of the effective date), and interim reporting periods within that reporting period. Early adoption is permitted for annual reporting periods beginning after December 15, 2016, and interim reporting periods within that reporting period. This ASU may be applied either retrospectively to each period presented or prospectively as a cumulative-effect adjustment as of the date of adoption. Stratus is currently evaluating the impact of the new guidance on its financial reporting and disclosures, but at this time does not expect the adoption of this ASU to have a material impact on its financial statements.

In April and August 2015, the FASB issued ASUs to simplify the presentation of debt issuance costs. These ASUs require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. Stratus adopted these ASUs on January 1, 2016, and retrospectively adjusted its previously issued financial statements. Upon adoption, Stratus adjusted its December 31, 2015, balance sheet by decreasing other assets and long-term debt by $2.5 million for debt issuance costs related to corresponding debt balances. Stratus elected to continue presenting debt issuance

11
Table of Contents


costs for its revolving credit facility as a deferred charge (asset) because of the volatility of its borrowings and repayments under the facility.

In January 2016, the FASB issued an ASU that amends the current guidance on the classification and measurement of financial instruments. This ASU makes limited changes to existing guidance and amends certain disclosure requirements. For public entities, this ASU is effective for interim and annual periods beginning after December 15, 2017. Early adoption is not permitted, except for the provision on recording fair value changes for financial liabilities under the fair value option. Stratus is currently evaluating the impact this ASU will have on its financial reporting and disclosures, but at this time does not expect the adoption of this ASU will have a material impact on its financial statements.

In February 2016, the FASB issued an ASU that will require lessees to recognize most leases on the balance sheet. This ASU allows lessees to make an accounting policy election to not recognize a lease asset and liability for leases with a term of 12 months or less and that do not have a purchase option that is expected to be exercised. For public entities, this ASU is effective for interim and annual reporting periods beginning after December 15, 2018, with early adoption permitted. This ASU must be applied using the modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements. Stratus is currently evaluating the impact this guidance will have on its financial statements.

In March 2016, the FASB issued an ASU that simplifies various aspects of the accounting for share-based payment
transactions, including the income tax consequences, statutory tax withholding requirements, an accounting policy
election for forfeitures and the classification on the statement of cash flows. For public entities, this ASU is effective
for interim and annual periods beginning after December 15, 2016, with early adoption permitted. Each of the amendments in this ASU provides specific transition requirements. Stratus is currently evaluating the impact this
guidance will have on its financial statements.

8.
SUBSEQUENT EVENTS
On October 4, 2016, Stratus entered into an agreement to sell The Oaks at Lakeway to TA Realty, LLC (TA Realty) for $114.0 million in cash. The sales agreement provides for a closing in fourth-quarter 2016, subject to the satisfaction or waiver of a number of significant conditions, in addition to customary closing conditions. As a condition to closing, the parties are required to enter into three master lease agreements: (1) one covering unleased in-line retail space, with a five-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. Stratus projects that, as of the closing, its master lease rent obligation will approximate $190,000 per month and will decline over time until leasing is complete and all leases are assigned to the purchaser, which is projected to occur by December 2018. Stratus expects pre-tax net cash proceeds at closing to approximate $50.0 million and expects to use these projected net cash proceeds to pay indebtedness outstanding under its revolving line of credit and its term loan with DRAIF, which would result in Stratus having substantially no debt outstanding except for other project-specific debt. Stratus has agreed to guarantee the obligations of its selling subsidiary under the purchase agreement, up to a liability cap of two percent of the purchase price. This cap does not apply to Stratus' obligation to satisfy the selling subsidiary’s indemnity obligations for its broker commissions or similar compensation or Stratus' liability in guaranteeing the selling subsidiary’s obligations under the master leases to be entered into with TA Realty at closing. To secure its obligations under the master leases, Stratus is required to provide a $1.5 million irrevocable letter of credit with a three-year term.

