SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED SEPTEMBER 30, 2001 ------------------ Commission File Number 1-15663 ------- 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, 2001) 1
PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS - ----------------------------- The accompanying Consolidated Financial Statements have not been audited by independent certified public accountants but in the opinion of the management of American Realty Investors, Inc. ("ARI"), all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of consolidated results of operations, consolidated financial position and consolidated cash flows at the dates and for the periods indicated, have been included. AMERICAN REALTY INVESTORS, INC. CONSOLIDATED BALANCE SHEETS <TABLE> <CAPTION> September 30, December 31, 2001 2000 --------------- ------------- (dollars in thousands, Assets except per share) ------ <S> <C> <C> Real estate held for investment.......................... $ 506,680 $ 559,461 Less - accumulated depreciation.......................... <130,567> <148,690> ----------- ----------- 376,113 410,771 Real estate held for sale................................ 228,476 242,973 Notes and interest receivable Performing ($20,019 in 2001 and $9,684 in 2000 from affiliates)........................................ 23,914 13,346 Nonperforming ($6,768 in 2001 and $1,540 in 2000 from affiliates)................................... 7,885 3,062 ----------- ----------- 31,799 16,408 Less--allowance for estimated losses..................... <2,577> <2,577> ----------- ----------- 29,222 13,831 Pizza parlor equipment................................... 11,207 10,191 Less - accumulated depreciation.......................... <3,823> <3,164> ----------- ----------- 7,384 7,027 Leasehold interest - oil and gas properties.............. 4,719 -- Less - accumulated depletion............................. <1> -- ----------- ----------- 4,718 -- Oilfield equipment....................................... 361 -- Less - accumulated depreciation.......................... <17> -- ----------- ----------- 344 -- Marketable equity securities, at market value............ 108 153 Cash and cash equivalents................................ 5,014 4,177 Investments in equity investees.......................... 78,046 44,777 Intangibles, net of accumulated amortization ($2,566 in 2001 and $2,233 in 2000)........................... 15,883 16,075 Other assets............................................. 35,070 47,231 ----------- ----------- $ 780,378 $ 787,015 =========== =========== </TABLE> The accompanying notes are an integral part of these Consolidated Financial Statements. 2
AMERICAN REALTY INVESTORS, INC. CONSOLIDATED BALANCE SHEETS - Continued <TABLE> <CAPTION> September 30, December 31, 2001 2000 -------------------------- (dollars in thousands, except per share) <S> <C> <C> Liabilities and Stockholders' Equity ------------------------------------ Liabilities Notes and interest payable............................... $582,139 $616,331 Margin borrowings........................................ 28,703 13,485 Accounts payable and other liabilities ($13,251 in 2001 and $3,030 in 2000 to affiliate)................... 44,513 41,221 ---------- --------- 655,355 671,037 Minority interest........................................ 37,634 42,576 Series F, 3,968.75 shares in 2001 (liquidation preference $3,969)...................................... 3,969 -- Stockholders' equity Preferred Stock, $2.00 par value, authorized 50,000,000 shares, issued and outstanding Series A, 2,724,910 shares in 2001 and 2,721,332 2000 (liquidation preference $27,249)................. 4,850 4,843 Series E, 50,000 shares in 2001 and 2000 (liquidation preference $500)......................... 100 100 Common Stock, $.01 par value; authorized 100,000,000 shares, issued 11,830,127 shares in 2001 and 11,829,217 in 2000...................................... 118 118 Paid-in capital.......................................... 112,195 112,301 Accumulated (deficit).................................... (33,827) (43,943) Treasury stock at par, 1,637,000 shares in 2001 and 1,718,749 shares in 2000................................ (16) (17) ---------- --------- 83,420 73,402 ---------- --------- $780,378 $787,015 ========== ========= </TABLE> The accompanying notes are an integral part of these Consolidated Financial Statements. 3
AMERICAN REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS <TABLE> <CAPTION> For the Three Months For the Nine Months Ended September Ended September 30, ---------------------- ---------------------- 2001 2000 2001 2000 ---------- --------- ---------- ---------- (dollars in thousands, except per share) <S> <C> <C> <C> <C> Property revenue Rents....................................... $ 32,712 $ 34,708 $ 98,748 $ 105,211 Property operations expenses................ 22,152 23,776 71,246 70,451 --------- --------- --------- ---------- Operating income.......................... 10,560 10,932 27,502 34,760 Land operations Sales....................................... 8,229 89,285 41,806 108,238 Cost of sales............................... 4,682 65,674 33,546 81,116 --------- --------- --------- ---------- Gain on land sales........................ 3,547 23,611 8,260 27,122 Pizza parlor operations Sales....................................... 8,723 8,124 25,282 24,388 Cost of sales............................... 7,164 6,798 20,715 20,138 --------- --------- --------- ---------- Gross margin.............................. 1,559 1,326 4,567 4,250 Oil and gas operations Sales....................................... 97 -- 97 -- Operating expenses.......................... 186 -- 186 -- --------- --------- --------- ---------- Gross margin.............................. (89) -- (89) -- Income from operations........................ 15,577 35,869 40,240 66,132 Other income Interest income............................. 837 283 1,997 3,295 Equity in income of investees............... 3,452 2,577 9,157 2,873 Gain on sale of real estate................. 12,334 3,474 54,600 51,706 Other....................................... (19) 606 58 419 --------- --------- --------- ---------- 16,604 6,940 65,812 58,293 Other expenses Interest.................................... 19,061 19,580 56,242 60,153 Depreciation, depletion and amortization.............................. 4,490 4,001 13,169 12,909 General and administrative.................. 4,610 2,873 9,083 11,705 Advisory fee to affiliate................... 1,437 1,522 4,971 4,146 Net income fee to affiliate................. (1,128) -- 638 -- Incentive fee to affiliate.................. 1,642 -- 7,477 -- Minority interest........................... 1,003 4,953 2,483 32,219 --------- --------- --------- ---------- 31,115 32,929 94,063 121,132 --------- --------- --------- ---------- Income before income taxes.................... 1,066 9,880 11,989 3,293 Provision for income taxes.................... -- (1,652) -- (1,652) --------- --------- --------- ---------- Net income.................................... 1,066 8,228 11,989 1,641 Preferred dividend requirement................ (620) (590) (1,868) (1,661) --------- --------- --------- ---------- Net income (loss) applicable to Common shares............................. $ 446 $ 7,638 $ 10,121 $ (20) ========= ========= ========= ========== </TABLE> The accompanying notes are an integral part of these Consolidated Financial Statements. 4
AMERICAN REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS <TABLE> <CAPTION> For the Three Months For the Nine Months Ended September 30, Ended September 30, ------------------------ ----------------------- 2001 2000 2001 2000 ------------ ---------- ----------- ---------- (dollars in thousands, except per share) <S> <C> <C> <C> <C> Earnings per share Net income.................................... $ .04 $ .76 $ 1.00 $ -- =========== =========== =========== =========== Weighted average Common shares used in computing earnings per share............... 10,193,217 10,013,087 10,141,840 10,496,364 =========== =========== =========== =========== </TABLE> The accompanying notes are an integral part of these Consolidated Financial Statements. 5
