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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED MARCH 31, 2003
--------------
Commission File Number 1-15663
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AMERICAN REALTY INVESTORS, INC.
- --------------------------------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
Nevada 75-2847135
- ---------------------------------------- -------------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
1800 Valley View Lane, Suite 300, Dallas, Texas 75234
- --------------------------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
(469) 522-4200
-------------------------------
(Registrant's Telephone Number,
Including Area Code)
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes ___. No X .
---
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.
Yes X No ___
---
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
Common Stock, as of the latest practicable date.
Common Stock, $.01 par value 10,628,155
- ---------------------------- ------------------------------
(Class) (Outstanding at April 30, 2003)
1
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
The accompanying Consolidated Financial Statements have not been audited by
independent certified public accountants, but, in the opinion of the management
of American Realty Investors, Inc. ("ARI"), all adjustments (consisting of
normal recurring accruals) necessary for a fair presentation of consolidated
results of operations, consolidated financial position and consolidated cash
flows at the dates and for the periods indicated, have been included.
AMERICAN REALTY INVESTORS, INC.
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2003 2002
------------ ------------
(dollars in thousands,
except per share)
Assets
------
Real estate held for investment ............................................ $ 1,199,092 $ 378,080
Less - accumulated depreciation ............................................ (190,528) (96,036)
----------- -----------
1,008,564 282,044
Real estate held for sale .................................................. 161,185 181,713
Notes and interest receivable
Performing ($34,494 in 2003 and $34,442 in 2002 from affiliates) ......... 70,408 77,354
Nonperforming ($6,826 in 2003 and $6,838 in 2002 from affiliates) ........ 10,703 7,856
----------- -----------
81,111 85,210
Less--allowance for estimated losses ....................................... (4,533) (3,077)
----------- -----------
76,578 82,133
Pizza parlor equipment ..................................................... 12,799 12,557
Less - accumulated depreciation ............................................ (4,568) (4,562)
----------- -----------
8,231 7,995
Marketable equity securities, at market value .............................. 6,713 209
Cash and cash equivalents .................................................. 8,740 8,432
Investments in equity investees ............................................ 2,701 80,990
Goodwill, net of accumulated amortization ($1,763 in 2003 and 2002) ........ 13,974 13,784
Other intangibles, net of accumulated amortization ($597 in 2003 and $773
in 2002) ................................................................. 1,506 1,744
Other assets ............................................................... 114,207 50,001
----------- -----------
$ 1,402,399 $ 709,045
=========== ===========
The accompanying notes are an integral part of these Consolidated Financial
Statements.
2
AMERICAN REALTY INVESTORS, INC.
CONSOLIDATED BALANCE SHEETS - Continued
March 31, December 31,
2003 2002
------------ -----------
(dollars in thousands,
except per share)
Liabilities and Stockholders' Equity
Liabilities
Notes and interest payable ($15,600 in 2002 to affiliates) ........................ $1,022,121 $ 349,740
Liabilities related to assets held for sale ....................................... 116,227 125,693
Margin borrowings ................................................................. 8,308 8,558
Accounts payable and other liabilities ($14,438 in 2003 and $41,085 in 2002 to
affiliates) .................................................................... 96,674 127,872
---------- ----------
1,243,330 611,863
Minority interest ................................................................. 88,566 19,940
Commitments and contingencies
Stockholders' equity
Preferred Stock, $2.00 par value, authorized 50,000,000 shares, issued and
outstanding
Series A, 3,226,858 shares in 2003 and 2002 (liquidation preference $32,269),
including 900,000 shares in 2003 and 2002 held by subsidiaries ............... 4,654 4,654
Series E, 50,000 shares in 2003 and 2002 (liquidation preference $5,000) ........ 100 100
Common Stock, $.01 par value, authorized 100,000,000 shares; issued 11,375,127
shares in 2003 and 2002 ......................................................... 114 114
Paid-in capital ................................................................... 93,366 93,954
Treasury stock, at cost, 746,972 shares in 2003 ................................... (9,924) --
Accumulated (deficit) ............................................................. (17,593) (24,784)
Accumulated other comprehensive income (loss) ..................................... (214) 3,204
---------- ----------
70,503 77,242
---------- ----------
$1,402,399 $ 709,045
========== ==========
The accompanying notes are an integral part of these Consolidated Financial
Statements.
3
AMERICAN REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months
Ended March 31,
-----------------------
2003 2002
--------- ---------
(dollars in thousands,
Property revenue except per share)
Rents ............................................................... $ 22,266 $ 21,800
Property operations expenses ........................................ 16,612 16,215
--------- ---------
Operating income .................................................... 5,654 5,585
Land operations
Sales ............................................................... 8,785 5,580
Cost of sales ....................................................... 8,711 4,211
Recognition of previously deferred gains ............................ 19,897 830
--------- ---------
Gain on land sales .................................................. 19,971 2,199
Pizza parlor operations
Sales ............................................................... 7,867 7,368
Cost of sales ....................................................... 6,407 5,781
--------- ---------
Gross margin ........................................................ 1,460 1,587
Income from operations ................................................. 27,085 9,371
Other income (loss)
Interest income ..................................................... 2,230 612
Equity in loss of investees ......................................... (4,339) (4,012)
Loss on sale of investments in equity investees ..................... -- (531)
Other ............................................................... 8 184
--------- ---------
(2,101) (3,747)
Other expenses
Interest ............................................................ 11,266 15,327
Depreciation and amortization ....................................... 2,501 2,297
Discount on sale of notes receivable ................................ 1,558 --
General and administrative .......................................... 3,308 3,312
Advisory fee to affiliate ........................................... 2,028 1,736
Net income fee to affiliate ......................................... 452 --
Incentive fee to affiliate .......................................... 261 --
Minority interest ................................................... 550 787
--------- ---------
21,924 23,459
--------- ---------
Net income (loss) from continuing operations ........................... 3,060 (17,835)
Discontinued operations:
Income (loss) from operations ....................................... 1,118 (848)
Gain on sale of real estate ......................................... 3,013 5,615
Equity in gain on sale of real estate by equity investees ........... -- 4,131
--------- ---------
Net income from discontinued operations ................................ 4,131 8,898
Net income (loss) ...................................................... 7,191 (8,937)
Preferred dividend requirement ......................................... (588) (611)
--------- ---------
Net income (loss) applicable to Common shares .......................... $ 6,603 $ (9,548)
========= =========
The accompanying notes are an integral part of these Consolidated Financial
Statements.
4
AMERICAN REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS - Continued
For the Three Months
Ended March 31,
-----------------------------
2003 2002
----------- -----------
(dollars in thousands,
except per share)
Basic earnings per share
Net income (loss) from continuing operations ................................... $ .22 $ (1.62)
Discontinued operations ........................................................ .36 .78
----------- -----------
Net income (loss) applicable to Common shares .................................. $ .58 $ (.84)
=========== ===========
Diluted earnings per share
Net income (loss) for continuing operations .................................... $ .21 $ (1.62)
Discontinued operations ........................................................ .28 .78
----------- -----------
Net income (loss) applicable to Common shares .................................. $ .49 $ (.84)
=========== ===========
Weighted average Common shares used in computing earnings per share: ..............
Basic ..................................................................... 11,375,127 11,375,127
Diluted ................................................................... 14,522,530 11,375,127
Convertible Preferred Stock (2,424,910 shares) and options to purchase 186,750
shares of ARI's Common Stock were excluded from the computation of diluted
earnings per share for the three months ended March 31, 2002, because the effect
of their inclusion would be antidilutive.
Options to purchase 105,750 shares of ARI's Common Stock were excluded from the
computation of diluted earnings per share for the three months ended March 31,
2003, because the effect of their inclusion would be antidilutive.
The accompanying notes are an integral part of these Consolidated Financial
Statements.
5
AMERICAN REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the Three Months Ended March 31, 2003
Series A Series E
Preferred Preferred Common Paid-in Treasury Accumulated
Stock Stock Stock Capital Stock Deficit
--------- --------- ------ ----------- -------- -----------
(dollars in thousands, except per share)
Balance, January 1, 2003 ...................... $ 4,654 $ 100 $ 114 $ 93,954 $ -- $ (24,784)
Comprehensive income
Foreign currency translation gain .......... -- -- -- -- -- --
Sale of foreign operations ................. -- -- -- -- -- --
Net income ................................. -- -- -- -- -- 7,191
Common shares held by acquired company ........ -- -- -- -- (9,924) --
Preferred dividends
Series A Preferred Stock ($.25 per
share) .................................. -- -- -- (581) -- --
Series E Preferred Stock ($.15 per
share) .................................. -- -- -- (7) -- --
--------- --------- ------ ----------- -------- -----------
Balance, March 31, 2003 ....................... $ 4,654 $ 100 $ 114 $ 93,366 $ (9,924) $ (17,593)
========= ========= ====== =========== ======== ===========
Accumulated
Other
Comprehensive Stockholders'
Income Equity
------------- -------------
Balance, January 1, 2003 ...................... $ 3,204 $ 77,242
Comprehensive income
Foreign currency translation gain .......... (301) (301)
Sale of foreign operations ................. (3,117) (3,117)
Net income ................................. -- 7,191
-------------
3,773
Common shares held by acquired company ........ -- (9,924)
Preferred dividends
Series A Preferred Stock ($.25 per
share) .................................. -- (581)
Series E Preferred Stock ($.15 per
share) .................................. -- (7)
------------- -------------
Balance, March 31, 2003 ....................... $ (214) $ 70,503
============= =============
The accompanying notes are an integral part of these Consolidated Financial
Statements.
