UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
Commission File Number 1-15663
AMERICAN REALTY INVESTORS, INC.
(Exact Name of Registrant as Specified in Its Charter)
(469) 522-4200
(Registrant’s Telephone Number, Including Area Code)
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes ¨. No x.
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of Common Stock, as of the latest practicable date.
PART I. FINANCIAL INFORMATION
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.
CONSOLIDATED BALANCE SHEETS
Real estate held for investment
Less—accumulated depreciation
Real estate held for sale
Notes and interest receivable
Performing ($28,416 in 2003 and $34,442 in 2002 from affiliates)
Nonperforming ($5,085 in 2003 and $6,838 in 2002 from affiliates)
Less—allowance for estimated losses
Pizza parlor equipment
Marketable equity securities, at market value
Cash and cash equivalents
Investments in equity investees
Goodwill, net of accumulated amortization ($1,763 in 2003 and 2002)
Other intangibles, net of accumulated amortization ($810 in 2003 and $773 in 2002)
Other assets ($11,130 in 2003 to affiliate)
The accompanying notes are an integral part of these Consolidated Financial Statements.
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CONSOLIDATED BALANCE SHEETS—Continued
Liabilities
Notes and interest payable ($15,600 in 2002 to affiliates)
Liabilities related to assets held for sale
Margin borrowings
Accounts payable and other liabilities ($27,207 in 2003 and $41,085 in 2002 to affiliates)
Minority interest
Commitments and contingencies
Stockholders’ equity
Preferred Stock, $2.00 par value, authorized 50,000,000 shares, issued and outstanding
Series A, 3,226,610 shares in 2003 and 3,226,858 shares in 2002 (liquidation preference $32,266), including 900,000 shares in 2003 and 2002 held by subsidiaries
Series E, 50,000 shares in 2003 and 2002 (liquidation preference $500)
Common Stock, $.01 par value, authorized 100,000,000 shares; issued 11,375,127 shares in 2003 and 2002
Paid-in capital
Treasury stock, at cost, 746,972 shares in 2003
Accumulated deficit
Accumulated other comprehensive income
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CONSOLIDATED STATEMENTS OF OPERATIONS
Property revenue
Rents
Property operations expenses
Operating income
Land operations
Sales
Cost of sales
Deferred current gain
Recognition of previously deferred gains
Gain on land sales
Pizza parlor operations
Gross margin
Income from operations
Other income
Interest income
Equity in loss of investees
Loss on sale of investments in equity investees
Other
Other expenses
Interest
Depreciation and amortization
Discount on sale of notes receivable
General and administrative
Advisory fee to affiliate
Net income fee to affiliate
Incentive fee to affiliate
Writedown of assets held for sale
Net loss from continuing operations
Discontinued operations:
Loss from operations
Gain on sale of real estate
Equity in gain <loss> on sale of real estate by equity investees
Net income from discontinued operations
Net income <loss>
Preferred dividend requirement
Net income <loss> applicable to Common shares
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CONSOLIDATED STATEMENTS OF OPERATIONS—Continued
Basic and diluted earnings per share
Discontinued operations
Weighted average Common shares used in computing earnings per share
Convertible Preferred Stock (2,326,610 shares) and options to purchase 108,750 shares of ARI’s Common Stock were excluded from the computation of diluted earnings per share for the three and nine months ended September 30, 2003, because the effect of their inclusion would be antidilutive.
Convertible Preferred Stock (2,326,858 shares) and options to purchase 186,750 shares of ARI’s Common Stock were excluded from the computation of diluted earnings per share for the three and nine months ended September 30, 2002, because the effect of their inclusion would be antidilutive.
