UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
AMENDMENT NO. 1
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED SEPTEMBER 30, 2002
------------------
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 (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 11,375,127
---------------------------- ---------------------------------
(Class) (Outstanding at October 31, 2002)
1
This Form 10-Q/A Amendment No. 1 amends the Registrant's Quarterly Report on
Form 10-Q for the quarter ended September 30, 2002 as follows:
ITEM 1. FINANCIAL STATEMENTS
Consolidated Statements of Operations - pages 4, 5
NOTE 1. "BASIS OF PRESENTATION" - pages 9, 10
NOTE 10. "OPERATING SEGMENTS - pages 23 - 25
NOTE 11. "DISCONTINUED OPERATIONS" - pages 25, 26
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Results of Operations - pages 38 - 41
This amendment is made pursuant to the SEC Staff comment letter dated January 7,
2003, to revise the presentation of discontinued operations, pursuant to
Statement of Financial Accounting Standards No. 144. See NOTE 1. "BASIS OF
PRESENTATION."
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
The accompanying Consolidated Financial Statements as of and for the three and
nine month periods ended September 30, 2002, 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
September 30, December 31,
2002 2001
------------- ------------
Assets (dollars in thousands, except per share)
------
Real estate held for investment ........................... $ 429,566 $ 495,437
Less - accumulated depreciation ........................... (107,318) (121,777)
----------- -----------
322,248 373,660
Real estate held for sale ................................. 181,791 214,543
Notes and interest receivable
Performing ($26,795 in 2002 and $18,896 in 2001 from
affiliates) ........................................... 38,806 22,612
Nonperforming ($6,632 in 2002 and $6,994 in 2001
from affiliates) ...................................... 7,650 10,347
----------- -----------
46,456 32,959
Less--allowance for estimated losses ...................... (3,077) (2,577)
----------- -----------
43,379 30,382
Pizza parlor equipment .................................... 12,455 10,454
Less - accumulated depreciation ........................... (4,567) (3,747)
----------- -----------
7,888 6,707
Leasehold interest - oil and gas properties ............... -- 4,719
Less - accumulated depletion .............................. -- (1)
----------- -----------
-- 4,718
Oilfield equipment ........................................ -- 511
Less - accumulated depreciation ........................... -- (21)
----------- -----------
-- 490
Marketable equity securities, at market value ............. 68 96
Cash and cash equivalents ................................. 3,283 709
Investments in equity investees ........................... 82,996 77,933
Goodwill, net of accumulated amortization ($1,763 in
2002 and 2001) .......................................... 11,858 11,858
Other intangibles, net of accumulated amortization
($948 in 2002 and $903 in 2001) ......................... 1,651 1,678
Other assets .............................................. 39,893 35,989
----------- -----------
$ 695,055 $ 758,763
=========== ===========
The accompanying notes are an integral part of these Consolidated Financial
Statements.
2
AMERICAN REALTY INVESTORS, INC.
CONSOLIDATED BALANCE SHEETS - Continued
September 30, December 31,
2002 2001
---------------------------
(dollars in thousands,
except per share)
Liabilities and Stockholders' Equity
Liabilities
Notes and interest payable ($6,929 in 2002 and $1,598 in
2001 to affiliates) ....................................... $ 380,738 $ 412,704
Liabilities related to assets held for sale ................. 124,309 151,594
Margin borrowings ........................................... 10,990 28,040
Accounts payable and other liabilities ($29,873 in 2002
and $11,389 in 2001 to affiliates) ........................ 89,618 48,960
----------- -----------
605,655 641,298
Minority interest ........................................... 19,589 27,612
Series F Preferred Stock, 3,968.75 shares in 2001
(liquidation preference $3,969) ........................... -- 3,969
Commitments and contingencies
Stockholders' equity
Preferred Stock, $2.00 par value, authorized 50,000,000
shares, issued and outstanding
Series A, 3,324,910 shares in 2002 and 2,724,910 shares
in 2001 (liquidation preference $33,249), including
900,000 shares in 2002 and 300,000 shares in 2001
held by subsidiaries .................................... 4,850 4,850
Series E, 50,000 shares in 2002 and 2001 (liquidation
preference $5,000) ...................................... 100 100
Common Stock, $.01 par value, authorized 100,000,000
shares; issued 11,375,127 shares in 2002 and 2001 ......... 114 114
Paid-in capital ............................................. 95,336 97,140
Accumulated deficit ......................................... (32,997) (16,320)
Accumulated other comprehensive income ...................... 2,408 --
----------- -----------
69,811 85,884
----------- -----------
$ 695,055 $ 758,763
=========== ===========
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 For the Nine Months
Ended September 30, Ended September 30,
-----------------------------------------
2002 2001 2002 2001
-------- -------- -------- --------
Property revenue (dollars in thousands, except per share)
Rents .......................................... $ 26,545 $ 28,968 $ 77,966 $ 87,822
Property operations expenses ................... 18,525 19,668 55,306 64,453
-------- -------- -------- --------
Operating income ............................. 8,020 9,300 22,660 23,369
Land operations
Sales .......................................... 18,681 8,229 39,382 41,806
Cost of sales .................................. 16,063 4,682 33,401 33,546
-------- -------- -------- --------
Gain on land sales ........................... 2,618 3,547 5,981 8,260
Pizza parlor operations
Sales .......................................... 9,274 8,723 27,550 25,282
Cost of sales .................................. 7,645 7,164 22,392 20,715
-------- -------- -------- --------
Gross margin ................................. 1,629 1,559 5,158 4,567
Income from operations ........................... 12,267 14,406 33,799 36,196
Other income (loss)
Interest income ................................ 509 837 1,906 1,997
Equity in loss of investees .................... (4,790) (3,137) (14,023) (8,425)
Equity in gain on sale of real estate by
equity investees ............................. -- 6,589 -- 17,969
Loss on sale of investments in equity
investees .................................... -- -- (531) (387)
Gain on sale of real estate .................... -- 12,334 -- 54,600
Other .......................................... 190 (19) 516 58
-------- -------- -------- --------
(4,091) 16,604 (12,132) 65,812
Other expenses
Interest ....................................... 13,656 17,107 45,751 49,793
Depreciation and amortization .................. 3,403 3,655 9,861 10,736
General and administrative ..................... 3,322 4,610 9,803 9,083
Advisory fee to affiliate ...................... 1,573 1,437 4,825 4,971
Net income fee to affiliate .................... -- (1,128) -- 638
Incentive fee to affiliate ..................... -- 1,642 -- 7,477
Writedown of assets held for sale .............. 445 -- 445 --
Minority interest .............................. 436 1,003 1,996 2,483
-------- -------- -------- --------
22,835 28,326 72,681 85,181
Net income (loss) from continuing operations ..... (14,659) 2,684 (51,014) 16,827
Discontinued operations:
Loss from operations ........................... (434) (1,618) (3,699) (4,838)
Gain on sale of real estate .................... 15,375 -- 23,140 --
Equity in gain on sale of real estate by
equity investees ............................. 6,616 -- 14,896 --
-------- -------- -------- --------
Net income (loss) from discontinued operations ... 21,557 (1,618) 34,337 (4,838)
Net income (loss) ................................ 6,898 1,066 (16,677) 11,989
Preferred dividend requirement ................... (601) (620) (1,801) (1,868)
-------- -------- -------- --------
Net income (loss) applicable to Common shares .... $ 6,297 $ 446 $(18,478) $ 10,121
======== ======== ======== ========
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 For the Nine Months
Ended September 30, Ended September 30,
-----------------------------------------------------------------------------
2002 2001 2002 2001
------------- -------------- -------------- --------------
(dollars in thousands, except per share)
Earnings per share - basic and diluted
Net income (loss) from continuing
operations ............................... $ (1.34) $ .20 $ (4.64) $ 1.48
Discontinued operations ..................... 1.89 (.16) 3.02 (.48)
-------------- -------------- -------------- --------------
Net income (loss) applicable to
Common shares ............................ $ .55 $ .04 $ (1.62) $ 1.00
============== ============== ============== ==============
Weighted average Common shares used
in computing earnings per share ............. 11,375,127 10,193,217 11,375,127 10,141,840
============== ============== ============== ==============
Options to purchase 110,450 and 107,450 of ARI's Common Stock were excluded in
the computation of diluted earnings available to common shares for the three and
nine months ended September 30, 2002 and 2001, respectively, because the effect
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 Nine Months Ended September 30, 2002
Accumulated
Series A Series E Other
Preferred Preferred Common Paid-in Accumulated Comprehensive Stockholders'
Stock Stock Stock Capital Deficit Income Equity
--------- --------- -------- -------- ----------- ------------- -------------
(dollars in thousands, except per share)
Balance, January 1, 2002 .................. $ 4,850 $ 100 $ 114 $ 97,140 $(16,320) $ -- $ 85,884
Comprehensive income
Foreign currency translation gain ...... -- -- -- -- -- 2,408 2,408
Net loss ............................... -- -- -- -- (16,677) -- (16,677)
--------
(14,269)
Common Stock dividends (pre-merger) ....... -- -- -- (25) -- -- (25)
Preferred dividends
Series A Preferred Stock ($.75 per
share) ............................... -- -- -- (1,778) -- -- (1,778)
Series E Preferred Stock ($.45 per
share) ............................... -- -- -- (23) -- -- (23)
Other ..................................... -- -- -- 22 -- -- 22
-------- -------- -------- -------- -------- -------- --------
Balance, September 30, 2002 ............... $ 4,850 $ 100 $ 114 $ 95,336 $(32,997) $ 2,408 $ 69,811
======== ======== ======== ======== ======== ======== ========
The accompanying notes are an integral part of these Consolidated Financial
Statements.