6
AMERICAN REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Months
Ended March 31,
--------------------------
2003 2002
---------- ----------
(dollars in thousands)
Cash Flows From Operating Activities
Net income (loss) ........................................................... $ 7,191 $ (8,937)
Reconciliation of net income (loss) to net cash used in operating activities
Adjustments to reconcile net income to net cash used in operating
activities
Depreciation and amortization ........................................... 2,566 3,555
Gain on sale of real estate ............................................. (22,984) (7,814)
Equity in (income) loss of investees .................................... 4,339 (119)
Loss on sale of investments in equity investees ......................... -- 531
(Increase) decrease in accrued interest receivable ...................... (1,099) 54
Decrease in other assets ................................................ 1,392 2,551
Increase in accrued interest payable .................................... 766 712
Decrease in accounts payable and other liabilities ...................... (469) (2,095)
-------- --------
Net cash used in operating activities ............................... $ (8,298) $(11,562)
Cash Flows From Investing Activities
Collections on notes receivable ........................................... $ 9,304 $ 3,689
Proceeds from sale of notes receivable .................................... 26,346 --
Pizza parlor equipment purchased .......................................... (767) (391)
Proceeds from sale of real estate ......................................... 27,172 22,175
Notes receivable funded ................................................... -- (1,868)
Earnest money/escrow deposits ............................................. (34) 232
Investment in real estate entities, net of cash acquired .................. (22,417) 1,071
Short-term advances funded ................................................ (24,723) --
Real estate improvements .................................................. (1,308) (2,063)
-------- --------
Net cash provided by investing activities ........................... $ 13,573 $ 22,845
Cash Flows from Financing Activities
Proceeds from notes payable ............................................... $ 42,494 $ 26,084
Payments on notes payable ................................................. (37,912) (29,628)
Deferred borrowing costs .................................................. (1,555) (915)
Net payments to affiliates ................................................ (7,413) (5,069)
Margin borrowings, net .................................................... -- (950)
Preferred dividends paid .................................................. (581) (611)
-------- --------
Net cash used in financing activities ............................... (4,967) (11,089)
Net increase in cash and cash equivalents ........................... 308 194
Cash and cash equivalents, beginning of period .............................. 8,432 709
-------- --------
Cash and cash equivalents, end of period .................................... $ 8,740 $ 903
======== ========
The accompanying notes are an integral part of these Consolidated Financial
Statements.
7
AMERICAN REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS - Continued
For the Three Months
Ended March 31,
-----------------------------
2003 2002
---------- ----------
(dollars in thousands)
Supplemental Disclosures of Cash Flow Information
Cash paid for interest ........................................ $ 9,610 $15,184
Schedule of noncash investing and financing
Notes payable assumed by buyer on sale of real estate ......... $ 3,439 $ 1,389
Notes receivable from sale of real estate ..................... 19,178 --
Disposal of property to satisfy debt .......................... 8,050 --
The accompanying notes are an integral part of these Consolidated Financial
Statements.
8
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The accompanying Consolidated Financial Statements have been prepared in
conformity with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. Dollar amounts in tables are in thousands, except per share amounts.
Certain balances for 2002 have been reclassified to conform to the 2003
presentation.
Operating results for the three month period ended March 31, 2003, are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2003. For further information, refer to the Consolidated Financial
Statements and Notes thereto included in ARI's Annual Report on Form 10-K for
the year ended December 31, 2002 (the "2002 Form 10-K").
On November 15, 2002, ARI commenced a tender offer for the common shares of
Transcontinental Realty Investors, Inc. ("TCI") and Income Opportunity Realty
Investors, Inc. ("IORI") not already owned by ARI. The tender offer was
completed on March 19, 2003. ARI paid $19.00 cash per IORI share and $17.50 cash
per TCI share for the stock of non-affiliated stockholders. Pursuant to the
tender offer, ARI acquired 265,036 IORI shares and 1,213,226 TCI shares. After
the tender offer, ARI owned 64.8% of the outstanding shares of TCI and 62.5% of
the outstanding shares of IORI (46.9% owned directly by ARI and 15.6% through
TCI's ownership of IORI shares). ARI began consolidation of TCI's and IORI's
accounts and operations effective March 31, 2003. The effect of consolidating
TCI's and IORI's operations from the completion of the tender offer through
March 31, 2003 was determined to be immaterial.
The following pro forma information reflects the results of operations for ARI
as though the consolidation of TCI's and IORI's operations had begun on January
1 of each year presented.
Three Months
Ended March 31,
------------------------
2003 2002
-------- --------
Revenue, as reported ....................... $ 38,918 $ 34,748
Revenue, pro forma ......................... 70,702 59,963
Net income (loss), as reported ............. 7,191 (8,937)
Net income (loss), pro forma ............... 6,417 (6,465)
Earnings per share:
Basic, as reported ...................... $ .58 $ (.84)
Basic, pro forma ........................ .51 (.62)
Diluted, as reported .................... $ .49 $ (.84)
Diluted, pro forma ...................... $ .44 $ (.62)
9
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 1. BASIS OF PRESENTATION (Continued)
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), which requires the consolidation of
variable interest entities, as defined. FIN 46 is applicable to financial
statements to be issued by ARI after 2003; however, disclosures are required
currently if ARI expects to consolidate any variable interest entities. ARI does
not currently believe that any entities will be consolidated as a result of FIN
46.
Stock-based employee compensation. Accounting Principles Board Opinion No. 25
"Accounting for Stock Issued to Employees," and related Interpretations are
utilized by management in accounting for the option plans. All share options
issued have exercise prices equal to the market price of the shares at the dates
of grant. Accordingly, no compensation cost has been recognized for the option
plans. Had compensation cost for the option plans been determined based on the
fair value at the grant dates consistent with the method of Statement of
Financial Accounting Standards No. 123 "Accounting for Stock-Based
Compensation," net income (loss) and net income (loss) per share would have been
the pro forma amounts indicated below.
Three Months Ended March 31,
------------------------------
2003 2002
-------- --------
(dollars in thousands,
except per share amounts)
Net income (loss) applicable to common shares, as reported .......................... $ 6,603 $(9,548)
Deduct: Total stock-based employee compensation
expense determined under fair value based
methods for all awards, net of related tax
effects ..................................................................... 19 18
------- -------
Pro forma net income (loss) applicable to common shares ............................. $ 6,584 $(9,566)
======= =======
Earnings (loss) per share:
Basic, as reported ............................................................... $ .58 $ (.84)
Basic, pro forma ................................................................. $ .58 $ (.84)
Diluted, as reported ............................................................. $ .49 $ (.84)
Diluted, pro forma ............................................................... $ .49 $ (.84)
NOTE 2. REAL ESTATE
In 2003, ARI purchased the following properties:
Purchase Net Cash Debt Interest Maturity
Property Location Units Price Paid Incurred Rate Date
-------- -------- ----- -------- -------- -------- -------- --------
First Quarter
Apartments
Capital Hill/(1)/ Little Rock, AR 156 Units $1,904 $ 615 $ 1,289 -- --
Second Quarter
Apartments
Longwood Long Beach, MS 200 Units 6,349 334 6,349 7.600% 04/12
10
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 2. REAL ESTATE (Continued)
(1) Land purchased for apartment construction.
In February 1990, ARI sold the Bridgeview Plaza Shopping Center, located in
LaCrosse, Wisconsin, providing purchase money financing of $5.0 million in the
form of a wrap mortgage. In 1996, the first lienholder called a default under
the ARI wrap note, and directed future payments be made directly to them. ARI
began legal proceedings against the first lienholder. In December 1999, ARI sold
the note to BCM at its carrying value of $489,000, retaining the right to
receive any amounts collected by BCM in excess of the amount paid, plus accrued
interest. In 2002, ARI prevailed in its litigation and ARI's lien on the
property was restored. The borrower continued in default, and ARI foreclosed on
the property in March 2003. The property was subsequently sold to TCI. See NOTE
8. "RELATED PARTY TRANSACTIONS."
In 2002, ARI purchased the following property:
Purchase Net Cash Debt Interest Maturity
Property Location Sq.ft. Price Paid Incurred Rate Date
-------- -------- ------ -------- -------- -------- -------- --------
First Quarter
Shopping Center
Plaza on Bachman
Creek/(1)/ Dallas, TX 80,278 Sq.Ft. $3,103 $-- $-- -- --
- ------------
(1) Exchanged with TCI for the Oaktree Village Shopping Center, Rasor land
parcel and Lakeshore Villas land parcel.
In 2003, ARI sold the following properties:
Net Cash
Units/Sq.Ft./ Sales Received/ Debt Gain/(Loss)
Property Location Acres/Rooms Price (Paid) Discharged on Sale
-------- -------- ----------- -------------- --------- ---------- -----------
First Quarter
Apartments
Bay Anchor Panama City, FL 12 Units $ 369 $ 36 $ 255 $ 143
Georgetown Panama City, FL 44 Units 1,175 323 789/(3)/ 72
Northside Villas Tallahassee, FL 81 Units 5,575 1,806 2,784 915
Rolling Hills Tallahassee, FL 134 Units 5,061 1,361 2,785 1,182
Seville Tallahassee, FL 62 Units 2,795 405 1,955 489
Shopping Centers
Bridgeview Plaza LaCrosse, WI 116,008 Sq.Ft. 8,700 -- -- 8,700/(1)/
Cullman Cullman, AL 92,466 Sq.Ft. 2,000 -- 2,650/(3)/ 1,118/(1)/
Office Building
4135 Beltline Road Addison, TX 90,000 Sq.Ft. 4,358 -- 2,858/(3)/ 178/(2)/
Land
Katrina Palm Desert, CA 89.3 Acres 8,550 (410) 2,840 (40)
Nashville Nashville, TN 8.8 Acres 235 (11) 217 114
Hotels
Grand Hotel Sofia Sofia, Bulgaria 136 Rooms 24,750 6,258 4,209 212/(4)/
11
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 2. REAL ESTATE (Continued)
(1) Sold to TCI to satisfy debt. Gain deferred until sale to unrelated party.