The accompanying unaudited consolidated balance sheets include the following balances associated with The Oaks at Lakeway (in thousands):
 
September 30, 2016
 
December 31, 2015
Real estate under development
$
19,953

 
$
28,839

Real estate held for investment, net
51,996

 
35,866

Other assets
3,671

 
1,782

Accrued liabilities, including taxes
5,644

 
549

Debt
53,556

 
45,931

Other liabilities
748

 
442

 

12
Table of Contents


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

OVERVIEW

In Management’s Discussion and Analysis of Financial Condition and Results of Operations, “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 financial statements, the related Management's Discussion and Analysis of Financial Condition and Results of Operations and the discussion of our business and properties included in our Annual Report on Form 10-K for the year ended December 31, 2015 (2015 Form 10-K) filed with the United States Securities and Exchange Commission (SEC). The results of operations reported and summarized below are not necessarily indicative of future operating results, and future results could differ materially from those anticipated in forward-looking statements (refer to "Cautionary Statement" for further discussion). All subsequent references to “Notes” refer to Notes to Consolidated Financial Statements (Unaudited) located in Part I, Item 1. “Financial Statements” of this Form 10-Q, unless otherwise stated.

We are a diversified real estate company engaged primarily in the acquisition, entitlement, development, management, operation and sale of commercial, hotel, entertainment, and multi- and single-family residential real estate properties, primarily located in the Austin, Texas area, but including projects in certain other select markets in Texas. We generate revenues from sales of developed properties, from our hotel and entertainment operations and from rental income from our commercial properties. See Note 6 for further discussion of our operating segments.

Sale of The Oaks at Lakeway. In October 2016, we entered into a sales agreement with TA Realty, LLC (TA Realty) to sell The Oaks at Lakeway for $114.0 million in cash. The sale is in accordance with our five-year plan, and we believe it provides strong evidence of the value created by our five-year plan strategy, including our grocery-anchored retail development program. While we have a number of steps to complete before closing, we believe the sale remains on track to close in December 2016.

The Oaks at Lakeway is a HEB Grocery Company, L.P. (HEB)-anchored retail project planned for 236,739 square feet of commercial space and is located in Lakeway, Texas in the Lake Travis community. The project, the tracts for which we acquired between May 2013 and September 2014, is 100 percent owned by Stratus. The sale does not include approximately 34.7 acres of undeveloped property in the back portion of the development, which is zoned for residential, hotel and civic uses.

We expect pre-tax net cash proceeds at closing to approximate $50.0 million, after payment of estimated transaction expenses, a net profits participation payment due to HEB, and payoff of the projected balance of the related construction loan. We expect to use these projected net cash proceeds to pay indebtedness outstanding under our Comerica credit facility and Diversified Real Asset Income Fund (DRAIF) term loan, which would result in Stratus having substantially no debt outstanding except for other project-specific debt.

We have agreed to guarantee the obligations of our selling subsidiary under the purchase 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 master leases to be entered into with TA Realty at closing, which are described below.

The transaction is expected to close on December 15, 2016, subject to the satisfaction or waiver of closing conditions. The purchase agreement is subject to a 45-day inspection period (which expires on November 18, 2016) during which TA Realty can terminate the purchase agreement in its sole discretion, and is conditioned on HEB agreeing to a specified amendment to its lease, which HEB may grant in its sole discretion. The purchase agreement also contains representations, warranties, covenants, closing conditions, and termination provisions customary for transactions of this type.

Additionally, as a condition to closing, our selling subsidiary is required to enter into three master lease agreements with TA Realty: (1) one covering unleased in-line retail space, with a five-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. The hotel pad is currently leased and the master hotel lease will become effective only if the current hotel lessee defaults prior to completion of the hotel. 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 TA Realty and the corresponding property will be removed from the master lease, reducing our selling

13
Table of Contents


subsidiary’s master lease payment obligation. We project that, as of the closing, our master lease payment obligation will approximate $190,000 per month and will decline over time until leasing is complete and all leases are assigned to TA Realty, which is projected to occur by December 2018. To secure our obligations under the master leases, we are required to provide a $1.5 million irrevocable letter of credit with a three-year term.