6
AMERICAN REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months
Ended September 30,
----------------------------------
2002 2001
----------------------------------
(dollars in thousands)
Cash Flows From Operating Activities
Rents collected ................................................. $ 86,322 $ 98,787
Pizza parlor sales collected .................................... 27,314 25,075
Interest collected .............................................. 979 397
Distributions received from equity investees'
operating cash flow ........................................... -- 53
Payments for property operations ................................ (59,422) (79,693)
Payments for pizza parlor operations ............................ (22,458) (20,804)
Payments for oil and gas operations ............................. -- (175)
Interest paid ................................................... (42,611) (45,691)
Advisory fee paid to affiliate .................................. (4,825) (4,971)
Incentive fees paid to affiliate ................................ -- (1,646)
Distributions to minority interest holders ...................... (1,966) (2,697)
General and administrative expenses paid ........................ (9,803) (9,079)
Other ........................................................... (5,746) 1,239
--------- ---------
Net cash used in operating activities ..................... (32,216) (39,205)
Cash Flows From Investing Activities
Collections on notes receivable ................................. 5,473 4,929
Pizza parlor equipment purchased ................................ (2,034) (1,066)
Proceeds from sale of real estate ............................... 69,677 102,415
Notes receivable funded ......................................... (1,965) (13,959)
Earnest money ................................................... 868 (696)
Investment in real estate entities .............................. (2,554) (36,975)
Acquisition of real estate ...................................... (1,359) --
Construction and development .................................... (12,303) (3,771)
Real estate improvements ........................................ (3,492) (9,518)
Settlement of interest rate swap contract ....................... (199) --
Acquisition of leasehold interests .............................. -- (350)
Purchase of oil field equipment ................................. -- (361)
--------- ---------
Net cash provided by investing activities ................. 52,112 40,648
Cash Flows from Financing Activities
Proceeds from notes payable ..................................... 80,893 136,832
Payments on notes payable ....................................... (95,280) (144,314)
Deferred borrowing costs ........................................ (4,684) (7,633)
Net advances from affiliates .................................... 20,630 1,028
Margin borrowings, net .......................................... (17,100) 15,073
Preferred dividends paid ........................................ (1,778) (1,454)
Stock sale profits received from affiliate ...................... 22 --
Repurchase of Common Stock ...................................... -- (133)
Common dividends paid ........................................... (25) (5)
--------- ---------
Net cash used in financing activities ..................... (17,322) (606)
Net increase in cash and cash equivalents ................. 2,574 837
Cash and cash equivalents, beginning of period ...................... 709 4,177
--------- ---------
Cash and cash equivalents, end of period ............................ $ 3,283 $ 5,014
========= =========
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 Nine Months
Ended September 30,
----------------------------
2002 2001
----------------------------
(dollars in thousands)
Reconciliation of net income (loss) to net cash used in
operating activities
Net income (loss) .............................................. $ (16,677) $ 11,989
Adjustments to reconcile net income (loss) to net cash
used in operating activities
Depreciation and amortization ............................... 11,549 13,169
Gain on sale of real estate ................................. (29,121) (62,860)
Writedown of assets held for sale ........................... 445 --
Distributions from equity investees' operating
cash flow ................................................ -- 53
Increase (decrease) in minority interest .................... 30 (214)
Equity in income of investees ............................... (873) (9,544)
Loss on sale of investments in equity investees ............. 531 387
Increase in accrued interest receivable ..................... (927) (1,600)
(Increase) decrease in other assets ......................... (96) 11,294
Increase in accrued interest payable ........................ 2,541 28
Increase (decrease) in accounts payable and other
liabilities .............................................. 382 (1,907)
--------- --------
Net cash used in operating activities .................... $ (32,216) $(39,205)
========= ========
Schedule of noncash investing and financing activities
Notes payable from acquisition of real estate .................. $ -- $ 2,549
Notes payable assumed by buyer on sale of properties ........... 56,495 30,263
Notes receivable from sale of real estate ...................... 10,321 4,329
Exchange of real estate at carrying value ...................... -- 3,726
Issuance of Series A Preferred Stock ........................... -- 35
Issuance of Series F Preferred Stock ........................... -- 3,969
Cancellation of Series F Preferred Stock ....................... (3,969) --
Note receivable from sales of leasehold interests .............. 1,300 --
Sale of real estate to affiliate to satisfy debt ............... 24,886 --
Acquisition of assets from affiliate to satisfy debt ........... (16,268) --
Change in fair value of interest rate swap ..................... 614 --
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 2001 have been reclassified to conform to the 2002
presentation.
Operating results for the nine month period ended September 30, 2002, are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2002. 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, 2001 (the "2001 Form 10-K").
On January 1, 2002, ARI adopted Statement 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" ("SFAS No. 144"). The Statement superceded
Statement 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of" ("SFAS No. 121") and Accounting Principles
Board Opinion No. 30, "Reporting the Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions" ("APB 30"), for segments of a
business to be disposed of. SFAS 144 retains the requirements of SFAS No. 121
relating to the recognition and measurement of an impairment loss and resolves
certain implementation issues resulting from SFAS No. 121. The adoption of SFAS
No. 144 did not have a material impact on the consolidated financial position or
results of operations of ARI.
The financial statements and accompanying footnotes have been amended to revise
the presentation of discontinued operations, pursuant to Statement of Financial
Accounting Standards No. 144. The revision had no impact on the net income
(loss) for the periods reported.
In April 2002, the FASB issued Statement 145, "Rescission of FASB Statements No.
4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Correction"
("SFAS No. 145"). Statement 4, "Reporting Gains and Losses from Extinguishment
of Debt" ("SFAS No. 4"), required that gains and losses from the extinguishment
of debt that were included in the determination of net income be aggregated and,
if material, classified as an extraordinary item. The provisions of SFAS No. 145
related to the rescission of SFAS No. 4 become effective in fiscal years
beginning after May 15, 2002. The adoption of SFAS No. 145 will not have a
material impact on the consolidated financial position or results of operations
of ARI.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which addresses accounting for restructuring
and similar costs. SFAS No. 146 supersedes previous
9
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 1. BASIS OF PRESENTATION (Continued)
accounting guidance, principally Emerging Issues Task Force ("EITF") Issue No.
94-3. ARI will adopt the provisions of SFAS No. 146 for restructuring activities
initiated after December 31, 2002. SFAS No. 146 requires that the liability for
costs associated with an exit or disposal activity be recognized when the
liability is incurred. Under EITF No. 94-3, a liability for an exit cost was
recognized at the date of a company's commitment to an exit plan. SFAS No. 146
also establishes that the liability should initially be measured and recorded at
fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing
future restructuring costs as well as the amount recognized.
NOTE 2. REAL ESTATE
In 2002, ARI purchased the following properties:
Units/ 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 $ -- $ -- -- --
Second Quarter
Apartments
Pinecrest/(2)/ North Augusta, SC 120 Units 2,979 -- 1,423/(3)/ 8.75% 03/03
Tiberon Trails/(2)/ Merrillville, IN 376 Units 12,336 -- 6,417/(3)/ 9.00 07/06
Shopping Center
Alta Mesa/(2)/ Ft. Worth, TX 59,933 Sq.Ft. 3,797 -- 1,804/(3)/ 10.43 10/04
Land
Pioneer Crossing Austin, TX 79.4 Acres 1,165 1,213 -- -- --
Willow Springs Beaumont, CA 20.7 Acres 140 146 -- -- --
---------------
(1) Exchanged with Transcontinental Realty Investors, Inc. ("TCI"), a related
party, for the Oaktree Village Shopping Center, Rasor land parcel and
Lakeshore Villas land parcel.
(2) Property received from Basic Capital Management, Inc. ("BCM"), a related
party, for forgiveness of debt. The purchase price was determined using a
market rate multiple of net operating income.
(3) Assumed debt of seller.
In 2001, ARI purchased the following properties:
Purchase Net Cash Debt Interest Maturity
Property Location Units Price Paid Incurred Rate Date
-------------------- ---------- ------------- ---------- -------- -------- -------- --------
Second Quarter
Apartments
Glenwood Addison, TX 168 Units $ 6,246 $ --/(1)/ $ 2,549/(2)/ 9.25% 10/04
---------------
(1) 8.88 acres of Hollywood Casino land and 10.5 acres of Vista Ridge land
given as consideration. Exchanged with TCI, a related party.
10
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 2. REAL ESTATE (Continued)
(2) Assumed debt of seller. Exchanged with TCI, a related party.
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)/ --
Second Quarter
Apartments
Oak Hill Tallahassee, FL 92 Units 3,200 156/(4)/ 2,550 527
Regency Tampa, FL 78 Units 3,200 851 1,710 (1,458)
Stonebridge Florissant, MO 100 Units 4,340 1,142 2,893 3,081
Office Building
Centura Dallas, TX 410,901 Sq.Ft. 50,000 -- 43,739/(3)/ --/(5)/
Land
Hollywood Casino Farmers Branch, TX 42.8 Acres 16,987 -- 6,222/(3)/ --/(5)/
Marine Creek Ft. Worth, TX 54.2 Acres 3,700 -- 1,500/(3)/ --/(5)/
Mason Goodrich Houston, TX 7.9 Acres 672 46 554 268
Mason Goodrich Houston, TX 10.3 Acres 1,444 93 1,225 895
Mason Goodrich Houston, TX 18.0 Acres 2,790 -- 2,690/(3)/ --/(5)/
Monterrey Riverside, CA 61.0 Acres 4,625 -- -- 34/(6)/
Nashville Nashville, TN 16.6 Acres 1,890 -- 955/(3)/ --/(5)/
Third Quarter
Apartments
Conradi House Tallahassee, FL 98 Units 1,809 388 1,047 452
Lee Hills Tallahassee, FL 16 Units 445 355 -- 131
Morning Star Tallahassee, FL 82 Units 2,217 718 1,187 638
Pheasant Ridge Bellevue, NE 264 Units 10,400 2,576 6,237 6,763
Stonegate Tallahassee, FL 83 Units 1,785 486 1,026 (124)
Valley Hi Tallahassee, FL 54 Units 1,452 75 1,159 436
White Pines Tallahassee, FL 85 Units 764 10 593 (49)
Woodsong Smyrna, GA 190 Units 9,200 (45) 8,196 7,128
Land
Elm Fork Denton County, TX 14.5 Acres 2,745 (105) 2,633 1,615
Elm Fork Denton County, TX 14.2 Acres 1,526 (54) 701 527
Elm Fork Denton County, TX 16.7 Acres 1,617 (299) 1,554 429
Katrina Palm Desert, CA 80.0 Acres 6,778 (1,382) 2,500 (2,045)
Messick Palm Desert, CA 71.0 Acres 6,015 (163) 1,300 2,058
11
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 2. REAL ESTATE (Continued)
Units/ Sales Net Cash Debt Gain/(Loss)
Property Location Acres/Sq.Ft. Price Received/(Paid) Discharged on Sale
-------------------- -------------------- -------------- ------- --------------- ---------- -----------
Fourth Quarter
Apartments
Daluce Tallahassee, FL 112 Units $ 3,634 $ 779 $ 2,491/(3)/ $ 772
Office Building
Melrose Business Park Oklahoma City, OK 124,200 Sq.Ft. 1,890 953 817 1,408
Shopping Center
Alta Mesa Fort Worth, TX 59,933 Sq.Ft. 3,617 1,399 1,791 --
Land
Nashville Nashville, TN 1.0 Acres 140 (4) 125 73
Varner Road Riverside, CA 129.7 Acres 3,700 571 -- 1,413
-----------------
/(1)/ Exchanged for Governor's Square, Grand Lagoon, Park Avenue, Greenbriar,
Regency and Westwood Apartments.
/(2)/ Exchanged with TCI, a related party, for the Plaza on Bachman Creek
Shopping Center.
/(3)/ Debt assumed by purchaser.