(2) Sold to Tacco Office Investors, Inc., a related party. Gain deferred until
sale to unrelated party.
(3) Debt assumed by purchaser.
(4) Includes recognition of $3.1 million of accumulated foreign currency
translation gains.
In 2002, ARI sold the following properties:
Net Cash
Units/ Sales Received/ Debt Gain/(Loss)
Property Location Acres/Sq.Ft. Price (Paid) Discharged on Sale
-------- -------- ------------ -------------- --------- ---------- -----------
First Quarter
Apartments
Mallard Lake/(1)/ Greensboro, NC 336 Units $ 14,400 $ -- $ 7,362 $ --
Villas Plano, TX 208 Units 8,525 3,701 4,023 5,615
Land
Katrina Palm Desert, CA 2.1 Acres 1,323 (40) 1,237 978
Lakeshore Villas/(2)/ Harris County, TX 16.9 Acres 1,499 215 -- --
Rasor/(2)/ Plano, TX 24.5 Acres 1,211 174 -- --
Thompson II Dallas County, TX .2 Acres 21 20 -- (11)
Vista Ridge Lewisville, TX 10.0 Acres 1,525 130 1,220 401
Shopping Center
Oaktree Village/(2)/ Lubbock, TX 45,623 Sq.Ft. 2,302 131 1,389 /(3)/ --
- -------------------------------
(1) Exchanged for Governor's Square, Grand Lagoon, Park Avenue, Greenbriar,
Regency and Westwood Apartments.
(2) Exchanged with TCI for the Plaza on Bachman Creek Shopping Center.
(3) Debt assumed by purchaser.
NOTE 3. NOTES RECEIVABLE
In February 2003, ARI sold an 89.3 acre tract of its Katrina land parcel for
$8.5 million, paying $410,000 after payment of closing costs and debt paydown
and providing purchase money financing of $5.6 million. The note bears interest
at 8.0% per annum and matures three years after the recording of the Deed of
Trust. Interest begins accruing after improvements to the site have been
completed by ARI. The future costs to ARI to complete the improvements are
estimated to be $2.5 million. A principal payment of $450,000 is due within ten
days after a Tentative Parcel Map is recorded. Interest payments will be due on
the first day of each calendar quarter, beginning with the first quarter
following the completion of the site improvements.
In March 2003, ARI sold the Grand Hotel Sofia for $24.8 million, receiving $6.3
million in cash after paying closing costs and debt assumption and providing
purchase money financing of $13.5 million. The loan is non-interest-bearing for
90 days, then bears interest at 9.0% per annum for the next 90 days and matures
in September 2003. The purchaser has the right to extend the note at 9.0% per
annum for an additional 90 days by providing notice of intent at least 15 days
prior to maturity and paying a 1.5% extension fee on the unpaid principal
balance. After the 90 day interest-free period, monthly interest payments are
required.
In September 2002, ARI sold its Messick land parcel and an 80.0 acre tract of
its Katrina land parcel for $12.8 million, paying $1.5 million after payment of
closing costs and debt paydown and providing purchase money financing of $9.6
million. The loan bore interest at 8.0% per annum, matured in September 2004 and
required quarterly payments of accrued interest. All principal and accrued
interest were due at maturity. In February 2003, ARI accepted $7.4 million as
full payment
12
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 3. NOTES RECEIVABLE (Continued)
for $7.7 million in principal and accrued interest. In March 2003, the remaining
$1.9 million loan balance was sold to an unrelated party for $1.8 million plus
accrued and unpaid interest.
In October 2002, ARI sold its Varner Road land parcel for $3.7 million,
receiving $671,000 after payment of closing costs and providing purchase money
financing of $2.8 million. The loan bears interest at 9.0% per annum, matures in
October 2004 and requires quarterly interest payments. All principal and accrued
but unpaid interest are due at maturity.
In December 2002, ARI sold its Willow Springs land parcel for $9.8 million,
paying $1.3 million after payment of closing costs and debt paydown and
providing purchase money financing of $7.8 million. The loan bore interest at
8.0% per annum, matured in December 2005 and required periodic interest payments
beginning in June 2003. In March 2003, the loan was sold to an unrelated party
for $7.5 million plus accrued and unpaid interest. The buyer of the loan has
limited recourse against a 53 acre parcel of ARI's Katrina land, in event of
default by the borrower. ARI recognized a previously deferred gain of $4.9
million upon completion of the sale of the note.
In December 2002, ARI sold a 238.0 acre tract of its Desert Wells land parcel
for $23.8 million, receiving $321,000 after payment of closing costs and debt
paydown and providing purchase money financing of $21.4 million. The first lien
financing of $17.8 million bore interest at 8.0% per annum, matured in December
2004 and required payments beginning in March 2003. In March 2003, the loan was
sold to an unrelated party for $17.1 million plus accrued and unpaid interest.
The buyer of the loan has limited recourse against a 53 acre parcel of ARI's
Katrina land, in event of default by the borrower. ARI recognized a previously
deferred gain of $15.0 million upon completion of the sale of the note. The
second lien financing of $3.6 million bore interest at 8.0% per annum and
matured on March 31, 2003. All principal and interest were due at maturity. At
May 2003, negotiations are underway to modify and extend the terms of the loan.
In December 2002, ARI sold a 171.1 acre tract of its Desert Wells land parcel
for $11.9 million receiving $1.4 million after payment of closing costs and debt
paydown and providing purchase money financing of $8.9 million. The loan bore no
interest and matured in March 2003. The principal was due at maturity. In
December 2002, interest in $7.7 million of the loan was sold to an unrelated
party for $7.7 million. ARI retained a junior interest in $1.2 million of the
loan. In March 2003, the note was collected in full.
In September 1999, in conjunction with the sale of two apartments in Austin,
Texas, $2.1 million in purchase money financing was provided, secured by limited
partnership interests in two limited partnerships owned by the buyer. The
financing bore interest at 16.0% per annum, required monthly payments of
interest only at 6.0% per annum, beginning
13
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 3. NOTES RECEIVABLE (Continued)
in February 2000 and required a $200,000 principal paydown in December 1999,
which was not received, and matured in August 2000. ARI had the option of
obtaining the buyer's general and limited partnership interests in the
collateral partnerships in full satisfaction of the financing. In March 2000,
ARI agreed to forbear foreclosing on the collateral securing the note and
released one of the partnership interests, in exchange for a payment of $250,000
and executed deeds of trusts on certain properties owned by the buyer. In March
2000, the borrower made a $1.1 million payment, upon receipt of which ARI
returned the deeds of trust. The borrower executed a replacement promissory note
for the remaining note balance of $1.0 million, which was unsecured,
non-interest bearing and matured in April 2003. At May 2003, negotiations are
underway to modify the terms of the loan.
Related Party. In June 2002, ARI converted $4.5 million of its receivable from
BCM, a related party, to a recourse note receivable. This transaction was to
provide ARI with additional security over that provided by an unsecured
receivable. The note bears interest at 10.0% per annum, matures in March 2004
and requires quarterly payments of principal and accrued interest, beginning in
December 2002.
In December 2002, ARI sold the Lakeshore Villas Apartments to Housing for
Seniors of Humble, LLC ("Humble"), a related party, for $22.0 million, paying
$764,000 after payment of closing costs and debt paydown and providing purchase
money financing of $8.4 million. One loan has a principal amount of $2.0
million. The loan is unsecured, and is guaranteed by Unified Housing Foundation,
Inc. ("Unified"), a related party. The second loan has a principal amount of
$6.4 million, and is secured by a pledge by Unified of 100% of the Member
Interest in Humble. Both loans bear interest at 11.5% per annum, mature in
December 2009 and require quarterly payments beginning in March 2003. Richard W.
Humphrey, a director of ARI, is the President of Humble and the President and
Treasurer of Unified. Ted P. Stokely, Chairman of the Board and a director of
ARI, is the General Manager of Unified.
In March 2001, ARI funded $13.6 million of a $15.0 million unsecured line of
credit to One Realco Corporation ("One Realco"), which owns approximately 2.1%
of the outstanding shares of ARI's Common Stock. One Realco periodically borrows
money to meet its cash obligations. The line of credit bears interest at 12.0%
per annum. All principal and interest were due at maturity in February 2002. The
line of credit is guaranteed by BCM. In June 2001, $394,000 in principal and
$416,000 in interest was collected. In December 2001, $21,000 in principal and
$804,000 in interest was collected. In February 2002, the line of credit was
increased to $18.0 million, accrued but unpaid interest of $217,000 was added to
the principal and the maturity date was extended to February 2004. In March
2002, ARI funded an additional $1.8 million, increasing the outstanding
principal balance to $15.5 million. In October 2002, $856,900 in interest was
collected, by the return of 85,690 shares of ARI Series A Preferred Stock. All
principal and
14
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 3. NOTES RECEIVABLE (Continued)
interest are due at maturity. Ronald E. Kimbrough, Acting Principal Executive
Officer, Executive Vice President and Chief Financial Officer of ARI, is a 10%
shareholder of One Realco. Mr. Kimbrough does not participate in the day-to-day
operations or management of One Realco.