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CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
For the Nine Months Ended September 30, 2003
Balance, January 1, 2003
Comprehensive income
Unrealized foreign currency translation loss
Sale of foreign operations
Net income
Repurchase of Series A Preferred stock
Common shares held by acquired company
Exchange of investments with affiliates
Preferred dividends
Series A Preferred Stock ($.75 per share)
Series E Preferred Stock ($.45 per share)
Balance, September 30, 2003
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CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash Flows From Operating Activities
Reconciliation of net income <loss> to net cash used in operating activities
Adjustments to reconcile net income to net cash used in operating activities
Gain on sale of land and real estate
Equity in <income> loss of investees
Distributions to minority interest holders
Loss allocated to minority interest
Loss on foreign currency transaction
Increase in accrued interest receivable
<Increase> decrease in other assets
Increase in accrued interest payable
Increase <decrease> in accounts payable and other liabilities
Net cash used in operating activities
Cash Flows From Investing Activities
Collections on notes receivable
Proceeds from sale of notes receivable
Pizza parlor equipment purchased
Proceeds from sale of real estate
Notes receivable funded
Earnest money deposits
Investment in real estate entities, net of cash acquired
Acquisition of real estate
Distributions to equity investees
Payments under interest rate swap contract
Real estate improvements
Net cash provided by investing activities
Cash Flows from Financing Activities
Proceeds from notes payable
Payments on notes payable
Deferred borrowing costs
Net <payments to>/advances from affiliates
Margin borrowings, net
Stock sale profits received from affiliate
Preferred dividends paid
Common dividends paid
Repurchase of Preferred shares
Net cash used in financing activities
Net <decrease> increase in cash and cash equivalents
Cash and cash equivalents, beginning of period
Cash and cash equivalents, end of period
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CONSOLIDATED STATEMENTS OF CASH FLOWS—Continued
Supplemental Disclosures of Cash Flow Information
Cash paid for interest
Schedule of noncash investing and financing
Notes payable assumed by buyer on sale of real estate
Notes receivable from sale of real estate
Disposal of property to satisfy debt
Cancellation of Series F Preferred Stock
Note receivable from sale of leasehold interests
Acquisition of property to satisfy debt
Assumed debt of seller on purchase of real estate
Exchange of interest in note receivable for stock
Note receivable from exchange of stock with affiliate
Funds collected by affiliate for property financing
Funds collected by affiliate on sale of real estate
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The accompanying Consolidated Financial Statements have been prepared in conformity with accounting principles generally accepted in the United States of America 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 accounting principles generally accepted in the United States of America for complete financial statements. Dollar amounts in tables are in thousands, except per share amounts. Certain balances for 2002 have been reclassified to conform to the 2003 presentation.
Operating results for the nine month period ended September 30, 2003, are not necessarily indicative of the results that may be expected for the year ending December 31, 2003. For further information, refer to the Consolidated Financial Statements and Notes thereto included in ARI’s Annual Report on Form 10-K for the year ended December 31, 2002 (the “2002 Form 10-K”).
On November 15, 2002, ARI, through wholly-owned subsidiaries, commenced a tender offer for the common shares of Transcontinental Realty Investors, Inc. (“TCI”) and Income Opportunity Realty Investors, Inc. (“IORI”) not already owned by ARI. The tender offer was completed on March 19, 2003. ARI paid $19.00 cash per IORI share and $17.50 cash per TCI share for the stock of non-affiliated stockholders. Pursuant to the tender offer, ARI acquired 265,036 IORI shares and 1,213,226 TCI shares. After the tender offer, ARI owned 64.8% of the outstanding shares of TCI and 62.5% of the outstanding shares of IORI (46.9% owned directly by ARI and 15.6% through TCI’s ownership of IORI shares). ARI began consolidation of TCI’s and IORI’s accounts and operations effective March 31, 2003. The effect of consolidating TCI’s and IORI’s operations from the completion of the tender offer through March 31, 2003 was determined to be immaterial. On June 2, 2003, ARI exchanged all of its 674,971 IORI shares with Basic Capital Management, Inc. (“BCM”), a related party and the contractual advisor to ARI until June 30, 2003, receiving 650,000 TCI shares from BCM. In addition, BCM has executed a promissory note in favor of ARI in the amount of $526,000 (see NOTE 3. “NOTES RECEIVABLE”). After the exchange, ARI owned 72.9% of the outstanding shares of TCI. On June 30, 2003, ARI sold a participating interest in $5.8 million of its $15.5 million line of credit receivable from One Realco Corporation (“One Realco”) to BCM, receiving 314,141 TCI shares from BCM (see NOTE 3. “NOTES RECEIVABLE”). After the transaction, ARI owned 76.8% of the outstanding shares of TCI. ARI no longer directly owns any IORI shares. At September 30, 2003, ARI owned 18.4% of IORI through TCI’s ownership of IORI shares. ARI ceased consolidation of IORI’s accounts and operations effective June 2, 2003.
The following pro forma information reflects the results of operations for ARI as though the consolidation of TCI’s operations had begun on January 1 of each year presented.