/(4)/ Represents dividends on and redemption of Innovo Preferred Stock. See
NOTE 7. "NOTES PAYABLE."
/(5)/ Sold to TCI, a related party, to satisfy debt. Gain deferred until sale
to unrelated party.
/(6)/ Sold to TCI, a related party, to satisfy debt. In September 2002, 36
acres sold to unrelated party. Remaining gain deferred until sale to
unrelated party.
In 2001, ARI sold the following properties:
Units/ Sales Net Cash Debt Gain/(Loss)
Property Location Acres/Sq.Ft. Price Received/(Paid) Discharged on Sale
-------------------- -------------------- -------------- ------- --------------- ------------ -----------
First Quarter
Apartments
Carriage Park Tampa, FL 46 Units $ 2,005 $ 757 $ 1,069 $ 663
Rockborough Denver, CO 345 Units 16,675 3,654 12,215/(1)/ 13,471
Land
Frisco Bridges Collin County, TX 27.8 Acres 4,500 4,130 -- 25
Katrina Palm Desert, CA 20.0 Acres 2,831 (124) 596 830/(2)/
Las Colinas Las Colinas, TX 1.7 Acres 825 233 400 539
Plano Parkway Plano, TX 11.3 Acres 1,445 312 950 --
Scoggins Tarrant County, TX 232.8 Acres 2,913 892 1,800 181
Scout Tarrant County, TX 408.0 Acres 5,087 1,586 3,200 2,969
Tree Farm Dallas County, TX 10.4 Acres 2,888 (87) 2,644 75
Shopping Center
Regency Pointe Jacksonville, FL 67,063 Sq.Ft. 7,350 5,126 1,500 2,232
Second Quarter
Apartments
Bent Tree Addison, TX 292 Units 12,050 2,480 8,867 7,081
Glenwood Addison, TX 168 Units 6,650 3,166 2,549 (581)
Kimberly Woods Tucson, AZ 279 Units 8,450 1,667 6,191/(1)/ 6,053
Place One Tulsa, OK 407 Units 12,935 3,310 7,539 8,623
Shadowood Addison, TX 184 Units 7,125 1,980 4,320 4,644
12
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 2. REAL ESTATE (Continued)
Units/ Sales Net Cash Debt Gain/(Loss)
Property Location Acres/Sq.Ft. Price Received/(Paid) Discharged on Sale
---------- ---------- -------------- ------- ----------------- ------------ ------------
Second Quarter
Land
Katrina Palm Desert, CA 20.0 Acres $ 2,940 $ 78 $ -- $ 616
Mason/Goodrich Houston, TX 22.1 Acres 4,168 (34) 3,750 2,896
Plano Parkway Plano, TX 12.0 Acres 740 672 -- (991)
Yorktown Harris County, TX 120.4 Acres 5,239 (160) 4,991 (1,497)
Third Quarter
Apartments
Ashford Tampa, FL 56 Units 2,145 593 1,182 (985)
Chalet I Topeka, KS 162 Units 5,650 1,288 4,108/(1)/ 3,952
Chalet II Topeka, KS 72 Units 2,100 485 1,550/(1)/ 434
Club Mar Sarasota, FL 248 Units 8,500 1,905 6,199/(1)/ 2,328
Covered Bridge Gainesville, FL 176 Units 7,900 2,463 4,339 6,042
Crossing at Church Tampa, FL 52 Units 1,880 750 948 623
Land
Chase Oaks Plano, TX 22.3 Acres 2,875 663 2,027 871
Chase Oaks Plano, TX 4.9 Acres 1,973 1,832 -- 1,416
Elm Fork Denton County, TX 10.0 Acres 1,002 (30) 958 283
Katrina Palm Desert, CA 6.1 Acres 1,196 1,108 -- 570
Katrina Palm Desert, CA 2.2 Acres 800 (24) 737 514
Nashville Nashville, TN 2.0 Acres 26 (1) 24 (82)
Nashville Nashville, TN 1.2 Acres 8 -- 4 (59)
Rasor Plano, TX 6.6 Acres 350 267 -- 34
----------------
(1) Debt assumed by purchaser.
(2) Gain deferred until 2002, when ARI-provided financing was collected.
NOTE 3. NOTES RECEIVABLE
In May 2002, ARI sold its leasehold interests in various oil and gas mineral
development properties for $1.3 million, receiving a note from the buyer for the
purchase price. The note bears interest at 10.0% per annum, matures in May 2004
and requires monthly payments of principal and accrued interest. See NOTE 4.
"OIL AND GAS OPERATIONS."
In August 2002, ARI sold a 14.2 acre tract of its Elm Fork land parcel for $1.5
million, paying $54,000 after payment of closing costs and debt paydown and
providing purchase money financing of $763,000. The loan bore interest at 10.0%
per annum and matured in October 2002. All principal and interest were due at
maturity. In October 2002, the note was collected in full, including accrued but
unpaid interest.
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 bears interest at 8.0% per annum, matures in September 2004
and requires quarterly payments of accrued interest. All principal and accrued
interest are due at maturity.
13
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 3. NOTES RECEIVABLE (Continued)
In October 2002, ARI sold its Varner Road land parcel for $3.7 million,
receiving $571,000 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 March 2001, ARI sold a 20.0 acre tract of its Katrina land parcel for $2.8
million, receiving $700,000 in cash and providing purchase money financing of
the remaining $2.1 million of the sales price. The loan bore interest at 12.0%
per annum and matured in July 2001. All principal and interest were due at
maturity. In January 2002, $274,000 in principal and $226,000 in interest was
collected. In March 2002, the note was collected in full, including accrued but
unpaid interest.
In November 2001, ARI sold a 12.7 acre tract of its Santa Clarita parcel for
$1.9 million, receiving $1.5 million in cash and providing purchase money
financing of the remaining $437,000 of the sales price. The loan bears interest
at 8.0% per annum and matures in November 2002. All principal and accrued but
unpaid interest are due at maturity.
Also in November 2001, ARI sold the Blackhawk Apartments for $7.1 million,
receiving $1.5 million in cash after the assumption of $4.0 million of mortgage
debt and providing purchase money financing of the remaining $1.6 million of the
sales price. The loan bore interest at 10.0% per annum and matured in May 2002.
Monthly principal and interest payments were required. In April 2002, the note
was collected in full, including accrued but unpaid interest.
In December 1999, a note with a principal balance of $1.2 million, secured by a
pledge of a partnership interest in a partnership which owns real estate in
Addison, Texas, matured. The maturity date was extended to April 2000 in
exchange for an increase in the interest rate to 14.0% per annum. All other
terms remained the same. In February 2001, the loan amount was increased to $1.6
million and the maturity date was extended to June 2001. In February 2002, $1.5
million in principal and $87,000 in interest was collected. In May 2002, $10,000
in principal and accrued interest was collected. In July 2002, the note was
collected in full, including accrued but unpaid interest.
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. The first
payment is due in December 2002.
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 14.7%
of the outstanding shares of ARI's Common Stock. One Realco periodically borrows
money to meet its cash obligations. The
14
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 3. NOTES RECEIVABLE (Continued)
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 $15.2 million. All principal and
interest are due at maturity. Ronald E. Kimbrough, Executive Vice President and
Chief Financial Officer of ARI, is a 10% shareholder of One Realco. Mr.
Kimbrough does not participate in day-to-day operations or management of One
Realco.
In December 2000, an unsecured loan with a principal balance of $1.8 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 May 2002, $33,000 of principal and
$267,000 of interest was collected. At September 2002, the loan, with a current
principal balance of $1.7 million and $97,000 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 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 September 2002, the
loan, and $633,000 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 principal balance of $2.5 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
September 2002, the loan, and $980,000 of accrued interest, remained unpaid.
Tara Group, Inc., 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., the
parent company of BCM. The loan, to provide funds for
15
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 3. NOTES RECEIVABLE (Continued)
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.
NOTE 4. OIL AND GAS OPERATIONS
In May 2001, ARI purchased the leasehold interests in 37 oil and gas mineral
development properties, which include 131 drilled wells. The total proved
reserves were 6.5 million barrels of oil and 3.3 billion cubic feet of natural
gas. The total purchase price was $4.7 million, plus a 40% profit participation.
The Operator's Interest was purchased for $375,000, with $25,000 cash paid at
closing. ARI gave a note payable for the remaining $350,000. The note bore no
interest, and matured in May 2002. Monthly principal payments of $25,000 were
required. The Working Interests were purchased for $4.3 million, with $125,000
cash paid at closing. ARI gave a note payable for $250,000. The note bore no
interest, and matured in November 2001. One-half of the principal was paid in
August 2001. The remaining $4.0 million was paid by issuing 3,968.75 shares of
ARI Series F Preferred Stock, which was redeemable quarterly in an amount equal
to 20% of net cash flow from the oil and gas operations. The stock had a
liquidation value of $1,000 per share, and paid no dividends.
In May 2002, ARI sold the leasehold interests for $1.3 million, receiving a note
from the buyer for the purchase price. The note bears interest at 10.0% per
annum, matures in May 2004 and requires monthly payments of principal and
accrued interest. As part of the sale, the notes payable given by ARI for the
purchase of the Operator's Interest ($350,000) and the Working Interests
($250,000) were canceled. The 3,968.75 shares of ARI Series F Preferred Stock
were also returned to ARI and canceled.
NOTE 5. INVESTMENTS IN EQUITY INVESTEES
Real estate entities. ARI's investment in real estate entities at September 30,
2002, included equity securities of two publicly traded real estate companies,
Income Opportunity Realty Investors, Inc. ("IORI") and TCI, and interests in
real estate joint venture partnerships. BCM, ARI's advisor, serves as advisor to
IORI and TCI.
ARI accounts for its investment in IORI and TCI and the joint venture
partnerships using the equity method. The equity securities of IORI and
16
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 5. INVESTMENTS IN EQUITY INVESTEES (Continued)
TCI are pledged as collateral for borrowings. See NOTE 8. "MARGIN BORROWINGS."
ARI's investment in real estate entities, accounted for using the equity method,
at September 30, 2002 was as follows:
Percentage Carrying Equivalent
of ARI's Value of Investee Market Value
Ownership at Investment at Book Value at of Investment at
Investee September 30, 2002 September 30, 2002 September 30, 2002 September 30, 2002
--------- ------------------ ------------------ ------------------ ------------------
IORI ............ 28.49% $ 7,628 $ 10,873 $ 5,227
TCI ............. 49.81 68,508 107,340 66,302
--------- ---------
76,136 $ 71,529
=========
Other ........... 6,860
---------
$ 82,996
=========
Management continues to believe that the market value of both IORI and TCI
undervalues their assets, and, therefore, ARI may continue to increase its
ownership in these entities in 2002, as its liquidity permits. On October 3,
2000, ARI and IORI entered into a stock option agreement which provided IORI and
ARI with an option to purchase 1,858,900 shares of TCI common stock from a third
party. On October 19, 2000, IORI assigned all of its rights to purchase such
shares to ARI. The total cost to purchase the TCI shares was $30.8 million. In
October 2000, ARI paid $5.6 million of the option price. In April 2001, the
remainder of the option price was paid and ARI acquired the TCI shares. See ITEM
2. "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS" for discussion of the proposed acquisition of TCI and IORI by ARI.