In December 2000, an unsecured loan with a current principal balance of $1.9
million to Warwick of Summit, Inc. ("Warwick") matured. The loan was made to
provide funds to purchase, renovate and expand a shopping center property in
Warwick, Rhode Island. All principal and interest were due at maturity. In
February 2002, $275,000 of interest was received. In April 2003, $75,000 of
interest was received. At May 2003, the loan, and $231,000 of accrued
interest, remained unpaid. Richard D. Morgan, a Warwick shareholder, served as a
director of ARI until October 2001.
In December 2000, a loan with a current principal balance of $1.6 million to
Bordeaux Investments Two, L.L.C. ("Bordeaux"), matured. The loan, to provide
funds to purchase and renovate a shopping center property in Oklahoma City,
Oklahoma, is secured by (1) a 100% interest in Bordeaux, which owns a shopping
center in Oklahoma City, Oklahoma; (2) 100% of the stock of Bordeaux Investments
One, Inc., which owns 6.5 acres of undeveloped land in Oklahoma City, Oklahoma;
and (3) the personal guarantees of the Bordeaux members. At May 2003, the
loan, and $746,000 of accrued interest, remained unpaid. Richard D. Morgan, a
Bordeaux member, served as a director of ARI until October 2001.
In March 2000, a loan with a current principal balance of $2.6 million to
Lordstown, L.P., matured. The loan, to provide funds to purchase for resale
various parcels of land, is secured by a second lien on land in Ohio and
Florida, by 100% of the general and limited partner interest in Partners
Capital, Ltd., the limited partner of Lordstown, L.P., and a profits interest in
subsequent land sales. At May 2003, the loan, and $1.1 million of accrued
interest, remained unpaid. A corporation controlled by Richard D. Morgan is the
general partner of Lordstown, L.P. Mr. Morgan served as a director of ARI until
October 2001.
In October 1999, ARI funded a $4.7 million loan to Realty Advisors, Inc., an
affiliate. The loan, to provide funds for acquisitions or working capital needs,
was secured by all of the outstanding shares of common stock of American Reserve
Life Insurance Company. The loan bore interest at 10.25% per annum, and matured
in November 2001. In January 2000, $100,000 was collected. In November 2001, the
maturity date was extended to November 2004. The collateral was changed to a
subordinate pledge of 850,000 shares of ARI Common Stock owned by BCM. The
shares are also pledged to a lender on ARI's behalf. The interest rate was
changed to 2% over the prime rate, currently 6.25% per annum, and the accrued
but unpaid interest of $984,000 was added to the principal. The new principal
balance is $5.6 million. All principal and accrued interest are due at maturity.
15
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 4. INVESTMENTS IN EQUITY INVESTEES
Real estate entities. Before 2003 ARI's investment in real estate entities
included equity securities of IORI and TCI, and interests in real estate joint
venture partnerships. BCM, ARI's advisor, serves as advisor to IORI and TCI.
Through March 31, 2003, ARI accounted for its investment in IORI and TCI and the
joint venture partnerships using the equity method. ARI began consolidation of
TCI's and IORI's accounts and operations effective March 31, 2003. See NOTE 1.
"BASIS OF PRESENTATION." The effect of consolidating TCI's and IORI's operations
from the completion of the tender offer through March 31, 2003 was determined to
be immaterial.
Set forth below are summarized results of operations of equity investees for the
three months ended March 31, 2003:
Revenues ................................................... $ 31,321
Property operating expenses ................................ 23,746
Depreciation ............................................... 5,460
Interest ................................................... 11,528
--------
Loss from continuing operations ............................ (9,413)
Loss from discontinued operations .......................... (459)
Equity in investees' gain from sale of real estate.......... 1,509
--------
Net loss ................................................... $ (8,363)
========
ARI's share of equity investees' loss before gains on the sale of discontinued
operations was $4.3 million for the three months ended March 31, 2003. ARI had
no share of equity investees' gains on sale of real estate for the three months
ended March 31, 2003.
ARI's cash flow from IORI and TCI is dependent on the ability of each entity to
make distributions. In the fourth quarter of 2000, IORI and TCI suspended
distributions.
ART Florida Portfolio II, Ltd. In January 2002, Investors Choice Florida Public
Funds II, in which ART Florida Portfolio II, Ltd., a subsidiary of ARI, owned an
interest, sold Villas Continental Apartments. ARI initially received $1.0
million in cash from the sale. In the three months ended March 31, 2002, ARI
recognized a $531,000 loss on the sale, which is included in loss on sale of
investments in equity investees in the Consolidated Statement of Operations.
Subsequently, ARI received an additional $245,000 in sales proceeds, reducing
the total loss to $286,000.
NOTE 5. MARKETABLE EQUITY SECURITIES - TRADING PORTFOLIO
Since 1994, ARI has been purchasing equity securities of entities other than
those of IORI and TCI to diversify and increase the liquidity of its margin
accounts. These equity securities are considered a trading
16
portfolio and are carried at market value. In the first quarter of
17
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 5. MARKETABLE EQUITY SECURITIES - TRADING PORTFOLIO (Continued)
2003, ARI purchased $1.6 million and sold $137,000 of equity securities. At
March 31, 2003, ARI recognized an unrealized decrease in the market value of its
trading portfolio securities of $3,000. Unrealized and realized gains and losses
on trading portfolio securities are included in other income in the accompanying
Consolidated Statements of Operations.
NOTE 6. NOTES PAYABLE
In February 2003, the lender on one of ARI's hotel properties located in
Virginia notified ARI that the loan on the property was in default, due to ARI's
failure to make timely debt service payments. The balance owed on the loan is
$11.6 million. In April 2003, the lender and ARI agreed to terms to cure the
default and extend the maturity date of the loan. In May 2003, ARI failed to
satisfy the conditions in the lender's Loan Modification Offer (the "Offer"),
and the Offer was revoked. The lender has notified ARI that they intend to
pursue all remedies available.
In May 2003, the lender on one of ARI's commercial properties located in Texas
notified ARI that the loan on the property was in default, due to ARI's failure
to make timely debt service payments. The balance owed on the loan is $6.5
million.
In 2003, ARI financed/refinanced or obtained second mortgage financing on the
following:
Net Cash
Debt Debt Received/ Interest Maturity
Property Location Acres/Sq. Ft. Incurred Discharged (Paid) Rate Date
- ------------------ ------------------ ---------------- ---------- ----------- ----------- ---------- --------
First Quarter
Land
Elm Fork Denton County, TX 101.0 Acres $5,000 $ 1,551 $ 2,885 10.750% 03/04
Nashville Nashville, TN 113.8 Acres 6,059 807 4,725 14.000 03/04
Vineyards II Tarrant County, TX 18.6 Acres 3,280 3,750 (583) 6.750/(1)/ 02/06
Second Quarter
Shopping Centers
Bridgeview LaCrosse, WI 116,008 Sq.Ft. 6,500 -- 6,152 6.250/(1)/ 04/05
Cullman Cullman, AL 92,433 Sq.Ft. 1,700 2,650 (1,048) 6.250/(1)/ 04/05
Land
Nashville Nashville, TN 113.8 Acres 941 -- 737 14.000 03/04
- -------------------
(1) Variable interest rate.
In 2002, ARI financed/refinanced or obtained second mortgage financing on the
following:
Debt Debt Net Cash Interest Maturity
Property Location Acres/Sq.Ft. Incurred Discharged Received/(Paid) Rate Date
- ------------------ ------------------ ---------------- ---------- ----------- --------------- ---------- --------
First Quarter
Land
Walker Dallas County, TX 90.6 Acres $ 8,500 $ 8,500 $ (1,411) 11.250%/(1)/ 01/03
18
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 6. NOTES PAYABLE (Continued)
Debt Debt Net Cash Interest Maturity
Property Location Acres/Sq.Ft. Incurred Discharged Received/(Paid) Rate Date
- -------------------------- ------------------ ------------- -------- ---------- --------------- -------- --------
First Quarter - Continued
Shopping Center
Plaza on Bachman
Creek Dallas, TX 80,278 Sq.Ft. $ 5,000 $ -- $ 4,444 6.625%/(1)/ 04/04
Related Party Transactions. In each of the following transactions, a related
party has purchased an entity, which owns the listed property asset, from ARI.
ARI has guaranteed that the asset will produce at least a 12% return on the
purchase price for a period of three years from the purchase date. If the asset
fails to produce the 12% return, ARI will pay the purchaser any shortfall. In
addition, if the asset fails to produce the 12% return for a calendar year, the
purchaser may require ARI to repurchase the entity for the purchase price.
Management has classified these related party transactions as notes payable.
Debt Debt Net Cash Interest Maturity
Property Location Sq.Ft. Incurred Discharged Received Rate Date
- -------------------------- ------------------ ------------- -------- ---------- -------- -------- --------
First Quarter
Office Building
Rosedale Towers Minneapolis, MN 84,798 Sq.Ft. $ 5,109 $ -- $ 5,109 12.000% 01/05/(2)/
Two Hickory Centre Farmers Branch, TX 96,127 Sq.Ft. 4,448 -- 4,448 12.000 01/05/(3)/
- -------------------
(1) Variable interest rate.
(2) IORI purchased 100% of the outstanding common shares of Rosedale
Corporation ("Rosedale"), a wholly-owned subsidiary of ARI, for $5.1
million. The purchase price was determined based upon the market value of
the property, using a market rate multiple of net operating income.