AMERICAN REALTY INVESTORS, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY For the Nine Months Ended September 30, 2001 <TABLE> <CAPTION> Series A Series E Preferred Preferred Common Treasury Paid-in Accumulated Stockholders' Stock Stock Stock Stock Capital (Deficit) Equity --------- --------- ------ -------- --------- ----------- ------------- (dollars in thousands, except per share) <S> <C> <C> <C> <C> <C> <C> <C> Balance, January 1, 2001.............. $ 4,843 $ 100 $ 118 (17) $ 112,301 (43,943) $ 73,402 Preferred dividends Series A Preferred Stock ($.75 per share)........................... -- -- -- -- -- ( 1,846) (1,846) Series E Preferred Stock ($.45 per share)........................... -- -- -- -- -- (22) (22) Common Stock dividends (pre-merger)... -- -- -- -- -- (5) (5) Retirement of Treasury Stock.......... -- -- -- 1 (1) -- -- Repurchase of Common Stock............ -- -- -- -- (133) -- (133) Series A Preferred Stock issued....... 7 -- -- -- 28 -- 35 Net income............................ -- -- -- -- -- 11,989 11,989 --------- --------- ------ -------- --------- ---------- ---------- Balance, September 30, 2001........... $ 4,850 $ 100 $ 118 (16) $ 112,195 (33,827) $ 83,420 ========= ========= ====== ======== ========= ========== ========== </TABLE> The accompanying notes are an integral part of these Consolidated Financial Statements. 6
AMERICAN REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS <TABLE> <CAPTION> For the Nine Months Ended September 30, ------------------------ 2001 2000 ----------- ---------- (dollars in thousands) <S> <C> <C> Cash Flows From Operating Activities Rents collected................................................... $ 98,787 $ 105,131 Pizza parlor sales collected...................................... 25,075 24,422 Interest collected................................................ 397 4,553 Distributions received from equity investees' operating cash flow.............................................. 53 1,869 Payments for property operations.................................. (79,693) (81,625) Payments for pizza parlor operations.............................. (20,804) (20,030) Payments for oil and gas operations............................... (175) -- Interest paid..................................................... (45,691) (55,855) Advisory fee paid to affiliate.................................... (4,971) (4,146) Incentive fees paid to affiliate.................................. (1,646) -- Distributions to minority interest holders........................ (2,697) (6,159) General and administrative expenses paid.......................... (9,079) (11,705) Other............................................................. 1,239 10,110 ---------- ---------- Net cash (used in) operating activities........................ (39,205) (33,435) Cash Flows From Investing Activities Collections on notes receivable................................... 4,929 39,930 Pizza parlor equipment purchased.................................. (1,066) (1,120) Proceeds from sale of real estate................................. 102,415 125,218 Purchase of marketable equity securities.......................... -- (5,307) Proceeds from sale of marketable equity securities................ -- 5,170 Notes receivable funded........................................... (13,959) (17,260) Earnest money/escrow deposits..................................... (696) (5,424) Investment in real estate entities................................ (36,975) 3,828 Acquisition of real estate........................................ -- (19,015) Construction and development...................................... (3,771) (9,415) Real estate improvements.......................................... (9,518) (8,587) Acquisition of leasehold interests................................ (350) -- Purchase of oil field equipment................................... (361) -- ---------- ---------- Net cash provided by investing activities........................... 40,648 108,018 </TABLE> The accompanying notes are an integral part of these Consolidated Financial Statements. 7
AMERICAN REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS - Continued <TABLE> <CAPTION> For the Nine Months Ended September 30, ---------------------------- 2001 2000 ------------ ------------ (dollars in thousands) <S> <C> <C> Cash Flows from Financing Activities Proceeds from notes payable...................................... $ 136,832 $ 136,321 Payments on notes payable........................................ (144,314) (152,871) Deferred borrowing costs......................................... (7,633) (6,690) Net (payments) to/advances from affiliates....................... 1,028 (34,208) Issuance of Series E Preferred Stock............................. -- 500 Margin borrowings, net........................................... 15,073 (10,953) Preferred dividends paid......................................... (1,454) (1,661) Repurchase of Common Stock....................................... (133) (746) Common dividends paid............................................ (5) -- ------------ ---------- Net cash (used in) financing activities.................... (606) (70,308) Net increase in cash and cash equivalents.................. 837 4,275 Cash and cash equivalents, beginning of period..................... 4,177 2,479 ------------ ---------- Cash and cash equivalents, end of period........................... $ 5,014 $ 6,754 ============ ========== Reconciliation of net income to net cash (used in) operating activities Net income....................................................... $ 11,989 $ 1,641 Adjustments to reconcile net income to net cash (used in) operating activities Depreciation, depletion and amortization...................... 13,169 12,909 Gain on sale of real estate................................... (62,860) (78,828) Distributions from equity investees' operating cash flow.................................................. 53 1,869 Increase (decrease) in minority interest...................... (214) 26,060 Equity in (income) of investees............................... (9,157) (2,873) (Increase) decrease in accrued interest receivable (1,600) 1,258 Decrease in other assets...................................... 11,294 17,666 Increase/(decrease) in accrued interest payable............... 28 (3,723) (Decrease) in accounts payable and other liabilities (1,907) (9,414) ------------ ---------- Net cash (used in) operating activities.................... $ (39,205) $ (33,435) ============ ========== </TABLE> The accompanying notes are an integral part of these Consolidated Financial Statements. 8
AMERICAN REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS - Continued <TABLE> <CAPTION> For the Nine Months Ended September 30, -------------------------- 2001 2000 ---------- ------------ (dollars in thousands) <S> <C> <C> Schedule of noncash investing and financing activities Notes payable from acquisition of real estate.......................... $ 2,549 $ 6,262 Notes payable assumed by buyer on sale of properties................... 30,263 32,460 Notes receivable from sale of real estate.............................. 4,329 2,790 Exchange of real estate at carrying value.............................. 3,726 2,989 Common Stock issued in exchange for NRLP units......................... -- 25,817 Issuance of Series A Preferred Stock................................... 35 1,213 Issuance of Series F Preferred Stock................................... 3,969 -- Purchase accounting writedown.......................................... -- (35,846) </TABLE> 9
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 2000 have been reclassified to conform to the 2001 presentation. Operating results for the nine month period ended September 30, 2001, are not necessarily indicative of the results that may be expected for the year ending December 31, 2001. 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, 2000 (the "2000 Form 10-K"). NOTE 2. NOTES RECEIVABLE - -------------------------- In September 1999, in conjunction with the sale of two apartments, $2.1 million in purchase money financing was provided, secured by limited partnership interests in two limited partnerships owned by the buyer. The financing bore interest at 16.0% per annum, required monthly payments of interest only at 6.0%, beginning in February 2000 and a $200,000 principal paydown in December 1999, which was not received, and matured in August 2000. ARI had the option to obtain the buyer's general and limited partnership interests in the collateral partnerships in full satisfaction of the financing. In March 2000, ARI agreed to forbear foreclosing on the collateral securing the note, and released one of the partnership interests, in exchange for payment of $250,000 and executed deeds of trusts on certain properties owned by the borrower. In March 2000, the borrower made a $1.1 million payment, upon receipt of which ARI returned the deeds of trust and terminated the option agreement. The borrower executed a replacement promissory note for the remaining note balance of $1.0 million, which is unsecured, non-interest bearing and matures in April 2003. In April 2000, ARI funded a $100,000 loan to the borrower. The loan is secured by five second lien deeds of trust, is non-interest bearing and matured in September 2001. At November 2001, extension terms are being negotiated. In April 2000, a loan with a then 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. In February 2001, the principal balance was increased to $1.6 million, the interest rate was increased to 18.0% per annum, and the maturity date was extended to June 2001. At November 2001, extension terms are being negotiated. At December 31, 2000, a loan with a principal balance of $404,000 to La Quinta Partners, LLC, was in default. In March 2001, a settlement was reached, whereby ARI collected $410,000 in full satisfaction of the note including accrued but unpaid interest. 10