Set forth below are summarized results of operations of equity investees for the
nine months ended September 30, 2002:
Revenues ................................................... $ 93,156
Equity in loss of partnerships ............................. (1,344)
Property operating expenses ................................ 73,747
Depreciation ............................................... 15,476
Interest expense ........................................... 30,921
Loss from discontinued operations .......................... (1,587)
---------
Loss before gains on sale of real estate ................... (29,919)
Gain on sale of real estate ................................ 32,884
---------
Net income ................................................. $ 2,965
=========
ARI's share of equity investees' loss before gains on the sale of real estate
was $14.1 million for the nine months ended September 30, 2002, and its share of
equity investees' gains on sale of real estate was $14.9 million for the nine
months ended September 30, 2002.
17
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 5. INVESTMENTS IN EQUITY INVESTEES (Continued)
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.
Realty Advisors - Korea. In June 2002, ARI purchased BCM's investment in Realty
Advisors - Korea for $6.0 million. The purchase price was based on the fair
value of the interests, which was determined by management and approved by the
respective boards of directors, based on expected management fees that will be
collected. The business purpose of this transaction was to reduce the affiliate
payable owed by BCM to ARI. ARI's receivable from BCM was reduced by $6.0
million, and no cash was paid by ARI.
ART Florida Portfolio II, Ltd. In January 2002, Investors Choice Florida Public
Funds II, in which ART Florida Portfolio II, Ltd. owned an interest, sold Villas
Continental Apartments. ARI received $1.0 million in cash from the sale. ARI's
share of the loss incurred on the sale was $531,000, which is included in loss
on sale of investments in equity investees in the accompanying Consolidated
Statements of Operations.
NOTE 6. 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 portfolio and are
carried at market value. In the first nine months of 2002, ARI did not purchase
or sell any such securities. At September 30, 2002, ARI recognized an unrealized
decrease in the market value of its trading portfolio securities of $28,000.
Unrealized and realized gains and losses on trading portfolio securities are
included in other income in the accompanying Consolidated Statements of
Operations.
NOTE 7. NOTES PAYABLE
In 2002, ARI financed/refinanced or obtained second mortgage financing on the
following:
Units/ 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
Shopping Center
Plaza on Bachman
Creek Dallas, TX 80,278 Sq.Ft. 5,000 -- 4,444 6.625 /(1)/ 04/04
Second Quarter
Apartments
Lee Hills Tallahassee, FL 16 Units 1,750 /(2)/ 117 590 6.625 /(1)/ 06/05
Valley Hi Tallahassee, FL 54 Units -- /(2)/ 878 -- -- --
White Pines Tallahassee, FL 85 Units -- /(2)/ -- -- -- --
18
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 7. NOTES PAYABLE (Continued)
Units/ Debt Debt Net Cash Interest Maturity
Property Location Acres/Sq.Ft. Incurred Discharged Received Rate Date
---------------- ---------------- ------------ ---------- ---------- -------- -------- --------
Second Quarter -
Continued
Office Buildings
Four Hickory
Centre Farmers Branch, TX 221,000 Sq.Ft. $ 12,500 /(3)/ $ -- $ 3,399 13.000% 05/03
Fourth Quarter
Shopping Center
University Square Anchorage, AK 22,260 Sq.Ft. 1,250 -- 1,229 8.500 /(1)/ 10/17
Related Party Transactions. In each of the following transactions, except those
footnoted as (6), 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 Units/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 /(4)/
Two Hickory
Centre Farmers Branch, TX 96,127 Sq.Ft. 4,448 -- 4,448 12.000 01/05 /(5)/
Second Quarter
Apartments
Bay Anchor Panama City, FL 12 Units 255 -- 203 5.000 05/03 /(6)/
Confederate Point Jacksonville, FL 206 Units 1,929 -- -- 12.000 04/05 /(7)/
Foxwood Memphis, TN 220 Units 1,093 -- -- 12.000 04/05 /(8)/
Governor Square Tallahassee, FL 168 Units 4,480 3,196 611 7.120 05/07 /(6)/
Grand Lagoon Panama City, FL 54 Units 2,083 1,209 655 5.000 05/03 /(6)/
Oak Hill Tallahassee, FL 92 Units 2,550 1,875 478 5.000 05/03 /(6)(10)/
Park Avenue Tallahassee, FL 121 Units 4,400 2,756 1,341 7.120 05/07 /(6)/
Seville Tallahassee, FL 62 Units 1,955 1,263 473 5.000 05/03 /(6)/
Westwood Mary Ester, FL 120 Units 3,382 2,327 1,023 7.570 05/12 /(6)/
Windsor Tower Ocala, FL 64 Units 1,989 1,128 702 5.000 05/03 /(6)/
Woodhollow San Antonio, TX 546 Units 8,160 5,349 2,775 7.120 05/07 /(6)/
Woodsong Smyrna, GA 190 Units 2,544 -- -- 12.000 04/05 /(9)/
Office Building
One Hickory Centre Farmers Branch, TX 102,615 Sq.Ft. 4,468 -- -- 12.000 04/05 /(11)/
----------------
(1) Variable interest rate.
(2) Single note with all properties as collateral.
(3) $10.1 million funded at September 30, 2002.
(4) IORI, a related party, 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
19
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 7. NOTES PAYABLE (Continued)
market rate multiple of net operating income. Rosedale owns 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.
(5) TCI, a related party, 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.
(6) Properties sold to partnerships controlled by Metra Capital, LLC
("Metra"). Innovo Group, Inc. ("Innovo") is a limited partner in the
partnerships that purchased the properties. Joseph Mizrachi, a Director
of ARI, controls approximately 11.67% of the outstanding common stock of
Innovo. Management has determined to treat this sale as a refinancing
transaction. ARI will continue to report the assets and the new debt
incurred by Metra on its financial statements. ARI also received $6.3
million of 8% non-recourse, non-convertible Series A Preferred Stock
("Preferred Shares") of Innovo.
The dividend on the Preferred Shares will be funded entirely and solely
through member distributions from cash flows generated by the operation
and subsequent sale of the sold properties. In the event the cash flows
for the properties are insufficient to cover the 8% annual dividend,
Innovo will have no obligation to cover any shortfall.
The Preferred Shares have a mandatory redemption feature, and are
redeemable from the cash proceeds received by Innovo from the operation
and sale of the properties. All member distributions that are in excess
of current and accrued 8% dividends must be used by Innovo to redeem the
Preferred Shares. Since redemption of these shares is subject to the
above future events, management has elected to record no basis in the
Preferred Shares.
(7) TCI, a related party, purchased all of the general and limited
partnership interests in Garden Confederate Point, L.P. ("Confederate
Point") from ARI for $1.9 million. The purchase price was determined
based upon the market value of the property, using a market rate
multiple of net operating income. Confederate Point owns the Confederate
Point Apartments. The business purpose of this transaction was for TCI
to make an equity investment in Confederate Point, anticipating a
profitable return, and for ARI to receive a return on its equity
investment.
20
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 7. NOTES PAYABLE (Continued)
(8) TCI, a related party, purchased all of the general and limited partnership
interests in Garden Foxwood, L.P. ("Foxwood") from ARI for $1.1 million.
The purchase price was determined based upon the market value of the
property, using a market rate multiple of net operating income. Foxwood
owns the Foxwood Apartments. The business purpose of this transaction was
for TCI to make an equity investment in Foxwood, anticipating a profitable
return, and for ARI to receive a return on its equity investment.
(9) TCI, a related party, purchased all of the general and limited partnership
interests in Garden Woodsong, L.P. ("Woodsong") from ARI for $2.5 million.
The purchase price was determined based upon the market value of the
property, using a market rate multiple of net operating income. Woodsong
owns the Woodsong Apartments. The business purpose of this transaction was
for TCI to make an equity investment in Woodsong, anticipating a profitable
return, and for ARI to receive a return on its equity investment. TCI sold
the Woodsong Apartments in July 2002.
(10) Sold to unrelated buyer in June 2002.
(11) TCI, a related party, purchased 100% of the common shares of ART One
Hickory Corporation ("One Hickory"), a wholly-owned subsidiary of ARI, for
$4.5 million. The purchase price was determined based upon the market value
of the property, using a market rate multiple of net operating income. One
Hickory owns the One Hickory Centre Office Building. The business purpose
of this transaction was for TCI to make an equity investment in One
Hickory, anticipating a profitable return, and for ARI to receive a return
on its equity investment.
In 2001, ARI financed/refinanced or obtained second mortgage financing on the
following:
Debt
Acres/Rooms/ Debt Discharged/ Net Cash Interest Maturity
Property Location Sq.Ft. Incurred (Paid) Received Rate Date
-------- -------- ------ -------- ------ -------- ---- ----
First Quarter
Land
Mason/Goodrich Houston, TX 235.0 Acres $ 6,750 $ -- $ 6,302 14.00% 01/02
Pioneer Crossing Austin, TX 350.1 Acres 7,000 -- 6,855 16.90 03/05
Pioneer Crossing Austin, TX 14.5 Acres 2,500 -- 2,350 14.50 01/02
Second Quarter
Land
Hollywood Casino Farmers Branch, TX 51.7 Acres 2,500/(1)/ -- 1,916 9.00 04/03
Valwood Dallas County, TX 19.4 Acres --/(1)/ -- -- -- --
Katrina Palm Desert, CA 300.5 Acres 22,000 15,584 4,417 12.50/(2)/ 10/01
Jeffries Ranch Oceanside, CA 82.4 Acres 5,250/(3)/ 750 3,944 14.50 06/02
Willow Springs Riverside, CA 1,485.7 Acres --/(3)/ -- -- -- --
Hotel
Williamsburg
Hospitality House Williamsburg, VA/(4)/ 296 Rooms 10,309 -- 9,851 36.00 01/02
21
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 7. NOTES PAYABLE (Continued)
Net Cash
Acres/Rooms/ Debt Debt Received/ Interest Maturity
Property Location Sq.Ft. Incurred Discharged (Paid) Rate Date
-------- -------- ------ -------- ---------- ---- ---- ----
Second Quarter - Continued
Shopping Center
Cullman Cullman, AL 92,486 Sq.Ft. $ --/(3)/ $ 129 $ -- -- --
Third Quarter
Apartments
Sun Hollow El Paso, TX 216 Units --/(5)/ -- -- -- --
Waters Edge III Gulfport, MS 238 Units --/(5)/ -- -- -- --
Woodlake Carrollton, TX 256 Units --/(5)/ -- -- -- --
Office Building
Centura Tower Farmers Branch, TX 410,910 Sq.Ft. 28,739 28,384 (526) 10.50% 07/02
Rosedale Towers Minneapolis, MN 84,798 Sq.Ft. 7,500/(5)/ -- 7,500 5.00 07/02
Land
Chase Oaks Plano, TX 6.9 Acres 1,633 1,000 425 13.00 03/03
Marine Creek Fort Worth, TX 54.2 Acres 1,500 750 701 9.00 01/03
Mercer Crossing Carrollton, TX 31.3 Acres 2,937 1,986 16 13.00 03/03
Vista Ridge Lewisville, TX 90.3 Acres 9,085 9,119 (101) 13.00 03/03
Vista Ridge Lewisville, TX 23.0 Acres 1,345 1,000 228 13.00 03/03
---------------------
(1) Single note, with both properties as collateral.