Rosedale owned the Rosedale Towers Office Building. The business purpose of
this transaction was for IORI to make an equity investment in Rosedale,
anticipating a profitable return, and for ARI to receive cash for its
equity investment. After the property was sold to an unrelated buyer in
December 2002, ARI owed $2.1 million to IORI for remaining principal and
12% return. In April 2003, ARI repaid $2.0 million in principal and accrued
interest. Beginning March 31, 2003, IORI is consolidated with ARI.
(3) TCI purchased 100% of the common shares of ART Two Hickory Corporation
("Two Hickory"), a wholly-owned subsidiary of ARI, for $4.4 million. The
purchase price was determined based upon the market value of the property,
using a market rate multiple of net operating income. Two Hickory owns the
Two Hickory Centre Office Building. The business purpose of this
transaction was for TCI to make an equity investment in Two Hickory,
anticipating a profitable return, and for ARI to receive cash for its
equity investment.
19
Beginning March 31, 2003, TCI is consolidated with ARI.
20
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 7. MARGIN BORROWINGS
ARI has margin arrangements with various financial institutions and brokerage
firms which provide for borrowing of up to 50% of the market value of marketable
equity securities. The borrowings under such margin arrangements are secured by
equity securities of IORI and TCI and ARI's trading portfolio securities and
bear interest rates ranging from 5.25% to 24.0%. Margin borrowing totaled $8.3
million at March 31, 2003.
In September 2001, ARI obtained a security loan in the amount of $20.0 million
from a financial institution. ARI received net cash of $16.1 million after the
payment of various closing costs and $3.4 million repayment of principal and
accrued interest on an existing loan with the same lender. Of the total loan
amount, $19.5 million bears interest at 24% per annum, while the remaining
$500,000 bears interest at 20% per annum. The loan required monthly payments of
interest only and matured in September 2002. In September 2002, $15.0 million in
principal was repaid. The loan is secured by 2,751,798 shares of TCI common
stock held by ARI and 920,507 shares of TCI common stock held by BCM, ARI's
advisor. The lender has informed ARI that the loan is in default.
In October 2001, ARI obtained a security loan in the amount of $1.0 million from
a financial institution. The loan bears interest at 1% over the prime rate,
currently 5.25% per annum, requires monthly payments of interest only and
matures in October 2003. The loan is callable upon 60 days prior notice, and is
secured by 200,000 shares of ARI Common Stock held by BCM, ARI's advisor.
NOTE 8. RELATED PARTY TRANSACTIONS
In March 2003, ARI sold the Bridgeview Plaza and Cullman shopping centers to TCI
for $10.7 million to satisfy debt. TCI assumed debt of $2.7 million on Cullman.
TCI received $5.1 million cash on the subsequent financing of the shopping
centers.
In April 2003, ARI paid $2.0 million in principal and accrued interest to IORI,
in partial payment of a note payable on the Rosedale Tower Office Building. See
NOTE 6. "NOTES PAYABLE."
The following table reconciles the beginning and ending balances of accounts
payable to affiliates as of March 31, 2003.
BCM
--------
Balance, December 31, 2002 ...................................... $(13,529)
Cash transfers to affiliates ................................. 47,158
Cash transfers from affiliates ............................... (45,953)
Fees and reimbursements payable to Advisor ................... (723)
Other additions .............................................. 12,083
Other repayments ............................................. (11,991)
--------
Balance, March 31, 2003 ......................................... $(12,955)
========
21
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 8. RELATED PARTY TRANSACTIONS (Continued)
Also at March 31, 2003, ARI owed $1.5 million to affiliates related to cash
received upon the sale of apartments to Metra.
NOTE 9. OPERATING SEGMENTS
Significant differences among the accounting policies of the operating segments
as compared to the Consolidated Financial Statements principally involve the
calculation and allocation of administrative expenses. Management evaluates the
performance of each of the operating segments and allocates resources to them
based on their net operating income and cash flow. Items of income that are not
reflected in the segments are equity in loss of investees, equity in gain on
sale of real estate by equity investees, loss on sale of investments in equity
investees and other income which totaled $(4.3) million for the three months
ended March 31, 2003 and $(228,000) for 2002. Expenses that are not reflected in
the segments are discount on sale of notes receivable, general and
administrative expenses, minority interest, incentive fees, advisory fees, net
income fees and discontinued operations which totaled $7.0 million for the three
months ended March 31, 2003 and $6.7 million for 2002. Excluded from operating
segment assets are assets of $134.0 million in 2003 and $116.3 million in 2002,
which are not identifiable with an operating segment. There are no intersegment
revenues and expenses, and ARI conducted all of its business within the United
States, with the exception of Hotel Sofia (Bulgaria), which began operations in
2001 and was sold in March 2003 and Realty Advisors Korea, Ltd. (South Korea),
which ARI acquired in 2002.
Presented below are ARI's reportable segments operating income for the three
months ended March 31, and segment assets at March 31.
Commercial Pizza Receivables/
2003 Properties Apartments Hotels Land Parlors Other Total
---- ---------- ---------- ------ ---- ------- ------------ ---------
Operating revenue ......... $ 8,072 $ 8,022 $ 6,126 $ 13 $ 7,867 $ 33 $ 30,133
Interest income ........... -- -- -- -- -- 2,230 2,230
Operating expenses ........ 4,528 5,023 5,485 1,570 6,407 6 23,019
---------- ---------- ------- -------- ------- ---------- ----------
Operating income
(loss) ................. $ 3,544 $ 2,999 $ 641 $ (1,557) $ 1,460 $ 2,257 $ 9,344
========== ========== ======= ======== ======= ---======= ==========
Depreciation .............. $ 942 $ 559 $ 551 $ -- $ 446 $ 3 $ 2,501
Interest .................. 2,414 2,856 1,107 4,138 206 545 11,266
Capital expenditures ...... 700 (70) 335 343 767 -- 2,075
Assets .................... 441,679 396,262 92,978 238,830 22,033 76,578 1,268,360
Property Sales: Apartments Hotels Land Total
---------- ------- -------- ----------
Sales price ............... $ 14,975 $24,750 $ 8,785 $ 48,510
Cost of sale .............. 12,174 24,538 8,711 45,423
Recognized prior
deferred gain .......... -- -- 19,897 19,897
---------- ------- -------- ----------
Gain on sale .............. $ 2,801 $ 212 $ 19,971 $ 22,984
========== ======= ======== ==========
22
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 9. OPERATING SEGMENTS (Continued)
Commercial Pizza Receivables/
2002 Properties Apartments Hotels Land Parlors Other Total
---- ---------- ---------- ------ ---- ------- ---------- ------------
Operating revenue ......... $ 8,185 $ 6,904 $ 6,406 $ 62 $ 7,368 $ 243 $ 29,168
Interest income ........... -- -- -- -- -- 612 612
Operating expenses ........ 4,283 4,202 5,272 2,374 5,781 84 21,996
---------- ---------- -------- -------- ------- ---------- -----------
Operating income
(loss) ................. $ 3,902 $ 2,702 $ 1,134 $ (2,312) $ 1,587 $ 771 $ 7,784
========== ========== ======= ======== ======= ========== ==========
Depreciation .............. $ 964 $ 551 $ 523 $ -- $ 257 $ 2 $ 2,297
Interest .................. 2,748 2,072 1,011 6,168 203 3,125 15,327
Capital expenditures ...... 1,289 212 161 393 391 -- 2,446
Assets .................... 172,354 95,231 89,995 212,626 20,794 28,507 619,507
Commercial
Property Sales: Properties Apartments Land Total
---------- ---------- ---- -----
Sales price ............... $ 2,302 $ 11,957 $ 5,580 $ 19,839
Cost of sale .............. 2,302 6,342 4,211 12,855
deferred gain .......... -- -- 830 830
---------- ---------- -------- -----------
Gain on sale .............. $ -- $ 5,615 $ 2,199 $ 7,814
========== ========== ======== ===========
NOTE 10. DISCONTINUED OPERATIONS
Effective January 1, 2002, ARI adopted Financial Accounting Standards Board
Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," which established a single accounting model for the impairment or
disposal of long-lived assets, including discontinued operations. This statement
requires that the operations related to properties that have been sold or
properties that are intended to be sold be presented as discontinued operations
in the statement of operations for all periods presented, and properties
intended to be sold are to be designated as "held-for-sale" on the balance
sheet.
For the three months ended March 31, 2003 and 2002, income from discontinued
operations relates to 23 properties and leasehold interest in oil and gas
properties that ARI sold during 2002 and eight properties that ARI sold during
2003. The following table summarizes revenue and expense information for these
properties sold and held-for-sale.
For the Three Months
Ended March 31,
---------------------
Revenue 2003 2002
------- -------
Rental .......................................................................... $ 2,839 $ 7,552
Property operations ............................................................. 1,441 3,677
------- -------
1,398 3,875
Expenses
Interest ........................................................................ 215 3,465
Depreciation .................................................................... 65 1,258
------- -------
280 4,723
------- -------
Net income (loss) from discontinued operations ..................................... 1,118 (848)
Gain of sale of real estate ..................................................... 3,013 5,615
Equity in gain on sale of real estate by equity investees ....................... -- 4,131
------- -------
................................................................................... $ 4,131 $ 8,898
======= =======
23
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 10. DISCONTINUED OPERATIONS (Continued)
Discontinued operations have not been segregated in the consolidated statements
of cash flows. Therefore, amounts for certain captions will not agree with
respective consolidated statements of operations.
NOTE 11. COMMITMENTS AND CONTINGENCIES
Liquidity. Management expects that excess cash generated from operations during
the remainder of 2003 will not be sufficient to discharge all of ARI's debt
obligations as they mature. Therefore, ARI will rely on aggressive land sales,
selected income producing property sales and, to the extent necessary,
additional borrowings to meet its cash requirements.