AMERICAN REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 2. NOTES RECEIVABLE (Continued) - -------------------------- In July 2000, ARI sold a 749.1 acre tract of its Keller land parcel for $10.0 million, receiving $8.7 million in cash and providing purchase money financing of the remaining $1.3 million of the sales price. The loan bears interest at 12.0% per annum. In September 2000, $500,000 in principal and interest was collected. All remaining principal and interest was due July 31, 2001. The loan was secured by 100% of the shares of DM Development, Inc. and an assignment of land sales proceeds. The loan had a principal balance of $817,000 at December 31, 2000. In March 2001, the loan was collected in full, including accrued but unpaid interest. In August 2000, ARI sold a 20.5 acre tract of its Mason Goodrich land parcel for $3.6 million, receiving $2.1 million in cash and providing purchase money financing of the remaining $1.5 million of the sales price. The loan matured in December 2000. In February 2001, the loan was collected in full, including accrued but unpaid interest. 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 bears interest at 12.0% per annum and matured in July 2001. All principal and interest were due at maturity. At November 2001, extension terms are being negotiated. In April 2001, ARI sold a 20.0 acre tract of its Katrina land parcel for $2.9 million receiving $700,000 in cash and providing purchase money financing of the remaining $2.2 million of the sales price. The loan bore interest at 10.0% per annum and matured in June 2001. In May 2001, ARI sold an 80% senior interest in the note to a financial institution. In June 2001, the interest rate was increased to 12.0% and the maturity date was extended to August 2001. All principal and accrued but unpaid interest are due at maturity. In July 2001, the note was collected in full, including accrued but unpaid interest. Related Party. 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. The line of credit bears interest at 12.0% per annum. All principal and interest are due at maturity in February 2002. The line of credit is guaranteed by Basic Capital Management, Inc, ("BCM"), ARI's advisor. In October 1999, ARI funded a $4.7 million loan to Realty Advisors, Inc., an affiliate. The loan is secured by all of the outstanding shares of common stock of American Reserve Life Insurance Company. The loan bears interest at 10.25% per annum and matured in November 2001. In January 2000, $100,000 in principal was collected. All remaining principal and accrued interest were due at maturity. A three year extension has been agreed upon, pending a change in collateral. 11
AMERICAN REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 2. NOTES RECEIVABLE (Continued) - -------------------------- In December 2000, an unsecured loan with a principal balance of $1.6 million to Warwick of Summit, Inc. ("Warwick") matured. All principal and interest were due at maturity. At September 2001, the loan, and $390,000 of accrued interest, remained unpaid. At November 2001, settlement terms are being negotiated. 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 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 2001, the loan, and $436,000 of accrued interest, remained unpaid. At November 2001, settlement terms are being negotiated. 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 $2.4 million to Lordstown, L.P., matured. The loan 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 2001, the loan, and $687,000 of accrued interest, remained unpaid. At November 2001, settlement terms are being negotiated. 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. NOTE 3. REAL ESTATE - --------------------- In 2001, ARI sold the following properties: <TABLE> <CAPTION> Units/ Sales Net Cash Debt Gain (Loss) Property Location Sq.Ft./Acres Price Received Discharged on Sale - --------------- ---------------- ------------- -------- ---------- ----------- ------------- <S> <C> <C> <C> <C> <C> <C> 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 Shopping Center Regency Pointe Jacksonville, FL 67,063 Sq.Ft. 7,350 5,126 1,500 2,292 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 -- /(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 Second Quarter Apartments Kimberly Woods Tucson, AZ 279 Units 8,450 1,667 6,191(1) 6,052 Place One Tulsa, OK 407 Units 12,935 3,310 7,539 8,623 </TABLE> 12
AMERICAN REALTY INVESTORS, INC. ------------------------------ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued ------------------------------------------------------ NOTE 3. REAL ESTATE (Continued) - --------------------- <TABLE> <CAPTION> Units/ Sales Net Cash Debt Gain (Loss) Property Location Sq.Ft./Acres Price Received Discharged on Sale - ----------------- --------------- ------------- -------- ---------- ------------ ----------- <S> <C> <C> <C> <C> <C> <C> Shadowood Addison, TX 184 Units $ 7,125 $1,980 $ 4,320 $ 4,644 Glenwood Addison, TX 168 Units 6,650 3,166 2,549 (560) Bent Tree Addison, TX 292 Units 12,050 2,480 8,867 7,081 Land Katrina Palm Desert, CA 20.0 Acres 2,940 78 -- 516 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 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 5,982 Crossing at Church Tampa, FL 52 Units 1,880 750 948 623 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 Land Elm Fork Denton County, TX 10.0 Acres 1,002 (30) 958 284 Katrina Palm Desert, CA 6.1 Acres 1,196 1,108 -- 570 Chase Oaks Plano, TX 22.3 Acres 2,874 663 2,027 870 Nashville Nashville, TN 2.0 Acres 26 (1) 24 (82) Nashville Nashville, TN 1.2 Acres 8 -- 4 (959) Rasor Plano, TX 6.6 Acres 350 267 -- 34 Katrina Palm Desert, CA 2.2 Acres 800 (24) 737 514 Chase Oaks Plano, TX 4.9 Acres 1,973 1,832 -- 1,416 Fourth Quarter Apartments Nora Pines Indianapolis, IN 254 Units 9,850 2,548 5,574 6,631 Land Katrina Palm Desert, CA 1.4 Acres 284 (9) 253 117 </TABLE> _______________________ (1) Debt assumed by purchaser. (2) Gain deferred until ARI-provided financing is collected. In 2000, ARI sold the following properties: <TABLE> <CAPTION> Units/ Sales Net Cash Debt Gain/(Loss) Property Location Sq.Ft./Acres Price Received Discharged on Sale - ----------------- --------------- ------------- -------- ---------- ------------ ----------- <S> <C> <C> <C> <C> <C> <C> First Quarter Apartments Summerwind Reseda, CA 172 Units $9,000 $3,082 $5,568/(1)/ $6,684 Windtree Reseda, CA 159 Units 8,350 2,911 5,063/(1)/ 6,170 Whispering Pines Canoga Park, CA 102 Units 5,300 1,597 3,437/(1)/ 3,106 Shopping Center Katella Plaza Orange, CA 62,290 Sq.Ft. 1,814 283 1,188 194 Land Duchense Duchense, UT 420 Acres 43 42 -- 16 Frisco Bridges Collin County, TX 15.00 Acres 2,675 706 2,000 297 Frisco Bridges Collin County, TX 19.74 Acres 2,971 -- --/(2)/ -- Mason/Goodrich Houston, TX 1.1 Acres 129 -- 116 70 </TABLE> 13