Revenue, as reported
Revenue, pro forma
Net income <loss>, as reported
Net income <loss>, pro forma
Earnings per share:
Basic, as reported
Basic, pro forma
Diluted, as reported
Diluted, pro forma
On June 30, 2003, ARI sold its 74.31% interest in Realty Advisors Korea, Ltd. (“RAK”) to Realty Advisors, Inc. (“Realty Advisors”), a related party. The sales price was $6.0 million. Realty Advisors also paid ARI $600,000, representing 10% interest on the $6.0 million price paid by ARI to purchase the 74.31% interest in RAK in 2002. The $6.0 million sales price reduced ARI’s affiliate debt. The $600,000 interest was received in cash in August 2003. ARI ceased consolidation of RAK’s accounts and operations effective June 30, 2003.
Effective July 1, 2003, Prime Asset Management, Inc. (“Prime”) became the advisor to ARI and TCI. Prime is owned by Realty Advisors (79%) and Syntek West, Inc. (“Syntek West”) (21%), related parties. Syntek West is owned by Gene Phillips. Effective August 18, 2003, Prime changed its name to Prime Income Asset Management, Inc. On October 1, 2003, Prime Income Asset Management, LLC (“Prime LLC”), which is 100% owned by Prime, replaced Prime as the advisor to ARI and TCI.
In July 2003, ARI sold its interest in Milano Restaurants International Corporation (“MRI”) to Gruppa Florentina, LLC (“Gruppa”), for $18.5 million, receiving $7.4 million in cash after debt assumption and providing purchase money financing of $2.3 million (see NOTE 3. “NOTES RECEIVABLE”). ARI owns 20% of Gruppa, thereby retaining a 20% interest in MRI. ARI remains as the guarantor of $8.7 million of assumed debt and is one of the guarantors of $7.5 million in new debt obtained by Gruppa. Due to the
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 1. BASIS OF PRESENTATION (Continued)
debt guarantees and ARI’s continuing ownership interest in MRI, management has determined that this should be accounted for as a financing transaction. In September 2003, ARI sold the note to Syntek West for $2.3 million, plus accrued but unpaid interest, to reduce affiliate debt. No gain or loss was recorded in this transaction.
Recent accounting pronouncements. In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”), which requires the consolidation of variable interest entities, as defined. FIN 46 is applicable to financial statements to be issued by ARI after 2003; however, disclosures are required currently if ARI expects to consolidate any variable interest entities. ARI does not currently believe that any entities will be consolidated as a result of FIN 46.
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires the issuer to classify a financial instrument that is within the scope of the standard as a liability if such financial instrument embodies an obligation of the issuer. The adoption of SFAS No. 150 is not expected to require ARI to reclass any financial instruments currently on its balance sheet.
Stock-based employee compensation. Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees,” and related Interpretations are utilized by management in accounting for the option plans. All share options issued have exercise prices equal to the market price of the shares at the dates of grant. Accordingly, no compensation cost has been recognized for the option plans. Had compensation cost for the option plans been determined based on the fair value at the grant dates consistent with the method of Statement of Financial Accounting Standards No. 123 “Accounting for Stock-Based Compensation,” net income (loss) and net income (loss) per share would have been the pro forma amounts indicated below.
Deduct: Total stock-based employee compensation expense determined under fair value based methods for all awards, net of related tax effects
Pro forma net income <loss>
Income <loss> per share:
NOTE 2. REAL ESTATE
In 2003, ARI purchased the following properties:
Property
First Quarter
Apartments
Capitol Hill(1)
Second Quarter
Breakwater Bay(1)
Longwood
Land
Pulaski
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Third Quarter
Sheffield Village
Fourth Quarter
Travelers(4)
In February 1990, ARI sold the Bridgeview Plaza Shopping Center, located in LaCrosse, Wisconsin, providing purchase money financing of $5.0 million in the form of a wrap mortgage. In 1996, the first lienholder called a default under the ARI wrap note, and directed future payments be made directly to them. ARI began legal proceedings against the first lienholder. In December 1999, ARI sold the note to BCM at its carrying value of $489,000, retaining the right to receive any amounts collected by BCM in excess of the amount paid, plus accrued interest. In 2002, ARI prevailed in its litigation and ARI’s lien on the property was restored. The borrower continued in default, and ARI foreclosed on the property in March 2003. The property was subsequently sold to TCI. See NOTE 8. “RELATED PARTY TRANSACTIONS.”