With respect to the master leases, if we are not successful in leasing unleased space as projected, or tenants currently paying rent default prior to their leases being assigned to TA Realty, our selling subsidiary would be responsible for the attributable lease payments to TA Realty through the earlier of (1) the time alternative lease arrangements can be made and the lease is assigned to TA Realty and (2) the end of the term of the applicable master lease.

In the event of a default by TA Realty after the 45-day inspection period, earnest money of $5.0 million would be delivered to us as liquidated damages in full satisfaction of our claims against TA Realty for the default.

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 home already built on it or condominium units at the W Austin Hotel & Residences. We may sell properties under development, undeveloped properties or commercial properties, if opportunities arise that we believe will maximize overall asset values as part of our business plan. See "Business Strategy and Related Risks" below.

The number of developed lots/units, acreage under development and undeveloped acreage as of September 30, 2016, that comprise our real estate development operations are presented in the following table.
 
 
 
Acreage
 
 
 
 
 
Under Development
 
Undeveloped
 
 
 
Developed
Lots/Units
 
Multi-
family
 
Commercial
 
Total
 
Single
family
 
Multi-family
 
Commercial
 
Total
 
Total
Acreage
Austin:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Barton Creek
298

 
38

 
—

 
38

 
512

 
289

 
398

 
1,199

 
1,237

Circle C
13

 
—

 
—

 
—

 
—

 
36

 
216

 
252

 
252

Lantana
—

 
—

 
—

 
—

 
—

 
—

 
56

 
56

 
56

W Austin Residences
2

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

The Oaks at Lakeway
—

 
—

 
87

 
87

 
—

 
—

 
—

 
—

 
87

Magnolia
—

 
—

 
—

 
—

 
—

 
—

 
124

 
124

 
124

West Killeen Market
—

 
—

 
9

 
9

 
—

 
—

 
—

 
—

 
9

San Antonio:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Camino Real
—

 
—

 
—

 
—

 
—

 
—

 
2

 
2

 
2

Total
313

 
38

 
96

 
134

 
512

 
325

 
796

 
1,633

 
1,767


Our residential holdings at September 30, 2016, are principally in southwest Austin, Texas, and include developed lots at Barton Creek and the Circle C community, and condominium units at the W Austin Hotel & Residences. See "Development Activities - Residential" for further discussion. Our commercial holdings at September 30, 2016, consist of the office and retail space at the W Austin Hotel & Residences, the first phase of Barton Creek Village, The Oaks at Lakeway and the first phase of the Santal multi-family project. See "Sale of The Oaks at Lakeway" above, and "Development Activities - Commercial" 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 (of which the remaining two unsold units were being marketed as of September 30, 2016), and office, retail and entertainment space. The hotel is managed by Starwood Hotels & Resorts Worldwide, Inc. The entertainment space, occupied by Austin City Limits Live at the Moody Theater (ACL Live), includes a live music and entertainment venue and production studio. Our 3TEN ACL Live venue, which is located on the site of the W Austin Hotel & Residences, opened in March 2016. The 3TEN ACL Live venue has a capacity of approximately 350 people and is designed to be more intimate than ACL Live, which can accommodate approximately 3,000 people.

For third-quarter 2016, our revenues increased to $21.2 million and our net loss attributable to common stockholders totaled $1.7 million, compared with revenues of $19.7 million and net income attributable to common stockholders of $10.2 million for third-quarter 2015. The increase in revenues in third-quarter 2016 primarily reflects