AMERICAN REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 3. REAL ESTATE (Continued) - --------------------- <TABLE> <CAPTION> Units/ Sales Net Cash Debt Gain/(Loss) Property Location Sq.Ft./Acres Price Received Discharged on Sale - -------------------- ---------------- ------------- --------- ---------- ----------- ----------- <S> <C> <C> <C> <C> <C> <C> Mason/Goodrich Houston, TX 12.8 Acres $ 2,536 $ -- $ 1,803 $ 1,783 Nashville Nashville, TN 2.6 Acres 405 -- 345 225 Rasor Plano, TX 43.01 Acres 1,850 -- 1,604 58 Second Quarter Apartments Pines Little Rock, AR 257 Units 4,650 1,281 3,063 2,441 Four Seasons Denver, CO 384 Units 16,600 6,543 9,220/(1) 8,191 Sherwood Glen Urbandale, IA 180 Units 6,250 1,244 4,626/(1) 4,161 Office Building Marina Playa Santa Clara, CA 124,205 Sq.Ft. 25,750 7,737 7,766 17,285 Land Rasor Plano, TX 5.4 Acres 915 -- 915 705 Salmon River Salmon River, ID 3.0 Acres 45 44 -- 38 Valley Ranch Irving, TX 22.4 Acres 1,455 -- 1,375 (585) Parkfield Denver, CO 2.6 Acres 615 (1) 584 512 Frisco Bridges Collin County, TX 24.3 Acres 4,194 (435) 4,000 259 Vista Business Park Travis County, TX 5.4 Acres 620 14 577 173 McKinney Corners II Collin County, TX 14.6 Acres 500 (599) 1,050 (40) Third Quarter Apartments Fair Oaks Euless, TX 208 Units 6,850 609 5,711 3,474 Land Mason/Goodrich Houston, TX 6.8 Acres 1,198 114 991 807 McKinney Corners I,II,III,IV,V Collin County, TX 82.0 Acres 9,150 613 8,123 1,638 Parkfield Denver, CO 326.8 Acres 13,164 7,969 3,279 3,768 Rasor Plano, TX 41.1 Acres 3,779 3,587 -- 1,902 Pantex Collin County, TX 182.5 Acres 8,160 -- 4,546/(1)/ 959 Rowlett Creek Collin County, TX 80.4 Acres 2,262 919 1,173 462 Vann Cattle Collin County, TX 126.6 Acres 3,564 1,872 1,471 1,257 Mastenbrook Collin County, TX 157.9 Acres 4,445 1,890 2,275 747 Wakefield Collin County, TX 70.3 Acres 1,981 1,239 612 478 Nashville Nashville, TN 3.0 Acres 523 19 450 310 Keller Tarrant County, TX 749.1 Acres 10,000 3,892 4,500 3,373 Frisco Bridges Collin County, TX 127.4 Acres 27,500 7,411 18,570 6,954 Mason/Goodrich Houston, TX 20.5 Acres 3,560 497 1,308 956 </TABLE> ___________________ (1) Debt assumed by purchaser. (2) Exchanged for 3.25 acres of Clark land. In 2001, ARI purchased the following properties: <TABLE> <CAPTION> Units/ Purchase Net Cash Debt Interest Maturity Property Location Sq.Ft./Acres Price Paid Incurred Rate Date - -------------- --------------- ------------ -------- --------- ----------- ---------- -------- <S> <C> <C> <C> <C> <C> <C> <C> Second Quarter Apartments Glenwood Addison, TX 168 Units $6,246 -/(1)/ $ 2,549/(2)/ 9.25% 10/04 </TABLE> 14
AMERICAN REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 3. REAL ESTATE (Continued) - --------------------- ______________ (1) 8.88 acres of Hollywood Casino land and 10.5 acres of Vista Ridge land given as consideration. Exchanged with a related party. (2) Assumed debt of seller. Exchanged with a related party. In 2000, ARI purchased the following properties: <TABLE> <CAPTION> Units/sq.ft. Purchase Net Cash Debt Interest Maturity Property Location Acres/Rooms Price Paid Incurred Rate Date - ----------------- ----------------- ------------ -------- -------- ---------- --------- -------- <S> <C> <C> <C> <C> <C> <C> <C> First Quarter Land Clark Farmers Branch, TX 3.25 Acres $ 2,989 $ -- $ --/(2)/ -- % -- Kelly lots Collin County, TX .75 Acres 130 20 100/(1)/ 10.0 03/10 Mastenbrook Collin County, TX 157.86 Acres 3,200 704 2,400/(1)/ 9.0 09/00 Second Quarter Land Sladek Travis County, TX 63.3 Acres 712 316 427/(1)/ 10.0 05/04 Third Quarter Hotel Grand Hotel Sofia (3) Sofia, Bulgaria 145 Rooms 17,975 17,975 -- -- -- </TABLE> _____________ (1) Seller financing. (2) Exchanged for 19.74 acres of Frisco Bridges land. (3) Related Party. ARI purchased 100% of the outstanding stock of World Trade Company, Ltd., owner of an 80% interest in the hotel, from One Realco Corporation, an affiliate, for $18.0 million in cash. 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 are 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 bears no interest, and matures in May 2002. Monthly principal payments of $25,000 are 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 bears no interest, and matures 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 is redeemable quarterly in an amount equal to 20% of net cash flow from the oil and gas operations. The stock has a liquidation value of $1,000 per share, and pays no dividends. Through September 2001, sales have totaled $97,000, total operating expenses are $186,000, and oilfield equipment purchases have been $361,000. 15
AMERICAN REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 5. INVESTMENTS IN EQUITY INVESTEES - ----------------------------------------- Real estate entities. ARI's investment in real estate entities at September 30, 2001, included equity securities of two affiliated publicly traded real estate investment companies, Income Opportunity Realty Investors, Inc. ("IORI") and Transcontinental Realty Investors, Inc. ("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. Substantially all of the equity securities of IORI and TCI are pledged as collateral for borrowings. See NOTE 8. "MARGIN BORROWINGS." ARI's investment in real estate entities at September 30, 2001 was as follows: <TABLE> <CAPTION> Percentage Carrying Equivalent of ARI's Value of Investee Market Value Ownership at Investment at Book Value at of Investment at Investee September 30, 2001 September 30, 2001 September 30, 2001 September 30, 2001 - ----------- ------------------ ------------------ ------------------ ------------------ <S> <C> <C> <C> <C> IORI 28.49% $ 6,872 $ 10,109 $ 5,329 TCI 49.99% 68,837 108,777 53,275 ---------- ---------- 75,709 $ 58,604 ========== Other 2,337 ---------- $ 78,046 ========== </TABLE> 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 2001, 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 Common Stock of TCI 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. Set forth below is summarized results of operations of equity investees for the nine months ended September 30, 2001: Revenues................................................... $115,641 Equity in income of partnerships........................... (2,886) Property operating expenses................................ 83,562 Depreciation............................................... 16,578 Interest expense........................................... 35,949 -------- (Loss) before gains on sale of real estate................. (23,334) Gain on sale of real estate................................ 46,485 -------- Net income................................................. $ 23,151 ======== 16
AMERICAN REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 5. INVESTMENTS IN EQUITY INVESTEES (Continued) - --------------------------------------- ARI's share of equity investees' loss before gains on the sale of real estate was $8.8 million for the nine months ended September 30, 2001, and its share of equity investees' gains on sale of real estate was $18.0 million for the nine months ended September 30, 2001. ARI's cash flow from IORI and TCI is dependent on the ability of each of them to make distributions. In the fourth quarter of 2000, IORI and TCI suspended distributions. In June 2000, ARI sold 1.6 million shares of TCI stock, resulting in a $7.7 million loss, and 54,000 shares of IORI stock, resulting in a $246,000 loss. These losses are included in equity income (loss) of investees on the Statement of Operations. ART Florida Portfolio II, Ltd. In June 2000, Vestavia Lakes Apartments partnership, in Orlando, Florida, in which ART Portfolio II, Ltd. owned an interest, was sold. A loss was incurred on the sale, of which ARI's share was $967,000, which is included in equity income (loss) of investees in the accompanying Consolidated Financial Statements. Elm Fork Ranch, L.P. In June 2000, ARI sold its partnership interests for $2.0 million in cash, retaining an option to repurchase its interests. In January 2001, ARI purchased 100% of the partnership interests for $9.2 million, including financing of $9.0 million. 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. In the first nine months of 2001, ARI did not purchase or sell any such securities. These equity securities are considered a trading portfolio and are carried at market value. At September 30, 2001, ARI recognized an unrealized decrease in the market value of its trading portfolio securities of $43,000. 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 2001, ARI financed/refinanced or obtained second mortgage financing on the following: <TABLE> <CAPTION> Acres/Rooms/ Debt Debt Net Cash Interest Maturity Property Location Sq.Ft. Incurred Discharged Received Rate Date - ----------------- ---------------- ------------ --------- ---------- -------- --------- -------- <S> <C> <C> <C> <C> <C> <C> <C> 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 </TABLE> 17