In 2002, ARI purchased the following property:
Shopping Center
Plaza on Bachman Creek(1)
Pinecrest(2)
Tiberon Trails(2)
Alta Mesa(2)
Pioneer Crossing
Willow Springs
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In 2003, ARI sold the following properties:
Bay Anchor
Georgetown
Northside Villas
Rolling Hills
Seville
Shopping Centers
Bridgeview Plaza
Cullman
Office Building
4135 Beltline Road
Katrina
Nashville
Hotel
Grand Hotel Sofia
Greenbriar
Lake Château
Pinecrest
Regency
Willow Wick
Industrial Warehouses
McLeod
Tricon
Mason Goodrich
Solco-Valley Ranch
Clarion KC Airport (6)
Landing & Marina
Lincoln Court
Quail Creek
Stone Oak
Office Buildings
Bonita Plaza
Encino Executive Plaza
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Sq. Ft./
Rooms/Units/Acres
Net CashReceived/
(Paid)
Third Quarter (Continued)
Oak Tree Village
Sheboygan
Westwood
Palm Desert
Vista Ridge
Hotels
City Suites
Majestic
Williamsburg Hospitality House
Willows
Summerfield
Keller
In 2002, ARI sold the following properties:
Mallard Lake(1)
Villas
Lakeshore Villas(2)
Rasor(2)
Thompson II
Oaktree Village(2)
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Oak Hill
Stonebridge
Centura
Hollywood Casino
Marine Creek
Monterrey
Conradi House
Lee Hills
Morning Star
Pheasant Ridge
Stonegate
Valley Hi
White Pines
Woodsong
Elm Fork
Messick
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At September 30, 2003, ARI had the following properties under construction:
Breakwater Bay
Capitol Hill
DeSoto Ranch
Echo Valley
Heather Creek
Kingsland Ranch
Verandas at City View
Vistas at Pinnacle Park
During the nine months ended September 30, 2003, ARI completed the 186 unit Blue Lake Villas in Waxahachie, Texas, the 284 unit Falcon Lakes in Arlington, Texas, the 180 unit River Oaks Apartments in Wiley, Texas, the 384 unit Sendero Ridge Apartments in San Antonio, Texas and the 256 unit Spyglass Apartments in Mansfield, Texas.
NOTE 3. NOTES RECEIVABLE
In February 2003, ARI sold an 89.3 acre tract of its Katrina land parcel for $8.5 million, paying $410,000 after payment of closing costs and debt paydown and providing purchase money financing of $5.6 million. The note bears interest at 8.0% per annum and matures three years after the recording of the Deed of Trust. Interest will begin accruing after improvements to the site have been completed by ARI. ARI expects that the improvements will be completed by the end of February 2004. The future costs to ARI to complete the improvements, estimated to be $2.5 million, were accrued in 2002. A principal payment of $450,000 is due within ten days after a Tentative Parcel Map (the “Map”) is recorded. ARI expects that the Map will be recorded by the end of November 2003. Interest payments will be due on the first day of each calendar quarter, beginning with the first quarter following the completion of the site improvements.
In March 2003, ARI sold the Grand Hotel Sofia for $24.8 million, receiving $6.3 million in cash after paying closing costs and debt assumption and providing purchase money financing of $13.5 million. The note was non-interest-bearing for 90 days, then bore interest at 9.0% per annum for the next 90 days and matured in September 2003. In September 2003, the note was collected in full.
In March 2003, ARI sold the 90,000 sq. ft., 4135 Beltline Office Building in Addison, Texas, for $4.4 million. No cash was received or paid by ARI, after debt assumption and providing purchase money financing of $1.5 million. The note bears interest at 12.0% per annum, requires quarterly payments of accrued interest and matures in March 2004.
In June 2003, ARI sold the 104 unit Willow Wick Apartments in North Augusta, South Carolina, for $2.7 million, receiving $255,000 after payment of closing costs and debt pay down and providing purchase money financing of $42,000. The note bears interest at 5.0% per annum and requires all interest and principal be paid at maturity in December 2003.
In September 2003, ARI sold a 367.4 acre tract of its Pioneer Crossing land parcel for $22.5 million, receiving $4.9 million after payment of closing costs and providing purchase money financing of $16.9 million. The note bears interest at 8.0% per annum, matures in September 2006 and requires quarterly payments of accrued interest beginning in January 2004. All principal and accrued but unpaid interest are due at maturity. In November 2003, ARI sold an interest in $8.0 million of the note for $7.5 million, receiving $7.2 million in cash after payment of closing costs and debt paydown.