14
Table of Contents


increased commercial leasing revenue relating to The Oaks at Lakeway and Santal, partially offset by lower room revenues from the W Austin Hotel. For the first nine months of 2016, our revenues were $59.4 million and our net loss attributable to common stockholders totaled $5.8 million, compared with revenues of $59.9 million and net income attributable to common stockholders of $11.9 million for the first nine months of 2015. The slight decrease in revenues for the first nine months of 2016, compared with the first nine months of 2015, primarily reflects decreased revenue from the W Austin Hotel and lower lot sales, partially offset by increased commercial leasing revenue relating to The Oaks at Lakeway and Santal. The results for the first nine months of 2016 also reflect an increase in general and administrative expenses primarily due to costs of $2.8 million associated with our successful proxy contest, and higher interest expense. Higher interest expense reflects increased borrowings and higher interest rates associated with our refinancing of the W Austin Hotel & Residences and construction loans to support our development projects. In January 2016, we refinanced debt associated with our wholly owned W Austin Hotel & Residences with longer-term, fixed-rate debt, and reported a loss on early extinguishment of debt totaling $0.8 million ($0.5 million to net loss attributable to common stockholders) for the first nine months of 2016.

The results for the third quarter and first nine months of 2015 included a gain of $20.7 million ($10.8 million to net income attributable to common stockholders) on the sales of Parkside Village and 5700 Slaughter, and reductions of $3.5 million and $5.4 million, respectively, for net income attributable to noncontrolling interests in subsidiaries relating to our former joint venture partner’s interest in the W Austin Hotel & Residences. The first nine months of 2015 also included the recognition of a deferred gain associated with the 2012 sale of 7500 Rialto totaling $5.0 million ($3.2 million to net income attributable to common stockholders).

For discussion of operating cash flows and debt transactions, including our refinancing of the W Austin Hotel & Residences, see "Capital Resources and Liquidity" below.

BUSINESS STRATEGY AND RELATED RISKS

Our overall strategy has been to enhance the value of our properties by securing and maintaining development entitlements and developing and building real estate projects on these properties for sale or investment. We have also pursued opportunities for new projects that offer the possibility of acceptable returns and risks.
In March 2015, we announced that our board of directors had unanimously approved a five-year plan to create value for stockholders by methodically developing certain existing assets and strategically marketing other assets for sale at appropriate values. Under the plan, any future new projects will be complementary to existing operations and will be projected to be developed and sold within a five-year time frame. Consistent with our five-year plan, on July 2, 2015, we completed the sales of our Austin-area Parkside Village and 5700 Slaughter commercial properties, both located in the Circle C community, for $32.5 million and $12.5 million, respectively. As discussed above in “Overview - Sale of The Oaks at Lakeway,” we have entered into an agreement to sell The Oaks at Lakeway for $114.0 million in cash. In addition, we continue to market our completed single-family homesites, have more than 55 percent of the first phase of our Santal multi-family units leased, have secured permits for the second phase of the Santal multi-family project, and continue to progress our development projects and plans, including additional HEB-anchored projects.

In April 2016, we announced that our board of directors authorized management to explore a full range of strategic alternatives to enhance value for our stockholders, including, but not limited to, a sale of Stratus, a sale of certain of our core assets, a share repurchase program, and continuing our long-term plans to develop the value of our properties. After conducting a thorough process of evaluating several financial advisors, we engaged Hentschel & Company, a premier boutique investment banking advisory firm focused on the real estate industry, as financial advisor in connection with the review of strategic alternatives. The board of directors has not set a definitive timeline for completion of this review process and has not determined to enter into any transaction. There can be no assurance that this process will result in any change to the previously announced five-year plan, a sale transaction or any other transaction. We do not intend to comment further or to disclose developments regarding the process until such time as our board of directors has determined the outcome of the process or otherwise determines that further disclosure is appropriate.
We believe that the Austin and surrounding sub-markets continue to be desirable. 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 assets, which are located in desirable areas with significant regulatory constraints, are highly entitled and now have utility capacity for full buildout. As a result, we believe that through strategic planning, development and marketing, as provided in our five-year plan, we can maximize and fully realize