AMERICAN REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 7. NOTES PAYABLE (Continued) - --------------------- <TABLE> <CAPTION> Acres/Rooms/ Debt Debt Net Cash Interest Maturity Property Location Sq.Ft. Incurred Discharged Received Rate Date - -------------------- -------------------- ----------------- ----------- ---------- -------- ---------- -------- <S> <C> <C> <C> <C> <C> <C> <C> 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)/ 10/02 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 Shopping Center Cullman Cullman, AL 92,486 Sq.Ft. --/(3)/ 129 -- -- -- Third Quarter Apartments Woodlake Carrollton, TX 256 Units --/(5)/ -- -- -- -- Sun Hollow El Paso, TX 216 Units --/(5)/ -- -- -- -- Waters Edge III Gulfport, MS 238 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 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 Chase Oaks Plano, TX 6.9 Acres 1,633 1,000 425 13.00 03/03 Vista Ridge LI Lewisville, TX 90.3 Acres 9,085 9,119 (101) 13.00 03/03 Vista Ridge MF Lewisville, TX 23.0 Acres 1,345 1,000 228 13.00 03/03 </TABLE> - ------------------ (1) Single note, with all 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 2000, ARI financed/refinanced or obtained second mortgage financing on the following: <TABLE> <CAPTION> Acres/ Debt Debt Net Cash Interest Maturity Property Location Units/Sq.Ft. Incurred Discharged Received Rate Date - ---------------- ------------------ ------------ -------- ---------- -------- --------- -------- <S> <C> <C> <C> <C> <C> <C> <C> First Quarter Land Centura, Clark and Woolley Farmers Branch, TX 10.1 Acres $ 7,150 $ -- $ 6,960 14.00% 03/03 Frisco Bridges Collin County, TX 127.4 Acres 18,000 11,900 6,190 13.00 03/01 Frisco Bridges Collin County, TX 62.8 Acres 7,800 4,985 2,432 14.00 03/02 Nashville Nashville, TN 144.8 Acres 10,000 2,034 7,039 15.50 07/00 </TABLE> 18
AMERICAN REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 7. NOTES PAYABLE (Continued) - --------------------- <TABLE> <CAPTION> Acres/ Debt Debt Net Cash Interest Maturity Property Location Units/Sq.Ft. Incurred Discharged Received Rate Date - ------------------- ------------------ -------------- ------------ ---------- -------- --------- -------- <S> <C> <C> <C> <C> <C> <C> <C> Second Quarter Apartments Rockborough Denver, CO 345 Units 2,222 $ -- $ 1,942 8.37% 11/10 Confederate Point Jacksonville, FL 206 Units 7,440 5,879 1,039 8.12 05/07 Whispering Pines Topeka, KS 320 Units 7,530 6,829 302 8.12 05/07 Chateau Bayou Ocean Springs, MS 122 Units 1,007 -- 988 8.36 05/10 Waters Edge Gulfport, MS 238 Units 7,532 3,993 3,447 8.08 05/07 Land Katy Harris County, TX 130.6 Acres 4,250 4,042 (9) 13.00 05/01 Third Quarter Office Buildings Centura Tower Farmers Branch, TX 410,910 Sq.Ft. 15,000 -- 14,612 16.90 07/02 Fourth Quarter Land Tree Farm Dallas, TX 10.4 Acres 8,000/(1)/ -- 7,750 14.00 10/01 Thompson Farmers Branch, TX 4.0 Acres /(1)/ Tomlin Farmers Branch, TX 9.0 Acres /(1)/ Lacy Longhorn Farmers Branch, TX 17.1 Acres /(1)/ Keller Fort Worth, TX 30.1 Acres /(1)/ McKinney Corners McKinney, TX 11.0 Acres /(1)/ </TABLE> _________________ (1) Single note, with all properties as collateral. NOTE 8. MARGIN BORROWINGS - ------------------------- ARI has margin arrangements with various 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, TCI and ARI's trading portfolio and bear interest rates ranging from 6.0% to 24.0%. Margin borrowings totaled $28.7 million at September 30, 2001. In April 2000, ARI obtained a security loan in the amount of $5.0 million with a financial institution. ARI received net cash of $4.6 million after various closing costs. The loan bears interest at 1% over the prime rate (currently 6.0% per annum), requires monthly payments of principal and interest and matures September 2002. The loan is secured by 1,050,000 shares of ARI Common Stock held by BCM, ARI's advisor. 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 owned by ARI and 128,000 shares of ARI 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 19
AMERICAN REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 8. MARGIN BORROWINGS (Continued) - -------------------------- million after the payment of various closing costs and $3.4 million repayment of principal and accrued interest on an existing loan with the same lender. Of the total loan amount, $19.5 million bears interest at 24% per annum, while the remaining $500,000 bears interest at 20% per annum. The loan requires monthly payments of interest only and matures in September 2002. 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 6.0% 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 a loss for federal income tax purposes in the three and nine months ended September 30, 2001; therefore, it recorded no provision for income taxes. For the nine months ended September 30, 2000, a provision for income taxes in the amount of $1.7 million was recorded. 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 income of investees and other income which totaled $3.4 million and $9.2 million for the three and nine months ended September 30, 2001 and $3.2 million and $3.3 million for the three and nine months ended September 30, 2000. Expenses that are not reflected in the segments are general and administrative expenses, minority interest, incentive fees, advisory fees and net income fees which totaled $7.6 million and $24.7 million for the three and nine months ended September 30, 2001 and $9.3 million and $48.1 million for the three and nine months ended September 30, 2000. Excluded from operating segment assets are assets of $119.9 million in 2001 and $92.1 million in 2000, which are not identifiable with an operating segment. There are no intersegment revenues and expenses and ARI conducted all of its business within the United States, with the exception of Hotel Sofia (Bulgaria). 20
AMERICAN REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 10. OPERATING SEGMENTS (Continued) - --------------------------- Presented below are ARI's reportable segments operating income for the three and nine months ended September 30, and segment assets at September 30. <TABLE> <CAPTION> Inter- Three Months Ended Commercial U.s. National Pizza Oil & Receivables/ September 30, 2001 Properties Apartments Hotels Hotels Land Parlors Gas Other Total - --------------------- ---------- ---------- ------- -------- -------- ------- ------ ------------ -------- <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> Operating revenue.... $ 8,866 $ 13,580 $ 8,750 $ 1,283 $ 40 $ 8,723 $ 97 $ 193 $ 41,532 Interest income...... -- -- -- -- -- -- -- 837 837 Operating expenses... 4,951 9,308 4,283 1,396 2,206 7,164 186 8 29,502 -------- -------- ------- ------- -------- ------- ------ --------- -------- $ 3,915 $ 4,272 $ 4,467 $ (113) $ (2,166) $ 1,559 $ (89) $ 1,022 $ 12,867 ======== ======== ======= ======= ======== ======= ====== ========= ======== Depreciation......... $ 1,842 $ 1,101 $ 629 $ 554 $ -- $ 345 $ 18 $ 1 4,490 Interest............. 3,834 3,466 1,102 325 7,940 932 -- 1,462 19,061 Capital expenditures....... 5,700 -- 116 -- 1,006 303 -- -- 7,125 Assets............... 166,811 115,326 68,024 25,952 228,476 21,626 5,062 29,222 660,499 <CAPTION> Property Sales: Apartments Land Total ---------- -------- -------- <S> <C> <C> <C> 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 ======== ======== ======== </TABLE> <TABLE> <CAPTION> Inter- Nine Months Ended Commercial U.s. National Pizza Oil & Receivables/ September 30, 2001 Properties Apartments Hotels Hotels Land Parlors Gas Other Total - -------------------- ---------- ---------- -------- -------- --------- ------- ------ ------------ --------- <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> Operating revenue... $ 25,599 $ 44,822 $24,688 $ 3,009 $ 145 $25,282 $ 97 $ 485 $124,127 Interest income..... -- -- -- -- -- -- -- 1,997 1,997 Operating expenses.. 14,981 27,827 18,781 2,821 6,750 20,715 186 86 92,147 -------- -------- ------- ------- -------- ------- ------ ------- -------- $ 10,618 $ 16,995 $ 5,907 $ 188 $ (6,605) $ 4,567 $ (89) $ 2,396 $ 33,977 ======== ======== ======= ======= ======== ======= ====== ======= ======== Depreciation........ $ 5,428 $ 3,644 $ 1,938 $ 1,204 $ -- $ 931 $ 18 $ 6 $ 13,169 Interest............ 12,412 14,086 3,375 519 21,308 741 -- 3,801 56,242 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 5,062 29,222 660,499 <CAPTION> Commercial Property Sales: Properties Apartments Land Total ---------- --------- -------- --------- <S> <C> <C> <C> <C> 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 ======== ======== ======== ======== </TABLE> <TABLE> <CAPTION> Three Months Ended Commercial Pizza Receivables/ September 30, 2000 Properties Apartments Hotels Land Parlors Other Total - ---------------------- ---------- ---------- ------- -------- ------- ------------ -------- <S> <C> <C> <C> <C> <C> <C> <C> Operating revenue..... $ 7,353 $ 16,694 $ 9,033 $ 1,628 $ 8,124 $ -- $ 42,832 Interest income....... -- -- -- -- -- 283 283 Operating expenses.... 4,899 10,354 6,298 2,225 6,798 -- 30,574 --------- -------- ------- -------- ------- ----------- -------- $ 2,454 $ 6,340 $ 2,735 $ (597) $ 1,326 $ 283 $ 12,541 ========= ======== ======= ======== ======= =========== ======== Depreciation.......... $ 1,733 $ 1,303 $ 703 $ -- $ 262 $ -- $ 4,001 Interest.............. 4,605 4,899 1,252 6,740 285 1,799 19,580 Capital expenditures.. 2,875 1,339 178 516 959 -- 5,867 Assets................ 171,490 148,560 87,966 253,562 22,108 13,824 697,510 <CAPTION> Property Sales: Apartments Land Total ---------- -------- -------- <S> <C> <C> <C> Sales price........... $ 6,850 $ 89,285 $ 96,135 Cost of sale.......... 3,376 65,674 69,050 -------- -------- -------- Gain on sale.......... $ 3,474 $ 23,611 $ 27,085 ======== ======== ======== </TABLE> 21