(2) Variable interest rate.
(3) Single note, with all properties as collateral.
(4) Also secured by 1,846,000 shares of TCI common stock.
(5) Single note, with all properties as collateral.
In August 2002, the lender on one of ARI's hotel properties notified ARI that
ARI was in default under the provisions of the loan agreement regarding timely
payment and debt service coverage ratio. ARI is negotiating with the lender and
expects to resolve the issue.
NOTE 8. 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 $11.0
million at September 30, 2002.
In April 2000, ARI obtained a security loan in the amount of $5.0 million from a
financial institution. ARI received net cash of $4.6 million after paying
various closing costs. The loan bore interest at 1% over the prime rate,
currently 5.25% per annum, required monthly payments of interest and matured in
September 2002. In September 2002, the interest rate was increased to 7.00% per
annum, and the maturity date was extended to February 2003. The loan is secured
by 1,050,000 shares of ARI Common Stock held by BCM, ARI's advisor.
22
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 8. MARGIN BORROWINGS (Continued)
In March 2001, ARI obtained a security loan in the amount of $3.5 million from a
financial institution. ARI received net cash of $3.5 million after paying
various closing costs. The loan bore interest at 16.0% per annum. In April and
May 2001, a total of $2.0 million in principal paydowns were made. In July 2001,
the loan was repaid in full, including accrued but unpaid interest. The loan was
secured by 472,000 shares of TCI common stock owned by ARI and 128,000 shares of
ARI Common Stock owned by One Realco.
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 bore interest at 24% per annum, while the remaining
$500,000 bore interest at 20% per annum. The loan required monthly payments of
interest only and matured in September 2002. In September 2002, $15.0 million of
the principal was repaid. The loan is secured by 2,602,608 shares of TCI common
stock held by ARI and 920,507 shares of TCI common stock held by BCM, ARI's
advisor.
In October 2001, ARI obtained a security loan in the amount of $1.0 million from
a financial institution. ARI received net cash of $1.0 million after payment of
various closing costs. 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 9. INCOME TAXES
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 or provision for income taxes in the nine months ended
September 30, 2002 or 2001.
NOTE 10. 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 $2.0 million and $858,000 for the three
and nine months ended September 30, 2002 and $3.4 million and
23
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 10. OPERATING SEGMENTS (Continued)
$9.2 million for 2001. Expenses that are not reflected in the segments are
general and administrative expenses, minority interest, incentive fees, advisory
fees, net income fees, provision for loss and discontinued operations, which
totaled $6.2 million and $20.8 million for the three and nine months ended
September 30, 2002 and $9.4 million and $31.2 million for 2001. Excluded from
operating segment assets are assets of $125.8 million in 2002 and $119.9 million
in 2001, 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, which is located in
Bulgaria.
Presented below are ARI's reportable segments operating income for the three and
nine months ended September 30, 2002 and 2001, and segment assets at September
30, 2002 and 2001.
Inter-
Three Months Ended Commercial U.S. national Pizza Receivables/
September 30, 2002 Properties Apartments Hotels Hotels Land Parlors Other Total
------------------ ---------- ---------- ------ ------ ---- ------- ----- -----
Operating revenue ......... $ 7,300 $ 9,073 $ 8,926 $ 1,250 $ 15 $ 9,274 $ (19) $ 35,819
Interest income ........... -- -- -- -- -- -- 509 509
Operating expenses ........ 4,030 6,129 6,315 675 1,358 7,645 18 26,170
-------- ------- ------- ------- -------- -------- -------- --------
Operating income (loss) ... $ 3,270 $ 2,944 $ 2,611 $ 575 $ (1,343) $ 1,629 $ 472 $ 10,158
======== ======= ======= ======= ======== ======== ======== ========
Depreciation .............. $ 1,323 $ 786 $ 776 $ 221 $ -- $ 295 $ 2 $ 3,403
Interest .................. 2,202 2,329 1,088 338 4,617 212 2,870 13,656
Capital expenditures ...... 5,194 211 387 -- 759 810 -- 7,361
Assets .................... 139,870 92,294 66,488 23,596 181,791 21,877 43,379 569,295
Property Sales: Apartments Land Total
---------- ---- -----
Sales price .......... $28,072 $ 18,681 $ 46,753
Cost of sale ......... 12,697 16,063 28,760
------- -------- --------
Gain on sale ......... $15,375 $ 2,618/(1)/ $ 17,993
======= ======= ========
---------------------------
(1) Includes $34,000 gain recognized in September 2002 upon the sale of land by
TCI to an unrelated party. The gain was deferred in June 2002 when the land
was sold to TCI by ARI.
Inter-
Nine Months Ended Commercial U.S. national Pizza Receivables/
September 30, 2002 Properties Apartments Hotels Hotels Land Parlors Other Total
------------------ ---------- ---------- ------ ------ ---- ------- ----- -----
Operating revenue ......... $ 23,310 $25,810 $24,628 $ 3,718 $ 76 $ 27,550 $ 424 $105,516
Interest income ........... -- -- -- -- -- -- 1,906 1,906
Operating expenses ........ 13,644 16,351 17,734 1,998 5,438 22,392 141 77,698
-------- ------- ------- ------- -------- -------- -------- --------
Operating income (loss) ... $ 9,666 $ 9,459 $ 6,894 $ 1,720 $ (5,362) $ 5,158 $ 2,189 $ 29,724
======== ======= ======= ======= ======== ======== ======== ========
Depreciation .............. $ 3,674 $ 2,279 $ 1,939 $ 1,128 $ -- $ 835 $ 6 $ 9,861
Interest .................. 8,268 8,093 3,211 368 16,013 631 9,167 45,751
Capital expenditures ...... 12,227 759 745 -- 2,064 2,034 -- 17,829
Assets .................... 139,870 92,294 66,488 23,596 181,791 21,877 43,379 569,295
24
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 10. OPERATING SEGMENTS (Continued)
Commercial
Property Sales: Properties Apartments Land Total
---------- ---------- ---- -----
Sales price ................ $ 52,302 $ 50,769 $ 39,382 $ 142,453
Cost of sale ............... 52,302 27,629 33,401 113,332
--------- --------- -------- ---------
Gain on sale ............... $ -- $ 23,140 $ 5,981/(1)/ $ 29,121
========= ========= ======== =========
--------------------------
(1) Includes $830,000 gain recognized in 2002 upon collection of note
receivable for 2001 land sale.
Inter-
Three Months Ended Commercial U.S. national Pizza Receivables/
September 30, 2001 Properties Apartments Hotels Hotels Land Parlors Other Total
------------------ ---------- ---------- ------ ------ ---- ------- ----- -----
Operating revenue .......... $ 7,783 $ 10,919 $ 8,750 $ 1,283 $ 40 $ 8,723 $ 193 $ 37,691
Interest income ............ -- -- -- -- -- -- 837 837
Operating expenses ......... 4,036 7,739 4,283 1,396 2,206 7,164 8 26,832
--------- --------- -------- ------- -------- -------- -------- ---------
Operating income (loss) .... $ 3,747 $ 3,180 $ 4,467 $ (113) $ (2,166) $ 1,559 $ 1,022 $ 11,696
========= ========= ======== ======= ======== ======== ======== =========
Depreciation ............... $ 1,229 $ 879 $ 629 $ 554 $ -- $ 345 $ 19 $ 3,655
Interest ................... 2,662 2,684 1,102 325 7,940 932 1,462 17,107
Capital expenditures ....... 5,700 -- 116 -- 1,006 303 -- 7,125
Assets ..................... 166,811 115,326 68,024 25,952 228,476 21,626 34,284 660,499
Property Sales: Apartments Land Total
---------- ---- -----
Sales price ................ $ 28,175 $ 8,229 $ 36,404
Cost of sale ............... 15,841 4,682 20,523
--------- -------- ---------
Gain on sale ............... $ 12,334 $ 3,547 $ 15,881
========= ======== =========
Inter-
Nine Months Ended Commercial U.S. national Pizza Receivables/
September 30, 2001 Properties Apartments Hotels Hotels Land Parlors Other Total
------------------ ---------- ---------- ------ ------ ---- ------- ----- -----
Operating revenue .......... $ 22,635 $ 36,860 $ 24,688 $ 3,009 $ 145 $ 25,282 $ 485 $ 113,104
Interest income ............ -- -- -- -- -- -- 1,997 1,997
Operating expenses ......... 12,432 23,583 18,781 2,821 6,750 20,715 86 85,168
--------- --------- -------- ------- -------- -------- -------- ---------
Operating income (loss) .... $ 10,203 $ 13,277 $ 5,907 $ 188 $ (6,605) $ 4,567 $ 2,396 $ 29,933
========= ========= ======== ======= ======== ======== ======== =========
Depreciation ............... $ 3,691 $ 2,948 $ 1,938 $ 1,204 $ -- $ 931 $ 24 $ 10,736
Interest ................... 8,206 11,843 3,375 519 21,308 741 3,801 49,793
Capital expenditures ....... 10,511 20 436 1,000 1,322 1,066 361 14,716
Assets ..................... 166,811 115,326 68,024 25,952 228,476 21,626 34,284 660,499
Commercial
Property Sales: Properties Apartments Land Total
---------- ---------- ---- -----
Sales price ................ $ 7,350 $ 94,065 $ 41,806 $ 143,221
Cost of sale ............... 5,058 41,757 33,546 80,361
--------- --------- -------- ---------
Gain on sale ............... $ 2,292 $ 52,308 $ 8,260 $ 62,860
========= ========= ======== =========
NOTE 11. DISCONTINUED OPERATIONS
Effective January 1, 2002, ARI adopted Statement of Financial Accounting
Standards 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
25
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 11. DISCONTINUED OPERATIONS (Continued)
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 and nine months ended September 30, 2002 and 2001, income from
discontinued operations relates to 15 properties and leasehold interest in oil
and gas properties that ARI sold during the first nine months of 2002. The
following table summarizes revenue and expense information for these properties
sold and held-for-sale.