Commitments. During 2002, Milano Restaurants International, Inc. ("MRI"), a
wholly-owned subsidiary of ARI, sold two restaurants to a corporation owned in
part by an officer of MRI. In conjunction with the sale of these restaurants,
MRI guaranteed the bank debt incurred by the related party. The guaranty applies
to all current debt, and to all future debt of the related party until such time
as the guaranty is terminated by MRI. The amount of the debt outstanding that is
subject to the guaranty is $1,250,000 at March 31, 2003.
Litigation. In August 2002, ARI obtained a favorable jury verdict in the legal
action entitled American Realty Trust v. Matisse Partners, L.L.C. ("Matisse").
However, the judge set aside the jury verdict and imposed a judgment against ARI
in excess of $6.0 million, including interest. The judgment is being appealed,
and, in the opinion of ARI's management and legal counsel, there is a reasonable
probability that the adverse judgment will be set aside and the jury verdict
reinstated. Therefore, ARI has not recognized any expense nor established any
reserve for this judgment. In November 2002, ARI posted a $6.0 million
supercedeas bond. In April 2003, an additional judgment was issued against ARI
for $1.2 million in legal fees. ARI will also appeal this judgment and will post
an additional bond in this amount. ARI has not recognized any expense nor
established any reserve for this additional judgment.
In addition to Matisse, ARI is involved in various lawsuits arising in the
ordinary course of business. In the opinion of management the outcome of these
lawsuits will not have a material impact on ARI's financial condition, results
of operations or liquidity.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Introduction
ARI's predecessor was organized in 1961 to provide investors with a
professionally managed, diversified portfolio of equity real estate and mortgage
loan investments selected to provide opportunities for capital
24
appreciation as well as current income.
25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Introduction (Continued)
On October 23, 2001, ARI, TCI, and IORI jointly announced a preliminary
agreement with the plaintiff's legal counsel of the derivative action entitled
Olive et al. V. National Income Realty Trust, et al. for complete settlement of
all disputes in the lawsuit (the "Olive Litigation"). In February 2002, the
court granted final approval of the proposed settlement (the "Olive
Settlement"). Under the Olive Settlement, ARI agreed to either (i) acquire all
of the outstanding shares of IORI and TCI not currently owned by ARI for a cash
payment or shares of ARI preferred stock or (ii) make a tender offer for all of
the outstanding shares of IORI and TCI not currently owned by ARI. On November
15, 2002, ARI commenced the tender offer for the IORI and TCI shares. The tender
offer was completed on March 19, 2003. ARI paid $19.00 cash per IORI share and
$17.50 cash per TCI share for the stock held by non-affiliated stockholders.
Pursuant to the tender offer, ARI acquired 265,036 IORI shares and 1,213,226 TCI
shares. The completion of the tender offer fulfills the obligations under the
Olive Settlement, and the Olive Litigation has been dismissed with prejudice.
After the tender offer, ARI owned 64.8% of the outstanding shares of TCI and
62.5% of the outstanding shares of IORI (46.9% owned directly by ARI and 15.6%
through TCI's ownership of IORI shares). ARI began consolidation of TCI's and
IORI's accounts and operations effective March 31, 2003. The effect of
consolidating TCI's and IORI's operations from the completion of the tender
offer through March 31, 2003 was determined to be immaterial. ARI has the same
advisor as TCI and IORI, and TCI and IORI have the same board of directors. Two
of the directors of TCI and IORI also serve as directors of ARI.
Critical Accounting Policies
Critical accounting policies are those that are both important to the
presentation of ARI's financial condition and results of operations and require
management's most difficult, complex or subjective judgements. ARI's critical
accounting policies relate to the evaluation of impairment of long-lived assets
and the evaluation of the collectibility of accounts and notes receivable.
If events or changes in circumstances indicate that the carrying value of a
rental property to be held and used or land held for development may be
impaired, management performs a recoverability analysis based on estimated
undiscounted cash flows to be generated from the property in the future. If the
analysis indicates that the carrying value is not recoverable from future cash
flows, the property is written down to estimated fair value and an impairment
loss is recognized. If management decides to sell rental properties or land held
for development, management evaluates the recoverability of the carrying amounts
of the assets. If the evaluation indicates that the carrying value is not
recoverable from estimated net sales proceeds, the property is written down to
estimated fair value less costs to sell and an impairment loss is recognized
within income from continuing operations.
26
ARI's estimates of cash flow and fair values of the properties are based
27
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Critical Accounting Policies (Continued)
on current market conditions and consider matters such as rental rates and
occupancies for comparable properties, recent sales data for comparable
properties and, where applicable, contracts or the results of negotiations with
purchasers or prospective purchasers. ARI's estimates are subject to revision as
market conditions and ARI's assessments of them change.
ARI's allowance for doubtful accounts receivable and notes receivable is
established based on analysis of the risk of loss on specific accounts. The
analysis places particular emphasis on past due accounts. Management considers
such information as the nature and age of the receivable, the payment history of
the tenant or other debtor, the financial condition of the tenant or other
debtor and ARI's assessment of its ability to meet its lease or interest
obligations. ARI's estimate of the required allowance, which is reviewed on a
quarterly basis, is subject to revision as these factors change and is sensitive
to the effects of economic and market conditions.
Liquidity and Capital Resources
ARI reported net income of $7.2 million for the three months ended March 31,
2003, which included the following non-cash charges and credits: depreciation
and amortization from real estate held for investment of $2.6 million, gain on
sale of real estate of $23.0 million and equity in loss of equity investees of
$4.3 million. Net cash used in operating activities amounted to $8.3 million
for the three months ended March 31, 2003, interest receivable increased by $1.1
million due to additional notes receivable from seller financings, other assets
decreased by $1.4 million primarily due to purchases of equity securities,
interest payable increased by $766,000 due to an increased balance of notes
payable and other liabilities decreased by $469,000 primarily due to a decrease
in real estate taxes payable.
Net cash provided by investing activities of $13.6 million was primarily due to
short-term advances of $24.7 million, real estate improvements of $1.3 million,
investments in real estate entities of $22.4 million, escrow and earnest money
deposits of $34,000 and purchases of pizza parlor equipment of $767,000. As of
May 12, 2003, $56,000 of the short-term advances was outstanding. These outflows
for investing activities were offset by the collection of $9.3 million on notes
receivable, $27.2 million from the sale of real estate and $26.3 million from
the sale of notes receivable.
Net cash used in financing activities of $5.0 million was comprised of
proceeds received from the funding or refinancing of notes payable of $42.5
million; offset by cash payments of $37.9 million to paydown existing notes
payable, $1.6 million for financing costs, $7.4 million in reimbursements to the
advisor and $581,000 in dividends on Preferred Stock.
28
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
In 2003, ARI purchased the following properties:
Purchase Net Cash Debt Interest Maturity
Property Location Units Price Paid Incurred Rate Date
- -------------- ----------------- ------------ ------------ ------------ -------------- ------------ ------------
First Quarter
Apartments
Capital Hill/(1)/ Little Rock, AR 156 Units $ 1,904 $ 615 $ 1,289 -- --
Second Quarter
Apartments
Longwood Long Beach, MS 200 Units 6,349 334 6,349 7.600% 04/12
- --------------
(1) Land purchased for apartment construction.
In February 1990, ARI sold the Bridgeview Plaza Shopping Center, located in
LaCrosse, Wisconsin, providing purchase money financing of $5.0 million in the
form of a wrap mortgage. In 1996, the first lienholder called a default under
the ARI wrap note, and directed future payments be made directly to them. ARI
began legal proceedings against the first lienholder. In December 1999, ARI sold
the note to BCM at its carrying value of $489,000, retaining the right to
receive any amounts collected by BCM in excess of the amount paid, plus accrued
interest. In 2002, ARI prevailed in its litigation and ARI's lien on the
property was restored. The borrower continued in default, and ARI foreclosed on
the property in March 2003. The property was subsequently sold to TCI. See NOTE
8. "RELATED PARTY TRANSACTIONS."
In 2002, ARI purchased the following property:
Purchase Net Cash Debt Interest Maturity
Property Location Sq.Ft./Acres Price Paid Incurred Rate Date
- -------------- ----------------- ------------ ------------ ------------ -------------- ------------ ------------
First Quarter
Shopping Center
Plaza on Bachman
Creek/(1)/ Dallas, TX 80,278 Sq.Ft. $ 3,103 $ -- $ -- -- --
- --------------
(1) Exchanged with TCI for the Oaktree Village Shopping Center, Rasor land
parcel and Lakeshore Villas land parcel.
In 2003, ARI sold the following properties:
Net Cash
Units/ Sales Received/ Debt Gain/(Loss)
Property Location Acres/Rooms Price (Paid) Discharged on Sale
- -------------- ----------------- ------------ ------------ --------------- ------------------ ----------------
First Quarter
Apartments
Bay Anchor Panama City, FL 12 Units $ 369 $ 36 $ 255 $ 143
Georgetown Panama City, FL 44 Units 1,175 323 789/(3)/ 72
Northside Villas Tallahassee, FL 81 Units 5,575 1,806 2,784 915
Rolling Hills Tallahassee, FL 134 Units 5,061 1,361 2,785 1,182
Seville Tallahassee, FL 62 Units 2,795 405 1,955 489
29
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
Net Cash
Units/ Sales Received/ Debt Gain/(Loss>
Property Location Acres/Rooms Price (Paid) Discharged on Sale
- -------------- ----------------- ------------ ------------ --------------- ------------------ ----------------
First Quarter - Continued
Shopping Centers
Bridgeview Plaza LaCrosse, WI 116,008 Sq.Ft. $ 8,700 $ -- $ -- $ 8,700 /(1)/
Cullman Cullman, AL 92,466 Sq.Ft. 2,000 -- 2,650 /(3)/ 1,118 /(1)/
Office Building
4135 Beltline Road Addison, TX 90,000 Sq.Ft. 4,358 -- 2,858/(3)/ 178 /(2)/
Land
Katrina Palm Desert, CA 89.3 Acres 8,550 (410) 2,840 (40)
Nashville Nashville, TN 8.8 Acres 235 (11) 217 114
Hotels
Grand Hotel Sofia Sofia, Bulgaria 136 Rooms 24,750 6,258 4,209 212/(4)/
- --------------
(1) Sold to TCI to satisfy debt. Gain deferred until sale to unrelated party.