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 note bore interest at 8.0% per annum, matured in September 2004 and required quarterly payments of accrued interest. All principal and accrued interest were due at maturity. In February 2003, ARI accepted $7.4 million as full payment for $7.7 million in principal and accrued interest. In March 2003, the remaining $1.9 million note balance was sold to an unrelated party for $1.8 million plus accrued and unpaid interest.
In December 2002, ARI sold its Willow Springs land parcel for $9.8 million, paying $1.3 million after payment of closing costs and debt paydown and providing purchase money financing of $7.8 million. The note bore interest at 8.0% per annum, matured in December 2005 and required periodic interest payments beginning in June 2003. In March 2003, the note was sold to an unrelated party for $7.5 million plus accrued and unpaid interest. The buyer of the note has limited recourse against a 53 acre parcel of ARI’s
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Katrina land, in event of default by the borrower. ARI recognized a previously deferred gain of $4.9 million upon completion of the sale of the note.
In December 2002, ARI sold a 238.0 acre tract of its Desert Wells land parcel for $23.8 million, receiving $321,000 after payment of closing costs and debt paydown and providing purchase money financing of $21.4 million. The first lien financing of $17.8 million bore interest at 8.0% per annum, matured in December 2004 and required payments beginning in March 2003. In March 2003, the note was sold to an unrelated party for $17.1 million plus accrued and unpaid interest. The buyer of the note has limited recourse against a 53 acre parcel of ARI’s Katrina land, in event of default by the borrower. ARI recognized a previously deferred gain of $15.0 million upon completion of the sale of the note. The second lien financing of $3.6 million bore interest at 8.0% per annum and matured on March 31, 2003. All principal and interest were due at maturity. At November 2003, negotiations are underway to modify and extend the terms of the note. In July 2003, ARI advanced an additional $357,000 to the borrower. The new note bears interest at 8.0% per annum and matures in July 2004. All principal and interest are due at maturity.
In December 2002, ARI sold a 171.1 acre tract of its Desert Wells land parcel for $11.9 million receiving $1.4 million after payment of closing costs and debt paydown and providing purchase money financing of $8.9 million. The note bore no interest and matured in March 2003. The principal was due at maturity. In December 2002, an interest in $7.7 million of the note was sold to an unrelated party for $7.7 million. ARI retained a junior interest in $1.2 million of the note. In March 2003, the note was collected in full.
In July 2001, ARI agreed to fund a $4.4 million line of credit secured by a second lien on 1,714.16 acres of unimproved land in Tarrant Country, Texas. As of April 2003, ARI had funded $2.9 million of the line of credit and it was classified as nonperforming. In May 2003, ARI received a $433,000 principal paydown. Also during May 2003, ARI received 14.373 acres of unimproved land in Tarrant County, Texas, valued at $1.1 million, as a principal paydown. As of July 2003, the line of credit has been paid in full.
In September 1999, in conjunction with the sale of two apartments in Austin, Texas, $2.1 million in purchase money financing was provided, secured by limited partnership interests in two limited partnerships owned by the buyer. The financing bore interest at 16.0% per annum, required monthly payments of interest only at 6.0% per annum, beginning in February 2000 and required a $200,000 principal paydown in December 1999, which was not received, and matured in August 2000. ARI had the option of obtaining the buyer’s general and limited partnership interests in the collateral partnerships in full satisfaction of the financing. In March 2000, ARI agreed to forbear foreclosing on the collateral securing the note and released one of the partnership interests, in exchange for a payment of $250,000 and executed deeds of trusts on certain properties owned by the buyer. In March 2000, the borrower made a $1.1 million payment, upon receipt of which ARI returned the deeds of trust. The borrower executed a replacement promissory note for the remaining note balance of $1.0 million, which was unsecured, non-interest bearing and matured in April 2003. At November 2003, negotiations are underway to modify the terms of the note.
Related Party. In May 2003, ARI sold the Clarion Kansas City Airport Hotel to One Realco Hotel for $5.3 million. No cash was received or paid by ARI, after debt assumption and providing purchase money financing of $400,000. The note bore interest at 12.0% per annum, matured in May 2004 and required quarterly interest payments beginning in June 2003. In August 2003, the hotel was sold through foreclosure proceedings. ARI is pursuing collection of the note from One Realco Hotel. In September 2003, One Realco Hotel filed for bankruptcy protection under Chapter 11.