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
----------------------- ----------------------
Revenue 2002 2001 2002 2001
-------- ------- ------- -------
Rental ............................................. $ 574 $ 3,841 $ 7,553 $11,023
Property operations ................................ 760 2,670 4,514 6,979
-------- ------- ------- -------
(186) 1,171 3,039 4,044
Expenses
Interest ........................................... 189 1,954 5,050 6,449
Depreciation ....................................... 59 835 1,688 2,433
-------- ------- ------- -------
248 2,789 6,738 8,882
-------- ------- ------- -------
Net loss from discontinued operations ................ (434) (1,618) (3,699) (4,838)
Gain on sale of real estate ........................ 15,375 -- 23,140 --
Equity in gain on sale of real estate by
equity investees ................................ 6,616 -- 14,896 --
-------- ------- ------- -------
Net income (loss) from discontinued operations ....... $ 21,557 $(1,618) $34,337 $(4,838)
======== ======= ======= =======
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 12. COMMITMENTS AND CONTINGENCIES
Liquidity. Management expects that cash generated from operations during the
remainder of 2002 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. In March 1999, ARI reached an agreement with the Class A
unitholders of Valley Ranch, L.P. to acquire their eight million Class A units
for $1.00 per unit. In 1999, three million units were purchased. Additionally,
one million units were purchased in January 2000, two million units were
purchased in May 2001 and one million units were purchased in May 2002. The
remaining one million units were purchased in August 2002.
Litigation. In August 2002, ARI obtained a favorable jury verdict in the legal
action entitled American Realty Trust v. Matisse. However,
26
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 12. COMMITMENTS AND CONTINGENCIES (Continued)
the judge set aside the jury verdict and imposed a judgment against ARI in
excess of $6.0 million. 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 addition to the Matisse litigation, and the Olive litigation as discussed in
ITEM 2. "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS," ARI is involved in various lawsuits arising in the ordinary
course of business. In the opinion of ARI's management, the outcome of these
lawsuits will not have a material impact on ARI's financial condition, results
of operations or liquidity.
NOTE 13. GOODWILL AND OTHER INTANGIBLES - ADOPTION OF SFAS 142
In June 2001, the Financial Accounting Standards Board finalized Statement of
Financial Accounting Standards No. 141, "Business Combinations" ("SFAS 141"),
and No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 141
requires the use of the purchase method of accounting and prohibits the use of
the pooling-of-interests method of accounting for business combinations
initiated after June 30, 2001. SFAS 141 also requires that ARI recognize
acquired intangible assets apart from goodwill if the acquired intangible assets
meet certain criteria. SFAS 141 applies to all business combinations initiated
after June 30, 2001. It also requires, upon adoption of SFAS 142, that ARI
reclassify the carrying amounts of intangible assets and goodwill based on the
criteria in SFAS 141.
SFAS 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS 142 requires that ARI identify reporting units in order to assess
potential future impairment of goodwill, reassess the useful lives of other
existing recognized intangible assets, and cease amortization of intangible
assets with an indefinite useful life. SFAS 142 requires that an intangible
asset with an indefinite useful life be tested for impairment in accordance with
specified guidelines. SFAS 142 is required to be applied in fiscal years
beginning after December 15, 2001 to all goodwill and other intangible assets
recognized at that date, regardless of when those assets were initially
recognized. SFAS 142 required ARI to complete a transitional goodwill impairment
test six months from the date of adoption. ARI was also required to reassess the
useful lives of other intangible assets within the first interim quarter after
adoption of SFAS 142.
The adoption of SFAS 141 did not have a material impact on ARI's results of
operations and financial position. ARI adopted SFAS 142 on January 1, 2002, and
accordingly ceased amortizing costs in excess of net assets acquired. In
connection with the adoption of SFAS 142, ARI completed
27
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 13. GOODWILL AND OTHER INTANGIBLES - ADOPTION OF SFAS 142 (Continued)
the first step of the goodwill impairment test during the quarter ended June 30,
2002. Based on the results of this step, ARI believes that the fair value of its
reporting unit that carries goodwill exceeds its carrying amount. Since the
first step of the goodwill impairment test indicates that goodwill is not
impaired, the second step of the goodwill impairment test is not necessary.
Transitional Disclosures. Net income (loss) applicable to Common shares and
earnings per share, including the after-tax effect of amortization expense
related to costs in excess of net assets acquired for the three and nine months
ended September 30, 2002 and 2001 are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
2002 2001 2002 2001
-------- -------- -------- --------
Net income (loss) applicable to Common shares .................. $ 6,297 $ 446 $(18,478) $ 10,121
Add back:
Amortization of costs in excess of net assets acquired ...... -- 89 -- 259
-------- -------- -------- --------
Adjusted net income (loss) applicable to Common shares ......... $ 6,297 $ 535 $(18,478) $ 10,380
======== ======== ======== ========
Earnings per share:
Net income (loss) applicable to Common shares ............... $ .55 $ .04 $ (1.62) $ 1.00
Amortization of costs in excess of net assets acquired ...... -- .01 -- .02
-------- -------- -------- --------
Adjusted net income (loss) applicable to Common shares ...... $ .55 $ .05 $ (1.62) $ 1.02
======== ======== ======== ========
Acquisitions. ARI made no acquisitions resulting in goodwill during the three
and nine months ended September 30, 2002 and 2001.
Intangible Assets not Subject to Amortization. The carrying value of ARI's costs
in excess of net assets acquired is as follows:
September 30, December 31,
2002 2001
-------------- -------------
Costs in excess of net assets acquired, net of accumulated
amortization of $1,763 in 2002 and 2001 ........................... $ 11,858 $ 11,858
======== ========
NOTE 14. DERIVATIVE FINANCIAL INSTRUMENTS
During the first quarter of 2002, ARI entered into an interest rate swap
agreement with a bank. This agreement contains a notional amount of $13.1
million and requires ARI to pay the bank a fixed rate of 4.3%, and requires the
bank to pay to ARI based on the 30 day LIBOR rate. This agreement was entered
into in order to effectively fix the rate on ARI's debt associated with the
Lakeshore Villas property. The swap agreement expires on December 25, 2004.
ARI has not designated the interest rate swap agreement as a hedge, as defined
within Statement of Financial Accounting Standards No. 133,
28
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 14. DERIVATIVE FINANCIAL INSTRUMENTS (Continued)
"Accounting for Derivative Instruments and Hedging Activities," and, as such,
changes in the fair value of the swap agreement are recognized in earnings
during the period of change and reflected in the statement of operations as
interest expense.
The fair value of the swap agreement at September 30, 2002 represents a
liability to ARI of $614,000 and is included within other liabilities in the
accompanying balance sheet. Amounts paid or received under the swap agreement
are settled monthly and are reflected as a reduction in the liability when paid.
Interest expense for the nine months ended September 30, 2002, was increased by
$813,000 representing both amounts paid to the bank under the agreement and
increases in the fair value of the related liability.
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 appreciation as
well as current income.
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. In February 2002, the court granted final approval
of the proposed settlement. Under the proposal, ARI will acquire all of the
outstanding common shares of IORI and TCI not currently owned by ARI for a cash
payment or shares of ARI preferred stock. ARI will pay $17.50 cash per TCI share
and $19.00 cash per IORI share for the stock held by non-affiliated
stockholders. ARI will issue one share of Series G Preferred Stock with a
liquidation value of $20.00 per share for each share of TCI Common Stock for
stockholders who affirmatively elect to receive ARI Preferred Stock in lieu of
cash. ARI will issue one share of Series H Preferred Stock with a liquidation
value of $21.50 per share for each share of IORI Common Stock for stockholders
who affirmatively elect to receive ARI Preferred Stock in lieu of cash. All
affiliated stockholders will receive ARI Preferred Stock. Each share of Series G
Preferred Stock will be convertible into 2.5 shares of ARI Common Stock, and
each share of Series H Preferred Stock will be convertible into 2.25 shares of
ARI Common Stock during a 75-day period that commences fifteen days after the
date of the first ARI Form 10-Q filing that occurs after the closing of the
merger transaction. Upon the acquisition of IORI and TCI shares, TCI and IORI
would become wholly-owned subsidiaries of ARI. The transaction is subject to the
negotiation of a definitive merger agreement and a vote of the shareholders of
all three entities. ARI has
29
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Introduction (Continued)
the same advisor as TCI and IORI, and TCI and IORI have the same board of
directors. Earl D. Cecil, a Director of ARI, is also a Director of TCI and IORI.
On November 7, 2002, ARI announced that it intends to commence, through
subsidiaries, a tender offer for shares of common stock of TCI and IORI. The
price per share to be paid will be $17.50 for TCI shares and $19.00 for IORI
shares. ARI has developed a financing plan, consisting primarily of new debt and
refinancing of existing debt. The tender offers are being made to cure a default
under the settlement resulting from ARI's failure to timely complete the SEC
review process of the registration statement for the proposed mergers with TCI
and IORI. ARI will defer further action on the mergers, pending completion of
the tender offers.
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. ARI's estimates of cash flow and fair
values of the properties are based 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
the information such 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
30
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Critical Accounting Policies (Continued)
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
General. Cash and cash equivalents at September 30, 2002, totaled $3.3 million,
compared with $709,000 at December 31, 2001. Although ARI anticipates that
during the remainder of 2002 it will generate cash from operations, as discussed
below, such excess cash is not sufficient to discharge all of ARI's debt
obligations as they mature. ARI will therefore again rely on externally
generated funds, including aggressive land sales, selected sales of income
producing properties, borrowings against its investments in various real estate
entities, refinancing of properties, and, to the extent necessary, borrowings to
meet its debt service obligations, pay taxes, interest and other non-property
related expenses.
At December 31, 2001, notes payable totaling $267.5 million had either scheduled
maturities or required principal reduction payments during 2002. During the
first nine months of 2002, ARI either extended, refinanced, paid down, paid off
or received commitments from lenders to extend or refinance $180.2 million of
the debt scheduled to mature in 2002.
Net cash used in operating activities decreased to $32.2 million in the nine
months ended September 30, 2002, from $39.2 million in the nine months ended
September 30, 2001. Fluctuations in the components of cash flow from operations
are discussed in the following paragraphs.
Net cash from property operations (rents collected less payments for expenses
applicable to rental income) increased to $26.9 million in the nine months ended
September 30, 2002 from $19.1 million in 2001. The increase was primarily
attributable to a decline in the payments for operating expenses in 2002 from an
elevated level in 2001, when there was a significant paydown of accounts
payable. ARI expects a decrease in cash flow from property operations during the
remainder of 2002. Such decrease is expected to result from the continued
selective sale of income producing properties.