(2) Sold to Tacco Office Investors, Inc., a related party. Gain deferred until
sale to unrelated party.
(3) Debt assumed by purchaser.
(4) Includes recognition of $3.1 million of accumulated foreign currency
translation gains.
In 2002, ARI sold the following properties:
Net Cash
Units/ Sales Received/ Debt Gain/(Loss>
Property Location Acres/Sq.Ft. Price (Paid) Discharged on Sale
- -------------- ----------------- ------------ ----------- --------------- ------------------ ----------------
First Quarter
Apartments
Mallard Lake/(1)/ Greensboro, NC 336 Units $ 14,400 $ -- $ 7,362 $ --
Villas Plano, TX 208 Units 8,525 3,701 4,023 5,615
Land
Katrina Palm Desert, CA 2.1 Acres $ 1,323 $ (40) $ 1,237 $ 978
Lakeshore Villas/(2)/ Harris County, TX 16.9 Acres 1,499 215 -- --
Rasor/(2)/ Plano, TX 24.5 Acres 1,211 174 -- --
Thompson II Dallas County, TX .2 Acres 21 20 -- (11)
Vista Ridge Lewisville, TX 10.0 Acres 1,525 130 1,220 401
Shopping Center
Oaktree Village/(2)/ Lubbock, TX 45,623 Sq.Ft. 2,302 131 1,389 /(3)/ --
- --------------
(1) Exchanged for Governor's Square, Grand Lagoon, Park Avenue, Greenbriar,
Regency and Westwood Apartments.
(2) Exchanged with TCI for the Plaza on Bachman Creek Shopping Center.
(3) Debt assumed by purchaser.
In February 2003, the lender on one of ARI's hotel properties located in
Virginia notified ARI that the loan on the property was in default, due to ARI's
failure to make timely debt service payments. The balance owed on the loan is
$11.6 million. In April 2003, the lender and ARI agreed
30
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
to terms to cure the default and extend the maturity date of the loan. In May
2003, ARI failed to satisfy the conditions in the lender's Loan Modification
Offer (the "Offer"), and the Offer was revoked. The lender has notified ARI that
they intend to pursue all remedies available.
In May 2003, the lender on one of ARI's commercial properties located in Texas
notified ARI that the loan on the property was in default, due to ARI's failure
to make timely debt service payments. The balance owed on the loan is $6.5
million.
In 2003, ARI financed/refinanced or obtained second mortgage financing on the
following:
Net Cash
Debt Debt Received/ Interest Maturity
Property Location Acres/Sq.Ft. Incurred Discharged (Paid) Rate Date
- -------------- ----------------- ------------ ------------ ------------ -------------- ------------ ------------
First Quarter
Land
Elm Fork Denton County, TX 101.0 Acres $ 5,000 $ 1,551 $ 2,885 10.750% 03/04
Nashville Nashville, TN 113.8 Acres 6,059 807 4,725 14.000 03/04
Vineyards II Tarrant County, TX 18.6 Acres 3,280 3,750 (583) 6.750 /(1)/ 02/06
Second Quarter
Shopping Centers
Bridgeview LaCrosse, WI 116,008 Sq.Ft. 6,500 -- 6,152 6.250 /(1)/ 04/05
Cullman Cullman, AL 92,433 Sq.Ft. 1,700 2,650 (1,048) 6.250 /(1)/ 04/05
Land
Nashville Nashville, TN 113.8 Acres $ 941 $ -- $ 737 14.000% 03/04
- --------------
(1) Variable interest rate.
In 2002, ARI financed/refinanced or obtained second mortgage financing on the
following:
Net Cash
Debt Debt Received/ Interest Maturity
Property Location Acres/Sq.Ft. Incurred Discharged (Paid) Rate Date
- -------------- ----------------- ------------ ------------ ------------ -------------- ------------ ------------
First Quarter
Land
Walker Dallas County, TX 90.6 Acres $ 8,500 $ 8,500 $ (1,411) 11.250% /(1)/ 01/03
Shopping Center
Plaza on Bachman
Creek Dallas, TX 80,278 Sq.Ft. 5,000 -- 4,444 6.625 /(1)/ 04/04
Related Party Transactions. In each of the following transactions, a related
party has purchased an entity, which owns the listed property asset, from ARI.
ARI has guaranteed that the asset will produce at least a 12% return on the
purchase price for a period of three years from the purchase date. If the asset
fails to produce the 12% return, ARI will pay the purchaser any shortfall. In
addition, if the asset fails to produce the 12% return for a calendar year, the
purchaser may require ARI to repurchase the entity for the purchase price.
Management has classified these related party transactions as notes payable.
31
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
Debt Debt Net Cash Interest Maturity
Property Location Sq.Ft. Incurred Discharged Received Rate Date
- -------------- ----------------- ------------ ------------ ------------ -------------- ------------ ------------
First Quarter
Office Building
Rosedale Towers Minneapolis, MN 84,798 Sq.Ft. $ 5,109 $ -- $ 5,109 12.000% 01/05 /(2)/
Two Hickory Centre Farmers Branch, TX 96,127 Sq.Ft. 4,448 -- 4,448 12.000 01/05 /(3)/
- --------------
(1) Variable interest rate.
(2) IORI purchased 100% of the outstanding common shares of Rosedale
Corporation ("Rosedale"), a wholly-owned subsidiary of ARI, for $5.1
million. The purchase price was determined based upon the market value of
the property, using a market rate multiple of net operating income.
Rosedale owned the Rosedale Towers Office Building. The business purpose of
this transaction was for IORI to make an equity investment in Rosedale,
anticipating a profitable return, and for ARI to receive cash for its
equity investment. After the property was sold to an unrelated buyer in
December 2002, ARI owed $2.1 million to IORI for remaining principal and
12% return. In April 2003, ARI repaid $2.0 million in principal and accrued
interest. Beginning March 31, 2003, IORI is consolidated with ARI.
(3) TCI purchased 100% of the common shares of ART Two Hickory Corporation
("Two Hickory"), a wholly-owned subsidiary of ARI, for $4.4 million. The
purchase price was determined based upon the market value of the property,
using a market rate multiple of net operating income. Two Hickory owns the
Two Hickory Centre Office Building. The business purpose of this
transaction was for TCI to make an equity investment in Two Hickory,
anticipating a profitable return, and for ARI to receive cash for its
equity investment. Beginning March 31, 2003, TCI is consolidated with ARI.
ARI has margin arrangements with various financial institutions and brokerage
firms which provide for borrowing up to 50% of the market value of ARI's
marketable equity securities. The borrowings under such margin arrangements are
secured by equity securities of IORI and TCI and ARI's trading portfolio and
bear interest rates ranging from 5.25% to 24.0%. Margin borrowing totaled $8.3
million at March 31, 2003.
Management expects that it will be necessary for ARI to sell $102.0
million, $34.1 million and $1.2 million of its land holdings during each of the
next three years to satisfy the debt on such land as it matures. If ARI is
unable to sell at least the minimum amount of land to satisfy the debt
obligations on such land as it matures, or, if it was not able to extend such
debt, ARI would either sell other of its assets to pay such debt or transfer the
property to the lender.
Management reviews the carrying values of ARI's properties and mortgage notes
receivable at least annually and whenever events or a change in circumstances
indicate that impairment may exist. Impairment is
32
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
considered to exist if, in the case of a property, the future cash flow from the
property (undiscounted and without interest) is less than the carrying amount of
the property. For notes receivable, impairment is considered to exist if it is
probable that all amounts due under the terms of the note will not be collected.
If impairment is found to exist, a provision for loss is recorded by a charge
against earnings to the extent that the investment in the note exceeds
management's estimate of the fair value of the collateral property securing each
note. The mortgage note receivable review includes an evaluation of the
collateral property securing such note. The property review generally includes:
(1) selective property inspections; (2) a review of the property's current rents
compared to market rents; (3) a review of the property's expenses; (4) a review
of maintenance requirements; (5) a review of the property's cash flow; (6)
discussions with the manager of the property; and (7) a review of properties in
the surrounding area.
Related Party Transactions
In March 2003, ARI sold the Bridgeview Plaza and Cullman shopping centers to TCI
for $10.7 million to satisfy debt. TCI assumed debt of $2.7 million on Cullman.
TCI received $5.1 million cash on the subsequent financing of the shopping
centers.
In April 2003, ARI paid $2.0 million in principal and accrued interest to IORI,
in partial payment of a note payable on the Rosedale Tower Office Building. See
NOTE 6. "NOTES PAYABLE."
Commitments and Contingencies
ARI has contractual obligations and commitments primarily with regards to
payment of mortgages.
Results of Operations
For the three months ended March 31, 2003, ARI reported net income of $7.2
million, compared to a net loss of $8.9 million for the three months ended March
31, 2002. The primary factors contributing to ARI's net income are discussed in
the following paragraphs.