15
Table of Contents


their value. Our development plans require significant additional capital, and may be pursued through joint ventures or other means. In addition, our strategy is subject to continued review by our board of directors and may change as a result of the outcome of our recently-announced review of strategic alternatives, market conditions or other factors deemed relevant by our board of directors.
In years past, economic conditions, including the constrained capital and credit markets, negatively affected the execution of our business plan, primarily by decreasing our pace of development to match economic and market conditions. We responded to these conditions by successfully restructuring our existing debt, including reducing interest rates and extending maturities, which enabled us to preserve our development opportunities until market conditions improved. Economic conditions have improved, and we believe we have the financial flexibility to fully exploit our development opportunities and resources in accordance with our five-year plan. During the first nine months of 2016, our operating cash flows reflect purchases and development of real estate properties totaling $10.9 million, funded primarily from construction and term loans, to invest in new development opportunities to be executed over the next 24 months. As of September 30, 2016, we had $12.2 million of availability under our credit facility with Comerica Bank, which matures in August 2017.

Although as of September 30, 2016, we have scheduled debt maturities of $8.7 million occurring in fourth-quarter 2016 and $40.6 million in 2017, and significant recurring costs, including property taxes, maintenance and marketing, we believe we will have sufficient sources of debt financing and cash from operations to address our cash requirements. See "Capital Resources and Liquidity" below regarding recent debt repayments and refinancing and “Risk Factors” included in Part 1, Item 1A. of our 2015 Form 10-K for further discussion.
DEVELOPMENT ACTIVITIES

Residential. As of September 30, 2016, the number of our residential developed lots/units, lots under development and lots for potential development by area are shown below:
 
 
Residential Lots/Units
 
 
Developed
 
Under
Development
 
Potential Developmenta
 
Total
Barton Creek:
 
 
 
 
 
 
 
 
Amarra Drive:
 
 
 
 
 
 
 
 
Phase II Lots
 
13

 
—

 
—

 
13

Phase III Lots
 
49

 
—

 
—

 
49

Townhomes
 
—

 
20

 
170

 
190

Section N Multi-family
 
 
 
 
 
 
 
 
Santal Multi-family
 
236

 
—

 
—

 
236

Other Section N
 
—

 
—

 
1,624

 
1,624

Other Barton Creek sections
 
—

 
—

 
156

 
156

Circle C:
 
 
 
 
 
 
 
 
Meridian
 
13

 
—

 
—

 
13

Tract 101 Multi-family
 
—

 
—

 
240

 
240

Tract 102 Multi-family
 
—

 
—

 
56

 
56

Flores Street
 
—

 
—

 
6

 
6

W Austin Residences:
 
 
 
 
 
 
 
 
Condominium units
 
2

 
—

 
—

 
2

Total Residential Lots/Units
 
313

 
20

 
2,252

 
2,585

a.
Our development of the properties identified under the heading “Potential Development” is dependent upon the approval of our development plans and permits by governmental agencies, including the City of Austin (the City). 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 on some of these properties, they are not considered to be “under development” for disclosure in this table unless other development activities necessary to fully realize the properties’ intended final use are in progress or scheduled to commence in the near term.

Amarra Drive. Amarra Drive Phase II, which consists of 35 lots on 51 acres, was substantially completed in October 2008. During the first nine months of 2016, we sold one Phase II lot for $0.6 million and as of September 30, 2016, 13 Phase II lots remained available for sale.

16
Table of Contents



In first-quarter 2015, we substantially completed the development of Amarra Drive Phase III, which consists of 64 lots on 166 acres. During the first nine months of 2016, we sold five Phase III lots for $3.9 million and as of September 30, 2016, 49 Phase III lots remained available for sale. As of October 31, 2016, four Phase III lots were under contract.

The Villas at Amarra Drive townhome project is a 20-unit development for which we completed site work in late 2015. Construction of the first five of 20 townhomes commenced in March 2016 and is expected to be completed in early 2017. As of October 31, 2016, we are marketing these townhomes for sale. The townhomes average approximately 4,400 square feet and are being marketed as “lock and leave” properties, with golf course access and cart garages.