Net cash from pizza operations (sales less cost of sales) increased to $4.9
million in the nine months ended September 30, 2002, from $4.3 million in 2001.
The increase was primarily attributable to the opening of three new stores
during 2001.
No net cash was used in oil and gas operations (sales collected less payments
for lease operating expenses) in the nine months ended September 30, 2002,
compared to a use of $175,000 in 2001. See NOTE 4. "OIL AND GAS OPERATIONS."
31
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
Interest collected increased to $979,000 in the nine months ended September 30,
2002, from $397,000 in 2001. The increase was primarily attributable to the
collection of $542,000 in past due interest.
Interest paid decreased to $42.6 million in the nine months ended September 30,
2002, from $45.7 million in 2001. The decrease was primarily attributable to
reduced mortgage balances as a result of property sales.
Advisory fees paid of $4.8 million in the nine months ended September 30, 2002,
approximated the $5.0 million in 2001.
No incentive fees were paid in the nine months ended September 30, 2002,
compared to $1.6 million in 2001.
General and administrative expenses paid increased to $9.8 million in the nine
months ended September 30, 2002 from $9.1 million in 2001. The increase is
primarily attributable to an increase in legal fees.
ARI's cash flow from its investments in IORI and TCI is dependent on the ability
of each of the entities to make distributions. In the fourth quarter of 2000,
IORI and TCI suspended distributions. Accordingly, ARI received no current
distributions in the first nine months of 2002 and 2001. However, in May 2001,
ARI received $53,000 in accumulated dividends on shares of Continental Mortgage
and Equity Trust that should have been exchanged for TCI Common Stock in 1999.
Other cash used in operating activities was $5.7 million in the nine months
ended September 30, 2002, compared to other cash from operations of $1.2 million
in 2001. The change was primarily attributable to a $2.7 million increase in
escrow deposits in 2002 compared to a $3.5 million decrease in 2001.
In the first nine months of 2002, ARI received a total of $5.5 million on the
collection of three mortgage notes receivable and partial paydown of three
mortgage notes receivable.
In 2002, ARI purchased the following property:
Units/ 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 $ -- $ -- -- --
Second Quarter
Apartments
Pinecrest/(2)/ North Augusta, SC 120 Units 2,979 -- 1,423/(3)/ 8.75% 03/03
Tiberon Trails/(2)/ Merrillville, IN 376 Units 12,336 -- 6,417/(3)/ 9.00 07/06
Shopping Center
Alta Mesa/(2)/ Ft. Worth, TX 59,933 Sq.Ft. 3,797 -- 1,804/(3)/ 10.43 10/04
32
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
Units/ Purchase Net Cash Debt Interest Maturity
Property Location Sq.Ft./Acres Price Paid Incurred Rate Date
---------- ---------- -------------- ---------- ---------- ---------- --------- ----------
Second Quarter - Continued
Land
Pioneer Crossing Austin, TX 79.4 Acres $1,165 $ 1,213 $ -- -- --
Willow Springs Beaumont, CA 20.7 Acres 140 146 -- -- --
(1) Exchanged with TCI, a related party, for the Oaktree Village Shopping
Center, Rasor land parcel and Lakeshore Villas land parcel.
(2) Property received from BCM, a related party, for forgiveness of debt.
The purchase price was determined using a market rate multiple of net
operating income.
(3) Assumed debt of seller.
In 2002, ARI sold the following properties:
Units/ Sales Net Cash Debt Gain/(Loss)
Property Location Acres/Sq.Ft. Price Received/(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)/ --
Second Quarter
Apartments
Oak Hill Tallahassee, FL 92 Units 3,200 156 /(4)/ 2,550 527
Regency Tampa, FL 78 Units 3,200 851 1,710 (1,458)
Stonebridge Florissant, MO 100 Units 4,340 1,142 2,893 3,081
Office Building
Centura Dallas, TX 410,901 Sq.Ft. 50,000 -- 43,739 /(3)/ -- /(5)/
Land
Hollywood Casino Farmers Branch, TX 42.8 Acres 16,987 -- 6,222 /(3)/ -- /(5)/
Marine Creek Ft. Worth, TX 54.2 Acres 3,700 -- 1,500 /(3)/ -- /(5)/
Mason Goodrich Houston, TX 7.9 Acres 672 46 554 268
Mason Goodrich Houston, TX 10.3 Acres 1,444 93 1,225 895
Mason Goodrich Houston, TX 18.0 Acres 2,790 -- 2,690 /(3)/ -- /(5)/
Monterrey Riverside, CA 61.0 Acres 4,625 -- -- 34 /(6)/
Nashville Nashville, TN 16.6 Acres 1,890 -- 955 /(3)/ -- /(5)/
Third Quarter
Apartments
Conradi House Tallahassee, FL 98 Units 1,809 388 1,047 452
Lee Hills Tallahassee, FL 16 Units 445 355 -- 131
Morning Star Tallahassee, FL 82 Units 2,217 718 1,187 638
Pheasant Ridge Bellevue, NE 264 Units 10,400 2,576 6,237 6,763
Stonegate Tallahassee, FL 83 Units 1,785 486 1,026 (124)
33
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/Sq.Ft. Price (Paid) Discharged on Sale
---------- ---------- -------------- --------- ---------- ------------ ------------
Third Quarter - Continued
Apartments - Continued
Valley Hi Tallahassee, FL 54 Units $ 1,452 $ 75 $ 1,159 $ 436
White Pines Tallahassee, FL 85 Units 764 10 593 (49)
Woodsong Smyrna, GA 190 Units 9,200 (45) 8,196 7,128
Land
Elm Fork Denton County, TX 14.5 Acres 2,745 (105) 2,633 1,615
Elm Fork Denton County, TX 14.2 Acres 1,526 (54) 701 527
Elm Fork Denton County, TX 16.7 Acres 1,617 (299) 1,554 429
Katrina Palm Desert, CA 80.0 Acres 6,778 (1,382) 2,500 (2,045)
Messick Palm Desert, CA 71.0 Acres 6,015 (163) 1,300 2,058
Fourth Quarter
Apartments
Daluce Tallahassee, FL 112 Units 3,634 779 2,491 /(3)/ 772
Office Building
Melrose Business Park Oklahoma City, OK 124,200 Sq.Ft. 1,890 953 817 1,408
Shopping Center
Alta Mesa Fort Worth, TX 59,933 Sq.Ft. 3,617 1,399 1,791 --
Land
Nashville Nashville, TN 1.0 Acres 140 (4) 125 73
Varner Road Riverside, CA 129.7 Acres 3,700 571 -- 1,413
(1) Exchanged for Governor's Square, Grand Lagoon, Park Avenue, Greenbriar,
Regency and Westwood Apartments.
(2) Exchanged with TCI, a related party, for the Plaza on Bachman Creek
Shopping Center.
(3) Debt assumed by purchaser.
(4) Represents dividends on and redemption of Innovo Preferred Stock. See NOTE
7. "NOTES PAYABLE."
(5) Sold to TCI, a related party. Gain deferred until sale to unrelated party.
(6) Sold to TCI, a related party. In September 2002, 36 acres sold to unrelated
party. Remaining gain deferred until sale to unrelated party.
In 2002, ARI financed/refinanced or obtained second mortgage financing on the
following:
Units/ 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
Shopping Center
Plaza on Bachman
Creek Dallas, TX 80,278 Sq.Ft. 5,000 -- 4,444 6.625 /(1)/ 04/04
34
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
Units/ Debt Debt Net Cash Interest Maturity
Property Location Acres/Sq.Ft. Incurred Discharged Received Rate Date
---------- ---------- -------------- ---------- ------------ ---------- --------- ---------
Second Quarter
Apartments
Lee Hills Tallahassee, FL 16 Units $1,750/(2)/ $ 117 $ 590 6.625%/(1)/ 06/05
Valley Hi Tallahassee, FL 54 Units --/(2)/ 878 -- -- --
White Pines Tallahassee, FL 85 Units --/(2)/ -- -- -- --
Office Buildings
Four Hickory Centre Farmers Branch, TX 221,000 Sq.Ft. 12,500/(3)/ -- 3,399 13.000 05/03
Fourth Quarter
Shopping Center
University Square Anchorage, AK 22,260 Sq.Ft. 1,250 -- 1,229 8.500/(1)/ 10/17
Related Party Transactions. In each of the following transactions, except those
footnoted as (6), 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 Units/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/(4)/
Two Hickory Centre Farmers Branch, TX 96,127 Sq.Ft. 4,448 -- 4,448 12.000 01/05/(5)/
Second Quarter
Apartments
Bay Anchor Panama City, FL 12 Units 255 -- 203 5.000 05/03/(6)/
Confederate Point Jacksonville, FL 206 Units 1,929 -- -- 12.000 04/05/(7)/
Foxwood Memphis, TN 220 Units 1,093 -- -- 12.000 04/05/(8)/
Governor Square Tallahassee, FL 168 Units 4,480 3,196 611 7.120 05/07/(6)/
Grand Lagoon Panama City, FL 54 Units 2,083 1,209 655 5.000 05/03/(6)/
Oak Hill Tallahassee, FL 92 Units 2,550 1,875 478 5.000 05/03/(6)(10)/
Park Avenue Tallahassee, FL 121 Units 4,400 2,756 1,341 7.120 05/07/(6)/
Seville Tallahassee, FL 62 Units 1,955 1,263 473 5.000 05/03/(6)/
Westwood Mary Ester, FL 120 Units 3,382 2,327 1,023 7.570 05/12/(6)/
Windsor Tower Ocala, FL 64 Units 1,989 1,128 702 5.000 05/03/(6)/
Woodhollow San Antonio, TX 546 Units 8,160 5,349 2,775 7.120 05/07/(6)/
Woodsong Smyrna, GA 190 Units 2,544 -- -- 12.000 04/05/(9)/
Office Building
One Hickory Centre Farmers Branch, TX 102,615 Sq.Ft. 4,468 -- -- 12.000 04/05/(11)/
-----------------
(1) Variable interest rate.
(2) Single note with all properties as collateral.
35
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
(3) $10.1 million funded at September 30, 2002.
(4) IORI, a related party, 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 owns 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.
(5) TCI, a related party, 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.
(6) Properties sold to partnerships controlled by Metra Capital, LLC ("Metra").
Innovo Group, Inc. ("Innovo") is a limited partner in the partnerships that
purchased the properties. Joseph Mizrachi, a Director of ARI, controls
approximately 11.67% of the outstanding common stock of Innovo. Management
has determined to treat this sale as a refinancing transaction. ARI will
continue to report the assets and the new debt incurred by Metra on its
financial statements. ARI also received $6.3 million of 8% non-recourse,
non-convertible Series A Preferred Stock ("Preferred Shares") of Innovo.