Rents of $22.3 million in the three months ended March 31, 2003 approximated the
$21.8 million in 2002. Rents from commercial properties of $8.1 million for the
three months ended March 31, 2003 approximated the $8.2 million in 2002, rent
from hotels of $6.1 million in the three months ended March 31, 2003,
approximated the $6.4 million in 2002 and rents from apartments increased to
$8.0 million in the three months ended March 31, 2003, from $6.9 million in
2002. The increase in apartment rents was primarily attributable to the
acquisition of two apartments and the completion of construction of one
apartment in 2002.
Property operations expense of $16.6 million in the three months ended March 31,
2003 approximated the $16.2 million in 2002. Property
33
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Results of Operations (Continued)
operations expense for commercial properties of $4.5 million in the three months
ended March 31, 2003 approximated the $4.3 million in 2002. For hotels, property
operations expense of $5.5 million in the three months ended March 31, 2003
approximated the $5.3 million in 2002. For land, property operations expense
decreased to $1.6 million in the three months ended March 31, 2003 from $2.4
million in 2002. For apartments, property operations expense increased to $5.0
million in the three months ended March 31, 2003, from $4.2 million in 2002. The
decrease in land operations expense was primarily attributable to decreased real
estate taxes as a result of land sales in 2002. The increase in apartment
operations expense was primarily attributable to the acquisition of two
apartments and the completion of construction of one apartment in 2002.
Pizza parlor sales and cost of sales increased to $7.9 million and $6.4 million,
respectively, in the three months ended March 31, 2003 from $7.4 million and
$5.8 million in 2002. The increase was primarily attributable to a 4.4% increase
in same-store sales volume.
Interest income from notes receivable increased to $2.2 million in the three
months ended March 31, 2003 from $612,000 in 2002, due to the addition of $67.5
million of mortgage notes receivable in 2002.
Equity in loss of investees decreased to $(4.3) million in the three months
ended March 31, 2003 from $(4.0) million in 2002. ARI began consolidation of
TCI's and IORI's operations effective after March 31, 2003.
Loss on sale of investments in equity investees was $531,000 for the three
months ended March 31, 2002. See NOTE 4. "INVESTMENTS IN EQUITY INVESTEES."
Interest expense decreased to $11.2 million in the three months ended March 31,
2003 from $15.3 million in 2002. The decrease was primarily attributable to
reduced balances payable on stock loans and land mortgages and a reduction in
borrowing cost amortization.
Depreciation and amortization expense of $2.5 million in the three months ended
March 31, 2003 approximated the $2.3 million in 2002.
General and administrative expenses of $3.3 million in the three months ended
March 31, 2003 approximated the $3.3 million in 2002.
Advisory fees of $2.0 million in the three months ended March 31, 2003
approximated the $1.7 million in 2002.
Net income fee to affiliate was $452,000 in the three months ended March 31,
2003. The net income fee payable to ARI's advisor is 10% of the year-to-date net
income, in excess of a 10% return on shareholders' equity.
34
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
Results of Operations (Continued)
Incentive fee to affiliate was $261,000 in the three months ended March 31,
2003. The incentive fee is due only if ARI is also subject to the net income
fee. This fee represents 10% of the excess of net capital gains over net capital
losses from sales of operating properties. The amount of this fee for the
remainder of 2003 will be dependent on the number of operating properties sold,
the net capital gains realized and whether the net income fee is due.
Minority interest decreased to $550,000 in the three months ended March 31, 2003
from $787,000 in 2002. The decrease is attributable to the repurchase of
partnership units by ARI in 2002.
Net income from discontinued operations decreased to $4.1 million in 2003 from
$8.9 million in 2002. The net income relates to 23 properties and leasehold
interests in oil and gas properties that ARI sold during 2002 and eight
properties that ARI sold in 2003. The following table summarizes revenue and
expense information for the properties sold.
For the Three Months
Ended March 31,
------------------------
Revenue 2003 2002
------- -------
Rental ............................................................................ $ 2,839 $ 7,552
Property operations ............................................................... 1,441 3,677
------- -------
1,398 3,875
Expenses
Interest .......................................................................... 215 3,465
Depreciation ...................................................................... 65 1,258
------- -------
280 4,723
Net income (loss) from discontinued operations ....................................... 1,118 (848)
Gain on sale of real estate ....................................................... 3,013 5,615
Equity in gain on sale of real estate by equity investees ......................... -- 4,131
------- -------
Net income from discontinued operations .............................................. $ 4,131 $ 8,898
======= =======
Tax Matters
Financial statement income varies from taxable income principally due to the
accounting for income and losses of investees, gains and losses from asset
sales, depreciation on owned properties, amortization of discounts on notes
receivable and payable and the difference in the allowance for estimated losses.
ARI had no taxable income after the use of NOL carryforwards or provision for
income taxes in the three months ended March 31, 2003 or 2002.
At March 31, 2003, ARI had a net deferred tax asset of $116.6 million due to tax
deductions available to it in future years. However, as management cannot
determine that it is more likely than not that ARI will realize the benefit of
the deferred tax asset, a 100% valuation allowance has been established.
35
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
Environmental Matters
Under various federal, state and local environmental laws, ordinances and
regulations, ARI may be potentially liable for removal or remediation costs, as
well as certain other potential costs relating to hazardous or toxic substances
(including governmental fines and injuries to persons and property) where
property-level managers have arranged for the removal, disposal or treatment of
hazardous or toxic substances. In addition, certain environmental laws impose
liability for release of asbestos-containing materials into the air, and third
parties may seek recovery for personal injury associated with such materials.
Management is not aware of any environmental liability relating to the above
matters that would have a material adverse effect on ARI's business, assets or
results of operations.
Inflation
The effects of inflation on ARI's operations are not quantifiable. Revenues from
apartment operations fluctuate proportionately with inflationary increases and
decreases in housing costs. Fluctuations in the rate of inflation also affect
the sales values of properties and the ultimate gains to be realized from
property sales. To the extent that inflation affects interest rates, earnings
from short-term investments and the cost of new borrowings as well as the cost
of variable interest rate debt will be affected.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
At March 31, 2003, ARI's exposure to a change in interest rates on its debt is
as follows:
Weighted Effect of 1%
Average Increase In
Balance Interest Rate Base Rates
------- ------------- ----------
Notes payable:
Variable rate .......................................... $ 33,298 10.606% $ 3,330
======== =======
Total decrease in ARI's annual
net income ............................................. $ 3,330
=======
Per share ................................................. $ .29
=======
36
ITEM 4. CONTROLS AND PROCEDURES
(a) Within the 90 days prior to the date of this report, ARI carried out an
evaluation, under the supervision and with the participation of ARI's
management, including ARI's Acting Principal Executive Officer and
principal accounting officer, of the effectiveness of the design and
operation of ARI's disclosure controls and procedures pursuant to Exchange
Act Rule 13a-14. Based upon the evaluation, ARI's Acting Principal
Executive Officer and principal accounting officer concluded that ARI's
disclosure controls and procedures are effective in timely alerting him to
material information relating to ARI (including its consolidated
subsidiaries) required to be included in ARI's periodic SEC filings.
(b) There have been no significant changes in ARI's internal controls or in
other factors that could significantly affect ARI's internal controls
subsequent to the date ARI carried out this evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit
Number Description
------- -----------
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.
(b) Reports on Form 8-K as follows:
A Current Report on Form 8-K, dated March 18, 2003, was filed with respect
to Item 5. "Other Events," which reports the completion of a cash tender
offer to purchase any and all issued and outstanding common stock of IORI
and TCI.
37
SIGNATURE PAGE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AMERICAN REALTY INVESTORS, INC.
Date: May 20, 2003 By: /s/ Ronald E. Kimbrough
-------------------- -------------------------------------
Ronald E. Kimbrough
Executive Vice President and Chief
Financial Officer (Principal
Financial and Accounting Officer and
Acting Principal Executive Officer)
38
CERTIFICATION
I, Ronald E. Kimbrough, Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer and Acting Principal Executive
Officer) of American Realty Investors, Inc. ("ARI"), certify that:
1. I have reviewed this quarterly report on Form 10-Q of ARI;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. I am responsible for establishing and maintaining internal controls and
procedures and have:
a. designed such internal controls to insure that material information
relating to ARI and its consolidated subsidiaries is made known to me
by others within those entities, particularly for the periods
presented in this quarterly report;
b. evaluated the effectiveness of ARI's internal controls as of a date
within 90 days prior to the filing date of this quarterly report; and
c. presented in this quarterly report my conclusions about the
effectiveness of the disclosure controls and procedures based on a
date within 90 days prior to the filing date of this quarterly report;
5. I have disclosed to ARI's auditors and Audit Committee of the Board of
Directors (or persons fulfilling the equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect ARI's ability to record,
process, summarize, and report financial data and have identified for
ARI's auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in ARI's internal controls; and
39
6. I have indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors that could
significantly affect internal controls subsequent to the date of my most
recent evaluation, including corrective actions with regard to significant
deficiencies and material weaknesses.
Date: May 20, 2003 /s/ Ronald E. Kimbrough
----------------------- -----------------------------------
Ronald E. Kimbrough
Executive Vice President
and Chief Financial Officer
(Principal Financial and
Accounting Officer and
Acting Principal Executive Officer)
40
AMERICAN REALTY INVESTORS, INC.
EXHIBITS TO
QUARTERLY REPORT ON FORM 10-Q
For the Quarter ended March 31, 2003
Exhibit Page
Number Description Number
------ ----------- ------
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted 38
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
41