AMERICAN REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 10. OPERATING SEGMENTS (Continued) - --------------------------- <TABLE> <CAPTION> Nine Months Ended Commercial Pizza Receivables/ September 30, 2000 Properties Apartments Hotels Land Parlors Other Total - ----------------------- ---------- ---------- -------- --------- -------- ------------ --------- <S> <C> <C> <C> <C> <C> <C> <C> Operating revenue...... $ 23,831 $ 53,003 $25,501 $ 2,876 $24,388 $ -- $129,599 Interest income........ -- -- -- -- -- 3,295 3,295 Operating expenses..... 14,838 30,743 17,758 7,112 20,138 -- 90,589 -------- -------- ------- -------- ------- ---------- -------- $ 8,993 $ 22,260 $ 7,743 $ (4,236) $ 4,250 $ 3,295 $ 42,305 ======== ======== ======= ======== ======= ========== ======== Depreciation........... $ 5,234 $ 4,752 $ 1,941 $ -- $ 982 $ -- $ 12,909 Interest............... 12,869 15,716 3,704 20,917 854 6,093 60,153 Capital expenditures... 4,404 10,827 495 2,276 1,120 -- 19,122 Assets................. 171,490 148,560 87,966 253,562 22,108 13,824 697,510 <CAPTION> Commercial Property Sales: Properties Apartments Land Total ---------- ---------- --------- --------- <S> <C> <C> <C> <C> Sales price............ $ 27,564 $ 57,000 $108,238 $192,802 Cost of sale........... 10,085 22,773 81,116 113,974 -------- -------- -------- -------- Gain on sale........... $ 17,479 $ 34,227 $ 27,122 $ 78,828 ======== ======== ======== ======== </TABLE> NOTE 11. COMMITMENTS AND CONTINGENCIES - --------------------------------------- Liquidity. Management expects that ARI will generate excess cash from operations, due to increased rental rates and occupancy at its properties; however, such excess will not be sufficient to discharge all of ARI's debt obligations as they mature. 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 and two million units were purchased in May 2001. ARI has committed to purchase the remaining two million units in May 2002. In April 2001, ARI reached an agreement with the Class A unitholders of ART Palm, L.P., to acquire 7,236,250 of their Class A units in December 2001, for $5.8 million. Litigation. 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. 22
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. In 2001, ARI's asset portfolio was expanded by the purchase of leasehold interests in 37 oil and gas mineral development properties. See NOTE 4. "OIL AND GAS OPERATIONS." All of the oil and gas operations are in East Texas. Liquidity and Capital Resources - ------------------------------- General. Cash and cash equivalents at September 30, 2001, totaled $5.0 million, compared with $4.2 million at December 31, 2000. Although ARI anticipates that during the remainder of 2001 it will generate excess cash flow from property operations, as discussed below, such excess cash is not sufficient to discharge all of ARI's debt obligations as they mature. ARI will therefore continue to 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, 2000, notes payable totaling $193.4 million had either scheduled maturities or required principal reduction payments during 2000. During the first nine months of 2001, ARI either extended, refinanced, paid down, paid off or received commitments from lenders to extend or refinance $123.3 million of the debt scheduled to mature in 2001. Net cash used in operating activities increased to a use of $39.2 million in the nine months ended September 30, 2001, from a use of $33.4 million in the nine months ended September 30, 2000. 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 property operations) decreased to $19.1 million in the nine months ended September 30, 2001, from $23.5 million in 2000. The decrease is primarily attributable to the sale of nine apartments in 2000 and 13 apartments in 2001. ARI expects a decrease in cash flow from property operations during the remainder of 2001. 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) of $4.3 million in the nine months ended September 30, 2001, approximated the $4.4 million in 2000. Net cash used in oil and gas operations (sales collected less payments for lease operating expenses) was $175,000 in the nine months ended September 30, 2001. Operations began in June 2001. 23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION - ------------------------------------------------------------------- AND RESULTS OF OPERATIONS (Continued) ------------------------- Liquidity and Capital Resources (Continued) - ------------------------------- Interest collected decreased to $397,000 in the nine months ended September 30, 2001, from $4.6 million in 2000. The decrease was attributable to the collection of $36.0 million of mortgage notes receivable in 2000 and $4.9 million in 2001. Interest paid decreased to $45.7 million in the nine months ended September 30, 2001, from $55.9 million in 2000. The decrease was attributable to the sale of all or portions of 24 land parcels and nine apartments in 2000, and all or portions of 13 land parcels, one commercial property and 13 apartments in 2001, resulting in the payoff, paydown or assumption by the purchaser of mortgage debt. Advisory fees paid increased to $5.0 million in the nine months ended September 30, 2001, from the $4.1 million in 2000. The increase is attributable to the inclusion of National Realty, L.P. assets in the basis for the advisory fees, after August 2000. Incentive fees paid were $1.6 million in the nine months ended September 30, 2001. The fees, earned in 2000, are 10% of the excess of net capital gains over net capital losses realized from sales of assets. General and administrative expenses paid decreased to $9.1 million in the nine months ended September 30, 2001, from $11.7 million in 2000. The decrease is primarily attributable to reduced consulting and partnership fees, and reduced cost reimbursements paid to the advisor. 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 nine months ended September 30, 2001, compared to $1.9 million in the nine months of 2000. 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 from operating activities was $1.2 million in the nine months ended September 30, 2001 compared to $10.1 million in 2000. The change was primarily attributable to a greater decrease in property prepaids, miscellaneous property receivables and property escrows in 2000 than in 2001. In 2001, ARI sold the following properties: <TABLE> <CAPTION> Units/ Sales Net Cash Debt Gain (Loss) Property Location Sq.Ft./acres Price Received Discharged On Sale - ----------------- ---------------- ------------- ------- -------- ------------- ----------- <S> <C> <C> <C> <C> <C> <C> 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 Shopping Center Regency Pointe Jacksonville, FL 67,063 Sq.Ft. 7,350 5,126 1,500 2,292 </TABLE> 24
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION - ------------------------------------------------------------------- AND RESULTS OF OPERATIONS (Continued) ------------------------- Liquidity and Capital Resources (Continued) - ------------------------------- <TABLE> <CAPTION> Units/ Sales Net Cash Debt Gain (Loss) Property Location Sq.Ft./acres Price Received Discharged On Sale - -------------------- ------------------ ------------ ------- -------- ------------ ----------- <S> <C> <C> <C> <C> <C> <C> 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 --/(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 Second Quarter Apartments Kimberly Woods Tucson, AZ 279 Units 8,450 1,667 6,191/(1)/ 6,052 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 Glenwood Addison, TX 168 Units 6,650 3,166 2,549 (560) Bent Tree Addison, TX 292 Units 12,050 2,480 8,867 7,081 Land Katrina Palm Desert, CA 20.0 Acres 2,940 78 -- 516 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 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 5,982 Crossing at Church Tampa, FL 52 Units 1,880 750 948 623 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 Land Elm Fork Denton County, TX 10.0 Acres 1,002 (30) 958 284 Katrina Palm Desert, CA 6.1 Acres 1,196 1,108 -- 570 Chase Oaks Plano, TX 22.3 Acres 2,874 663 2,027 870 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 Katrina Palm Desert, CA 2.2 Acres 800 (24) 737 514 Chase Oaks Plano, TX 4.9 Acres 1,973 1,832 -- 1,416 Fourth Quarter Apartments Nora Pines Indianapolis, IN 254 Units 9,850 2,548 5,574 6,631 Land Katrina Palm Desert, CA 1.4 Acres 284 (9) 253 117 </TABLE> _____________________ (1) Debt assumed by purchaser. (2) Gain deferred until ARI-provided financing is collected. 