The dividend on the Preferred Shares will be funded entirely and solely
through member distributions from cash flows generated by the operation and
subsequent sale of the sold properties. In the event the cash flows for the
properties are insufficient to cover the 8% annual dividend, Innovo will
have no obligation to cover any shortfall.
The Preferred Shares have a mandatory redemption feature, and are
redeemable from the cash proceeds received by Innovo from the operation and
sale of the properties. All member distributions that are in excess of
current and accrued 8% dividends must be used by Innovo to redeem the
Preferred Shares. Since redemption of these shares is subject to the above
future events, management has elected to record no basis in the Preferred
Shares.
(7) TCI, a related party, purchased all of the general and limited partnership
interests in Garden Confederate Point, L.P. ("Confederate Point") from ARI
for $1.9 million. The purchase
36
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
price was determined based upon the market value of the property, using a
market rate multiple of net operating income. Confederate Point owns the
Confederate Point Apartments. The business purpose of this transaction was
for TCI to make an equity investment in Confederate Point, anticipating a
profitable return, and for ARI to receive a return for its equity
investment.
(8) TCI, a related party, purchased all of the general and limited partnership
interests in Garden Foxwood, L.P. ("Foxwood") from ARI for $1.1 million.
The purchase price was determined based upon the market value of the
property, using a market rate multiple of net operating income. Foxwood
owns the Foxwood Apartments. The business purpose of this transaction was
for TCI to make an equity investment in Foxwood, anticipating a profitable
return, and for ARI to receive a return for its equity investment.
(9) TCI, a related party, purchased all of the general and limited partnership
interests in Garden Woodsong, L.P. ("Woodsong") from ARI for $2.5 million.
The purchase price was determined based upon the market value of the
property, using a market rate multiple of net operating income. Woodsong
owns the Woodsong Apartments. The business purpose of this transaction was
for TCI to make an equity investment in Woodsong, anticipating a profitable
return, and for ARI to receive a return for its equity investment. TCI sold
the Woodsong Apartments in July 2002.
(10) Sold to unrelated buyer in June 2002.
(11) TCI, a related party, purchased 100% of the common shares of ART One
Hickory Corporation ("One Hickory"), a wholly-owned subsidiary of ARI, for
$4.5 million. The purchase price was determined based upon the market value
of the property, using a market rate multiple of net operating income. One
Hickory owns the One Hickory Centre Office Building. The business purpose
of this transaction was for TCI to make an equity investment in One
Hickory, anticipating a profitable return, and for ARI to receive a return
for its equity investment.
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 $11.0
million at September 30, 2002.
Management expects that it will be necessary for ARI to sell $113.4 million,
$2.8 million and $7.0 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 is 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.
37
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
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 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.
Commitments and Contingencies
In March 1999, an agreement was reached with the Class A unitholders of Valley
Ranch, L.P. to acquire their eight million Class A units for $1.00 per unit. In
1999, three million units were purchased. Additionally, one million units were
purchased in January 2000, two million units were purchased in May 2001 and one
million units were purchased in May 2002. The remaining one million units were
purchased in August 2002.
In August 2002, ARI obtained a favorable jury verdict in the legal action
entitled American Realty Trust v. Matisse. However, the judge set aside the jury
verdict and imposed a judgment against ARI in excess of $6.0 million. 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.
Results of Operations
For the nine months ended September 30, 2002, ARI reported a net loss of $16.7
million, compared to net income of $12.0 million for the nine months ended
September 30, 2001. The primary factors contributing to ARI's net loss are
discussed in the following paragraphs.
Rents decreased to $26.5 million and $78.0 million in the three and nine months
ended September 30, 2002, from $29.0 million and $87.8 million in 2001. Rents
from commercial properties increased to $23.3 million for the nine months ended
September 30, 2002, from $22.6 million in 2001, rent from hotels increased to
$28.3 million in the nine months ended September 30, 2002, from $27.7 million in
2001 and rent from apartments decreased to $25.8 million in the nine months
ended September
38
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
Results of Operations (Continued)
30, 2002, from $36.9 million in 2001. The increase in commercial property rents
was primarily attributable to increased occupancy, the increase in hotel
property rents was primarily attributable to increases in occupancy and average
rate at Hotel Sofia in 2002 and the decrease in apartment rent was primarily
attributable to the sale of 17 apartments in 2001. Rental income is expected to
decrease in the remainder of 2002 as a result of continued property sales.
Property operations expense decreased to $18.5 million and $55.3 million in the
three and nine months ended September 30, 2002, from $19.7 million and $64.5
million in 2001. Property operations expense for commercial properties increased
to $13.6 million in the nine months ended September 30, 2002, from $12.4 million
in 2001. For hotels, property operations expense decreased to $19.7 million in
the nine months ended September 30, 2002, from $21.6 million in 2001. For land,
property operations expense decreased to $5.4 million in the nine months ended
September 30, 2002 from $6.7 million in 2001. For apartments, property
operations expense decreased to $16.4 million in the nine months ended September
30, 2002, from $23.6 million in 2001. The increase in commercial property
operations expense was primarily attributable to the acquisition of Plaza on
Bachman Creek in 2002. The decrease in hotel property operations expense was
primarily attributable to the over-estimation of expenses at Hotel Sofia in
2001. The decrease in land property operations expense was primarily
attributable to reduced professional services fees in 2002. The decrease in
apartment property operations expense was primarily attributable to the sale of
17 apartments in 2001. Property operations expense is expected to decrease in
the remainder of 2002 as a result of continued property sales.
Pizza parlor sales and cost of sales increased to $9.3 million and $7.6 million,
respectively, in the three months ended September 30, 2002 and $27.5 million and
$22.4 million for the nine months ended September 30, 2002 from $8.7 million and
$7.2 million, respectively, for the three months ended September 30, 2001 and
$25.3 million and $20.7 million for the nine months ended September 30, 2001.
The increase was primarily attributable to the opening of three new stores in
2001, plus an increase in same-store sales.
Interest income from notes receivable of $509,000 and $1.9 million in the three
and nine months ended September 30, 2002 approximated the $837,000 and $2.0
million in 2001.
Equity in loss of investees decreased to $(4.8) million and $(14.0) million in
the three and nine months ended September 30, 2002, from $(3.1) million and
$(8.4) million in 2001. The decrease was attributable to increased net losses
for TCI and IORI in 2002.
Loss on the sale of investments in equity investees increased to $531,000 for
the nine months ended September 30, 2002 from $387,000 in the nine months ended
September 30, 2001. See NOTE 5. "INVESTMENTS IN EQUITY INVESTEES."
39
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
Results of Operations (Continued)
Equity in gain on sale of real estate by equity investees decreased to $6.6
million and $14.9 million in the three and nine months ended September 30, 2002,
from $6.6 million and $18.0 million in 2001. The 2001 results are reported as a
component of net income (loss) from continuing operations, while the 2002
results are reported as a component of net income (loss) from discontinued
operations.
Other income increased to $190,000 and $516,000 in the three and nine months
ended September 30, 2002 from $(19,000) and $58,000 in the three and nine months
ended September 30, 2001. The increase was primarily attributable to service fee
income and dividends on and redemption of Innovo Preferred Stock. See NOTE 2.
"REAL ESTATE" and NOTE 7. "NOTES PAYABLE."
Interest expense decreased to $13.7 million and $45.8 million in the three and
nine months ended September 30, 2002, from $17.1 million and $49.8 million in
2001. The decrease was primarily attributable to the sale of 17 apartments in
2001. Also in the nine months ended September 30, 2002, ARI recognized
$813,000 loss on an interest rate swap contract. See NOTE 14. "DERIVATIVE
FINANCIAL INSTRUMENTS."
Depreciation and amortization expense decreased to $3.4 million and $9.9 million
in the three and nine months ended September 30, 2002, from $3.7 million and
$10.7 million in 2001. The decrease was primarily attributable to the sale of 17
apartments in 2001.
General and administrative expenses decreased to $3.3 million in the three
months ended September 30, 2002 from $4.6 million in 2001, and increased to $9.8
million in the nine months ended September 30, 2002 from $9.1 million in 2001.
The three month decrease was primarily attributable to reduced cost
reimbursements paid to the advisor. The nine month increase was primarily
attributable to increased legal fees.
Advisory fees of $1.6 million and $4.8 million in the three and nine months
ended September 30, 2002 approximated the $1.4 million and $5.0 million in 2001.
There was no net income fee to affiliate in the three and nine months ended
September 30, 2002 compared to $(1.1) million and $638,000 in the three and nine
months ended September 30, 2001. The income fee payable to ARI's advisor is 10%
of the annualized net income for the year, in excess of a 10% return on
shareholders' equity. At September 30, 2002, ARI's annualized net income is
below the 10% return threshold.
There was no incentive fee to affiliate in the three and nine months ended
September 30, 2002 compared to $1.6 million and $7.5 million in the three and
nine months ended September 30, 2001. The incentive fee is only due if ARI is
also subject to the net income fee. At September 2002, the net income fee
requirements are not met; therefore, no
40
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
Results of Operations (Continued)
incentive fee is due. 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 2002 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 $436,000 and $2.0 million in the three and nine
months ended September 30, 2002, from $1.0 million and $2.5 million in 2001. The
decrease is attributable to the repurchase of partnership units by ARI in 2001
and 2002.
Writedown of assets held for sale was $445,000 in the three and nine months
ended September 30, 2002. There was no asset writedown in 2001. The carrying
value of a shopping center in Fort Worth, Texas, sold in the fourth quarter of
2002, was reduced to its net realizable value.
Related Party Transactions
Historically, TCI, ARI, BCM and IORI have each engaged in and may continue to
engage in business transactions, including real estate partnerships, with
related parties. Management believes that all of the related party transactions
represented the best investments available at the time and were at least as
advantageous to ARI as could have been obtained from unrelated parties.
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.
41
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
At September 30, 2002, 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 ................................... $76,394 10.618% $ 764
======= =====
Total decrease in ARI's annual net income ........ $ 764
=====
Per share ........................................ $ .07
=====
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 August 30, 2002, was filed with respect
to ITEM 2. "ACQUISITION AND DISPOSITION OF ASSETS" and ITEM 7. "FINANCIAL
STATEMENTS AND EXHIBITS," which reports the disposition of 10 apartments,
two commercial properties and 14 land parcels.
42
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: March 4, 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)
43
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/A 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
44
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: March 4, 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)
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AMERICAN REALTY INVESTORS, INC.
EXHIBITS TO
QUARTERLY REPORT ON FORM 10-Q/A
For the Quarter ended September 30, 2002
Exhibit Page
Number Description Number
--------- ------------------------------------------------------------ ------
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 47
46