Section N. The Santal multi-family project, a garden-style apartment complex, was substantially completed in August 2016 and includes 236 apartment units. We began recognizing rental revenue, which is included in the Commercial Leasing segment, in January 2016. As of October 31, 2016, 131 units were leased. Permits for the second 212-unit phase have been secured.

Circle C. We are developing 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. 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 first-quarter 2014. During the first nine months of 2016, we sold 18 Meridian lots for $5.0 million and as of September 30, 2016, 13 lots remained available for sale. During October 2016, we sold one additional Meridian lot and as of October 31, 2016, one Meridian lot was under contract.

W Austin Residences. As of September 30, 2016, two condominium units remained available for sale and are being marketed.

Commercial. As of September 30, 2016, the number of square feet of our commercial property developed, under development and our remaining entitlements for potential development (excluding property associated with our unconsolidated joint venture with Tramell Crow Central Texas Development, Inc. relating to Crestview Station in Austin (the Crestview Station Joint Venture)) are shown below:
 
Commercial Property
 
Developed
 
Under Development
 
Potential Developmenta
 
Total
Barton Creek:
 
 
 
 
 
 
 
Treaty Oak Bank
3,085

 
—

 
—

 
3,085

Barton Creek Village Phase I
22,366

 
—

 
—

 
22,366

Barton Creek Village Phase II
—

 
—

 
16,000

 
16,000

Entry corner
—

 
—

 
5,000

 
5,000

Amarra retail/office
—

 
—

 
83,081

 
83,081

Section N
—

 
—

 
1,500,000

 
1,500,000

Circle C:
 
 
 
 
 
 
 
Tract 110
—

 
—

 
614,500

 
614,500

Tract 114
—

 
—

 
78,357

 
78,357

Lantana:
 
 
 
 
 
 
 
Tract GR1
—

 
—

 
325,000

 
325,000

Tract G07
—

 
—

 
160,000

 
160,000

W Austin Hotel & Residences:
 
 
 
 
 
 
 
Office
38,316

 
—

 
—

 
38,316

Retail
18,327

 
—

 
—

 
18,327

The Oaks at Lakeway
217,736

 
19,003

 
—

 
236,739

Magnolia
—

 
—

 
351,000

 
351,000

West Killeen Market
—

 
44,000

 
—

 
44,000

Total Square Feet
299,830

 
63,003

 
3,132,938

 
3,495,771


17
Table of Contents


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. 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 on some of these properties, they are not considered to be “under development” for disclosure in this table unless other development activities necessary to fully realize the properties’ intended final use are in progress or scheduled to commence in the near term.
 
Barton Creek. The first phase of Barton Creek Village consists of a 22,366-square-foot retail complex and a 3,085-square-foot bank building. As of September 30, 2016, occupancy was 100 percent for the retail complex, and the bank building is leased through January 2023.

Lantana.  Lantana is a partially developed, mixed-use real-estate development project. As of September 30, 2016, we had entitlements for approximately 485,000 square feet of office and retail space on the remaining 56 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 received final approval from the City in August 2015 for a mixed-use development of approximately 320,000 square feet, and we expect to be in position to move forward with development in 2017.

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 September 30, 2016, both the office and retail space were substantially occupied.

The Oaks at Lakeway. As further discussed in Note 8 and "Overview - Sale of The Oaks at Lakeway," in October 2016, we entered into an agreement to sell The Oaks at Lakeway. The Oaks at Lakeway is a HEB-anchored retail project planned for 236,739 square feet of commercial space. As of September 30, 2016, leases for approximately 90 percent of the space, including the HEB lease, have been executed and leasing for the remaining space is under way. The HEB store opened in October 2015, and 19 retail tenants opened as of September 30, 2016. Construction of 217,736 square feet is substantially complete, and construction of the remaining space will be started once leases have been executed.

Magnolia. The Magnolia project is a HEB-anchored retail project planned for 351,000 square feet of commercial space. Planning and infrastructure work by the city of Magnolia is complete and road expansion by the Texas Department of Transportation is in progress and expected to be completed in 2017. The HEB store is presently expected to open in late 2018 or early 2019.