On June 2, 2003, ARI exchanged all of its 674,971 IORI shares with BCM, receiving 650,000 TCI shares from BCM. In addition, BCM has executed a promissory note in favor of ARI in the amount of $526,000. The note bears interest at 2% over the prime rate, currently 6.00% per annum, matures in June 2004 and requires monthly interest payments beginning in June 2003 and quarterly principal payments beginning in September 2003.
In July 2003, ARI sold its interest in MRI to Gruppa for $18.5 million, receiving $7.4 million in cash after debt assumption and providing purchase money financing of $2.3 million (see NOTE 1. “BASIS OF PRESENTATION”). The note bore interest at 10.0% per annum, matured in August 2013 and required monthly payments of principal and interest beginning in September 2003. ARI owns 20% of Gruppa, thereby retaining a 20% interest in MRI. Due to debt guarantees and ARI’s continuing ownership interest in MRI, management has determined that this should be accounted for as a financing transaction. In September 2003, ARI sold the note to Syntek West for $2.3 million, plus accrued but unpaid interest, to reduce affiliate debt.
In August 2003, ARI sold the Williamsburg Hospitality House to One Realco Hotel for $19.5 million, receiving $250,000 after debt assumption and providing purchase money financing of $5.7 million. The note bears interest at 12.0% per annum, matures in August 2006 and requires semi-annual payments of principal and interest beginning in June 2004. In September 2003, One Realco Hotel filed for bankruptcy protection under Chapter 11. The parent company of One Realco Hotel has guaranteed the note; therefore, management has not established reserves or classified the note as nonperforming.
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In August 2003, ARI sold the City Suites, Majestic, and Willows hotels to One Realco Hotel for $13.5 million in a single transaction, receiving $250,000 after debt assumption and providing purchase money financing of $2.7 million. The note bears interest at 12.0% per annum, matures in August 2006 and requires semi-annual payments of principal and interest beginning in June 2004. In September 2003, One Realco Hotel filed for bankruptcy protection under Chapter 11. The parent company of One Realco Hotel has guaranteed the note; therefore, management has not established reserves or classified the note as nonperforming.
In October 2003, ARI advanced $1.6 million to the Class A Limited Partners of Encino Executive Plaza, Ltd., of which ARI is the general partner. The loans bear interest at 8.5% per annum and mature in June 2006. Interest due to ARI will be deducted from the quarterly return owed by ARI to the Class A Limited Partners, eliminating the quarterly payments. The outstanding principal is due at maturity.
In March 2001, ARI funded $13.6 million of a $15.0 million unsecured line of credit to One Realco. A wholly-owned subsidiary of One Realco owns approximately 2.1% of the outstanding shares of ARI’s Common Stock. One Realco periodically borrows money to meet its cash obligations. The line of credit bears interest at 12.0% per annum. All principal and interest were due at maturity in February 2002. The line of credit is guaranteed by BCM. In June 2001, $394,000 in principal and $416,000 in interest was collected. In December 2001, $21,000 in principal and $804,000 in interest was collected. In February 2002, the line of credit was increased to $18.0 million, accrued but unpaid interest of $217,000 was added to the principal and the maturity date was extended to February 2004. In March 2002, ARI funded an additional $1.8 million, increasing the outstanding principal balance to $15.5 million. In October 2002, $856,900 in interest was collected, by the return of 85,690 shares of ARI Series A Preferred Stock. In June 2003, ARI sold a participating interest in $5.8 million of the $15.5 million balance to BCM, receiving 314,141 TCI shares from BCM (see NOTE 1. “BASIS OF PRESENTATION”). All principal and interest are due at maturity. Ronald E. Kimbrough, Acting Principal Executive Officer, Executive Vice President and Chief Financial Officer of ARI, is a 10% shareholder of One Realco. Mr. Kimbrough does not participate in the day-to-day operations or management of One Realco.
In December 2000, an unsecured loan with a remaining 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 March 2003, $27,000 of principal and $223,000 of interest was received. In April 2003, $149,000 of principal and $26,000 of interest was received. In July 2003, $10,000 of interest was received. At November 2003, the loan, 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, was 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. Richard D. Morgan, a Bordeaux member until July 2003, served as a director of ARI until October 2001. In July 2003, the members of Bordeaux assigned 100% of the membership interest in Bordeaux to ARI in payment of the note. ARI recorded real estate assets of $8.8 million and assumed $7.2 million of mortgage debt and other liabilities on the shopping center and the undeveloped land. No gain or loss was recorded on this transaction.