25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION - --------------------------------------------------------------------- AND RESULTS OF OPERATIONS (Continued) ------------------------- Liquidity and Capital Resources (Continued) - ------------------------------- In 2001, ARI purchased the following properties: <TABLE> <CAPTION> Units/ Purchase Net Cash Debt Interest Maturity Property Location Sq.ft./acres Price Paid Incurred Rate Date - ---------------- ----------- ------------ -------- ----------- ------------ --------- -------- <S> <C> <C> <C> <C> <C> <C> <C> Second Quarter Apartments Glenwood Addison, TX 168 Units $ 6,246 $ --/(1)/ $ 2,549/(2)/ 9.25% 10/04 </TABLE> _____________ (1) 8.88 acres of Hollywood Casino land and 10.5 acres of Vista Ridge land given as consideration. Exchanged with a related party. (2) Assumed debt of seller. Exchanged with a related party. In 2001, ARI financed/refinanced or obtained second mortgage financing on the following: <TABLE> <CAPTION> Acres/rooms/ Debt Debt Net Cash Interest Maturity Property Location Sq.ft. Incurred Discharged Received Rate Date - -------------------- --------------------- -------------- ------------ ---------- -------- ------------ -------- <S> <C> <C> <C> <C> <C> <C> <C> 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)/ 10/02 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 Shopping Center Cullman Cullman, AL 92,486 Sq.Ft. --/(3)/ 129 -- -- -- Third Quarter Apartments Woodlake Carrollton, TX 256 Units --/(5)/ -- -- -- -- Sun Hollow El Paso, TX 216 Units --/(5)/ -- -- -- -- Waters Edge III Gulfport, MS 238 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 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 Chase Oaks Plano, TX 6.9 Acres 1,633 1,000 425 13.00 03/03 Vista Ridge LI Lewisville, TX 90.3 Acres 9,085 9,119 (101) 13.00 03/03 Vista Ridge MF Lewisville, TX 23.0 Acres 1,345 1,000 228 13.00 03/03 </TABLE> ___________________ 26
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION - --------------------------------------------------------------------- AND RESULTS OF OPERATIONS (Continued) ------------------------- Liquidity and Capital Resources (Continued) - ------------------------------- (1) Single note, with all 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. 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 6.0% to 24.0%. Margin borrowing totaled $28.7 million at September 30, 2001. Management expects that it will be necessary for ARI to sell $219.1 million, $51.7 million and $6.4 million of its land holdings during each of the next three years to satisfy the debt on such land as it matures. If ARI is unable to sell at least the minimum amount of land to satisfy the debt obligations on such land as it matures, or, if it was not able to extend such debt, ARI would either sell other assets to pay such debt or return the property to the lender. Management reviews the carrying values of ARI's properties and mortgage note receivables 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. In those instances where impairment is found to exist, a provision for loss is recorded by a charge against earnings. ARI's mortgage note receivable review includes an evaluation of the collateral property securing such note. The property review generally includes selective property inspections, a review of the property's current rents compared to market rents, a review of the property's expenses, a review of maintenance requirements, a review of the property's cash flow, discussions with the manager of the property and a review of properties in the surrounding area. Commitments and Contingencies - ----------------------------- 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 and two million units were purchased in May 2001. ARI has committed to purchase the remaining two million units in May 2002. In April 2001, ARI reached an agreement with the Class A unitholders of ART Palm, L.P., to acquire 7,236,250 of their Class A units in December 2001 for $5.9 million. 27
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION - --------------------------------------------------------------------- AND RESULTS OF OPERATIONS (Continued) ------------------------- Recent Accounting Pronouncements - -------------------------------- In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 requires the fair value of a liability for an asset retirement obligation to be recognized in the period which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived assets. SFAS No. 143 is effective for the fiscal year beginning after June 15, 2002. We believe the adoption of this statement will have no material impact on our financial statements. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long Lived Assets." SFAS No. 144 requires that those long-lived assets be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations. Therefore discontinued operations will no longer be measured at net realizable value or include amounts for operating losses that have not yet occurred. SFAS No. 144 is effective for financial statements issued for fiscal years beginning after December 15, 2001 and, generally, is to be applied prospectively. Results of Operations - --------------------- For the nine months ended September 30, 2001, ARI reported net income of $12.0 million, compared to net income of $1.6 million for the nine months ended September 30, 2000. The primary factors contributing to ARI's net income are discussed in the following paragraphs. Rents decreased to $32.7 million and $98.7 million in the three and nine months ended September 30, 2001, from $34.7 million and $105.2 million in 2000. Rents from commercial properties increased to $25.6 million for the nine months ended September 30, 2001, from $23.8 million in 2000, rent from hotels increased to $27.7 million in the nine months ended September 30, 2001, from $25.5 million in 2000 and rent from apartments decreased to $44.8 million in the nine months ended September 30, 2001, from $53.0 million in 2000. The increase in commercial property rents was primarily attributable to higher occupancy in buildings completed in late 1999 and early 2000. The increase in hotel rent was primarily due to the opening of Hotel Sofia in 2001. The decrease in apartment rent was due to the sale of nine apartments in 2000 and 13 apartments in 2001. Rental income is expected to decrease significantly in the remainder of 2001 as a result of the income producing properties sold in 2001 and 2000. Property operations expense decreased to $22.2 million in the three months ended September 30, 2001, from $23.8 million in 2000, and increased to $71.2 million in the nine months ended September 30, 2001, from $70.5 million in 2000. Property operations expense for commercial properties increased to $15.0 million in the nine months ended September 30, 2001, from $14.8 million in 2000. For hotels, property operations expense increased to $21.6 million in the nine months ended September 30, 2001, from $17.8 million in 2000. For land, property operations expense decreased to $6.8 million in the nine months ended September 30, 28
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION - --------------------------------------------------------------------- AND RESULTS OF OPERATIONS (Continued) ------------------------- Results of Operations (Continued) - --------------------- 2001 from $7.1 million in 2000. For apartments, property operations expense decreased to $27.8 million in the nine months ended September 30, 2001, from $30.7 million in 2000. The increase in hotel property operations expense was primarily due to the opening of Hotel Sofia in 2001. The decrease in land operating expenses was primarily due to the 13 land parcels sold in 2000. The decrease in property operations expense for apartments was due to the sale of nine apartments in 2000 and 13 apartments in 2001. Property operations expense is expected to decrease significantly in the remainder of 2001 as a result of the properties sold in 2000 and 2001. Pizza parlor sales and cost of sales were $8.7 million and $7.2 million, respectively, in the three months ended September 30, 2001 and $25.3 million and $20.7 million for the nine months ended September 30, 2001 compared to $8.1 million and $6.8 million, respectively, for the three months ended September 30, 2000 and $24.4 million and $20.1 million for the nine months ended September 30, 2000. The increased sales were primarily attributable to the effects of a more aggressive marketing and advertising strategy. Interest income from notes receivable increased to $837,000 in the three