West Killeen Market. In 2015, we acquired approximately 21 acres in Killeen, Texas, to develop the West Killeen Market project, a HEB-anchored retail project planned for 44,000 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 the HEB store is scheduled to open in March 2017.

UNCONSOLIDATED AFFILIATE

Crestview Station. Crestview Station is a single-family, multi-family, retail and office development, located on the site of a commuter rail line. As of September 30, 2016, the Crestview Station Joint Venture has sold all of its properties except for one commercial site (see Note 6 in our 2015 Form 10-K). We account for our 50 percent interest in the Crestview Station Joint Venture under the equity method.


18
Table of Contents


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. 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.

The following table summarizes our results (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Operating income (loss):
 
 
 
 
 
 
 
Hotel
$
562

 
$
311

 
$
4,829

 
$
3,680

Entertainment
(19
)
 
365

 
1,373

 
1,956

Commercial leasing
452

 
20,904

 
1,844

 
21,962

Real estate operations
2,032

 
1,702

 
1,539

 
2,215

Corporate, eliminations and other
(2,602
)
 
(2,306
)
 
(10,049
)
 
(6,686
)
Operating income (loss)
$
425

 
$
20,976

 
$
(464
)
 
$
23,127

Interest expense, net
$
(2,579
)
 
$
(855
)
 
$
(6,894
)
 
$
(2,736
)
Income from discontinued operations, net of taxes
$
—

 
$
—

 
$
—

 
$
3,218

Net (loss) income
$
(1,659
)
 
$
13,741

 
$
(5,825
)
 
$
17,285

Net income attributable to noncontrolling interests in subsidiaries
$
—

 
$
(3,493
)
 
$
—

 
$
(5,414
)
Net (loss) income attributable to common stockholders
$
(1,659
)
 
$
10,248

 
$
(5,825
)
 
$
11,871


We have four operating segments: Hotel, Entertainment, Commercial Leasing and Real Estate Operations (see Note 6 for further discussion). The following is a discussion of our operating results by segment.

Hotel
The following table summarizes our Hotel operating results (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Hotel revenue
$
8,328

 
$
8,597

 
$
29,721

 
$
31,411

Hotel cost of sales, excluding depreciation
6,893

 
6,792

 
22,322

 
23,247

Depreciation
873

 
1,494

 
2,570

 
4,484

Operating income
$
562

 
$
311

 
$
4,829

 
$
3,680


Hotel Operating Income. Operating income for the Hotel segment increased during the 2016 periods, primarily reflecting lower depreciation expense.

Hotel Revenue. Hotel revenue primarily includes revenue from W Austin Hotel room reservations and food and beverage sales. Revenue per available room, which is calculated by dividing total room revenue by the average total rooms available, averaged $227 for third-quarter 2016 and $265 for the first nine months of 2016, compared with $241 for third-quarter 2015 and $282 for the first nine months of 2015. Lower Hotel revenues in the 2016 periods primarily reflect lower room revenue resulting from decreased occupancy rates, partly attributable to increased hotel capacity in the Austin area.

Hotel Cost of Sales. Hotel operating costs (excluding depreciation) were $6.9 million in third-quarter 2016, compared with $6.8 million in third-quarter 2015, and decreased slightly to $22.3 million for the first nine months of 2016, compared with $23.2 million for the first nine months of 2015.

Hotel Depreciation. Hotel depreciation decreased to $0.9 million in third-quarter 2016 and $2.6 million for the first nine months of 2016, compared with $1.5 million in third-quarter 2015 and $4.5 million for the first nine months of 2015, primarily reflecting certain furniture and equipment being fully depreciated as of December 31, 2015.

19
Table of Contents



Entertainment
The following table summarizes our Entertainment operating results (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Entertainment revenue
$
4,196

 
$
4,181

 
$
13,326

 
$
13,587

Entertainment cost of sales, excluding depreciation
3,837

 
3,493