months ended September 30, 2001 from $283,000 in 2000, and decreased to $2.0 million in the nine months ended September 30, 2001, from $3.3 million in 2000. The three month increase is due to new loans funded in 2001. The nine month decrease is due to the collection of mortgage notes receivable and related interest at maturity in 2000 and 2001. Oil and gas sales were $97,000 in the three and nine months ended September 30, 2001, representing start-up production from six wells. Oil and gas operating expenses were $186,000 in the three and nine months ended September 30, 2001. Operating expenses include lifting costs and repairs and maintenance. Other income decreased to a loss of $19,000 and income of $58,000 in the three and nine months ended September 30, 2001, from $606,000 and $419,000 in 2000. ARI recognized an unrealized decrease in market value of its trading portfolio securities of $43,000 in the nine months ended September 30, 2001 compared to $267,000 in 2000. See NOTE 6. "MARKETABLE EQUITY SECURITIES - TRADING PORTFOLIO." Interest expense decreased to $19.1 million and $56.2 million in the three and nine months ended September 30, 2001, from $19.6 million and $60.2 million in 2000. The decrease was attributable to the sale of 13 apartments, one commercial property and 19 parcels of land in 2001 and nine apartments, four commercial properties and 36 parcels of land in 2000. In the remainder of 2001, interest expense is expected to continue to decrease due to the properties sold in 2000 and 2001. Depreciation, depletion and amortization expense increased to $4.5 million and $13.2 million in the three and nine months ended September 30, 2001, from the $4.0 million and $12.9 million in 2000. This increase was due to the Hotel Sofia opening in 2001. 29
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION - --------------------------------------------------------------------- AND RESULTS OF OPERATIONS (Continued) ------------------------- Results of Operations (Continued) - --------------------- General and administrative expenses increased to $4.6 million and decreased to $9.1 million in the three and nine months ended September 30, 2001, from $2.9 million and $11.7 million in 2000. The three month increase is primarily due to increases in legal and audit fees while the nine month decrease is primarily due to reduced consulting and partnership fees, and reduced cost reimbursements paid to the advisor. Advisory fees of $1.4 million for the three months ended September 30, 2001 approximated the $1.5 million for the same period in 2000 and increased to $5.0 million for the nine months ended September 30, 2001 from $4.1 million in 2000. The increase is due to the addition of the National Realty, L.P. assets to the advisory fees basis, after August 2000. Net income fee to affiliate was $<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 net income for the year, in excess of a 10% return on shareholders' equity. Incentive fee to affiliate was $1.6 million and $7.5 million in the three and nine months ended September 30, 2001. The incentive fee payable to ARI's advisor is 10% of the excess of net capital gains over net capital losses realized from sales of assets. Incentive fees are expected to increase as ARI selectively sells properties. Minority interest decreased to $1.0 million and $2.5 million in the three and nine months ended September 30, 2001, from $5.0 million and $32.2 million in 2000. The decrease is attributable to the acquisition of National Realty, L.P. by ARI in August 2000. Equity in income of investees increased to $3.5 million and $9.2 million in the three and nine months ended September 30, 2001, from $2.6 million and $2.9 million in 2000. The increase in equity income was attributable to the loss associated with the sale of TCI and IORI stock in 2000 and gains from property sales by TCI in 2001. Tax Matters - ----------- Financial statement income varies from taxable income principally due to the accounting for income and losses of investees, gains and losses from asset sales, depreciation on owned properties, amortization of discounts on notes receivable and payable and the difference in the allowance for estimated losses. ARI had a loss for federal income tax purposes in the three and nine months ended September 30, 2001; therefore, it recorded no provision for income taxes. For the nine months ended September 30, 2000, a provision for income taxes in the amount of $1.7 million was recorded. Environmental Matters - --------------------- Under various federal, state and local environmental laws, ordinances and regulations, ARI may be potentially liable for removal or 30
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION - --------------------------------------------------------------------- AND RESULTS OF OPERATIONS (Continued) ------------------------- Environmental Matters (Continued) - --------------------- remediation costs, as well as certain other potential costs relating to hazardous or toxic substances (including governmental fines and injuries to persons and property) where property-level managers have arranged for the removal, disposal or treatment of hazardous or toxic substances. In addition, certain environmental laws impose liability for release of asbestos-containing materials into the air, and third parties may seek recovery for personal injury associated with such materials. Management is not aware of any environmental liability relating to the above matters that would have a material adverse effect on ARI's business, assets or results of operations. Inflation - --------- The effects of inflation on ARI's operations are not quantifiable. Revenues from apartment operations fluctuate proportionately with inflationary increases and decreases in housing costs. Fluctuations in the rate of inflation also affect the sales values of properties and the ultimate gains to be realized from property sales. To the extent that inflation affects interest rates, earnings from short-term investments and the cost of new borrowings as well as the cost of variable interest rate debt will be affected. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS - --------------------------------------------------------------------- At September 30, 2001, 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 ---------- --------------- ------------- (Amounts in thousands, except per share) Notes payable: Variable rate.................. $135,845 12.00% $ 1,358 Total decrease in ARI's annual ========== net income..................... $ 1,358 ========== Per share....................... $ .13 ========== _________________________________________ PART II. OTHER INFORMATION ITEM 5. OTHER INFORMATION - --------------------------- On October 23, 2001, ARI, Transcontinental Realty Investors, Inc. ("TCI"), and Income Opportunity Realty Investors, Inc. ("IORI") jointly announced a preliminary agreement with the plaintiff's legal counsel of the derivative action entitled Olive et al. V. National Income Realty 31
ITEM 5. OTHER INFORMATION (Continued) - --------------------------- Trust, et al. for complete settlement of all disputes in the lawsuit. Under the proposal, ARI would acquire all of the outstanding shares of IORI and TCI not currently owned by ARI for a cash payment or shares of ARI preferred stock. 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 would 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 elect to receive ARI Preferred Stock in lieu of cash. ARI would 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 elect to receive ARI Preferred Stock in lieu of cash. The preferred shares will be convertible into ARI Common Stock during a six month period commencing on the first anniversary of the effective date of the transaction. Upon the acquisition of IORI and TCI shares, TCI and IORI would become wholly-owned subsidiaries ARI. The transaction is subject to the negotiation of a definitive merger agreement (not yet accomplished), approval of the court (not yet scheduled) and a vote of the shareholders of all three entities. ARI has the same advisor as TCI and IORI, and TCI and IORI have the same board of directors. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K - ------------------------------------------ (a) Exhibits: None. (b) Reports on Form 8-K as follows: None. 32
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: November 13, 2001 By: /s/ Karl L. Blaha ------------------------- ----------------------------------- Karl L. Blaha President Date: November 13, 2001 By: /s/ Brent Horak -------------------------- ----------------------------------- Brent Horak Vice President and Chief Financial Officer (Principal Financial Officer) 33