In March 2000, a loan with a remaining principal balance of $2.6 million to Lordstown, L.P., matured. The loan, to provide funds to purchase for resale various parcels of land, is secured by a second lien on land in Ohio and Florida, by 100% of the general and limited partner interest in Partners Capital, Ltd., the limited partner of Lordstown, L.P., and a profits interest in subsequent land sales. At November 2003, the loan, and $1.3 million of accrued interest, remained unpaid. A corporation controlled by Richard D. Morgan is the general partner of Lordstown, L.P. Mr. Morgan served as a director of ARI until October 2001.
NOTE 4. INVESTMENTS IN EQUITY INVESTEES
Real estate entities. Before 2003, ARI’s investment in real estate entities included equity securities of IORI and TCI, and interests in real estate joint venture partnerships. BCM, ARI’s advisor until June 30, 2003, served as advisor to IORI and TCI until June 30, 2003.
Through March 31, 2003, ARI accounted for its investment in IORI and TCI and the joint venture partnerships using the equity method. ARI began consolidation of TCI’s and IORI’s accounts and operations effective March 31, 2003. See NOTE 1. “BASIS OF PRESENTATION.” The effect of consolidating TCI’s and IORI’s operations from the completion of the tender offer through March 31, 2003 was determined to be immaterial. On June 2, 2003, ARI exchanged all of its 674,971 IORI shares with BCM, receiving 650,000 TCI shares from BCM. In addition, BCM has executed a promissory note in favor of ARI in the amount of $526,000 (see NOTE 3. “NOTES RECEIVABLE”). After the exchange, ARI owned 72.9% of the outstanding shares of TCI. On June 30, 2003, ARI sold a participating interest in $5.8 million of its $15.5 million line of credit receivable from One Realco to BCM, receiving 314,141
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TCI shares from BCM (see NOTE 3. “NOTES RECEIVABLE”). After the transaction, ARI owned 76.8% of the outstanding shares of TCI. ARI no longer directly owns any IORI shares. At June 30, 2003, ARI owned 18.4% of IORI through TCI’s ownership of IORI shares. ARI ceased consolidation of IORI’s accounts and operations effective June 2, 2003.
Effective July 1, 2003, Prime became the advisor to ARI and TCI. Prime is owned by Realty Advisors (79%) and Syntek West (21%), related parties. Syntek West is owned by Gene Phillips. Effective August 18, 2003, Prime changed its name to Prime Income Asset Management, Inc. On October 1, 2003, Prime LLC, which is 100% owned by Prime, replaced Prime as the advisor to ARI and TCI.
ARI’s investment in real estate entities, accounted for using the equity method, at September 30, 2003 was as follows:
Investee
IORI
Set forth below are summarized results of operations of TCI and IORI for the three months ended March 31, 2003, prior to their consolidation by ARI:
Revenues
Property operating expenses
Depreciation
Loss from continuing operations
Loss from discontinued operations
Equity in investees’ gain from sale of real estate
Net loss
Set forth below are summarized results of operations of IORI for the four months of June—September 2003, following ARI’s exchange of its IORI shares:
Net income from continuing operations
ARI’s share of equity investees’ loss before gains on the sale of discontinued operations was $4.3 million for the nine months ended September 30, 2003, and its share of equity investees’ loss on sale of real estate was $165,000 for the nine months ended September 30, 2003.
ARI’s cash flow from IORI is dependent on the ability of IORI to make distributions. In the fourth quarter of 2000, IORI suspended distributions.
ART Florida Portfolio II, Ltd. In January 2002, Investors Choice Florida Public Funds II, in which ART Florida Portfolio II, Ltd., a subsidiary of ARI, owned an interest, sold Villas Continental Apartments. ARI initially received $1.0 million in cash from the sale. In the nine months ended September 30, 2002, ARI recognized a $531,000 loss on the sale, which is included in loss on sale of investments in equity investees in the Consolidated Statements of Operations. Subsequently, ARI received an additional $245,000 in sales proceeds, reducing the total loss to $286,000.
NOTE 5. MARKETABLE EQUITY SECURITIES
Since 1994, ARI has been purchasing equity securities 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 2003, ARI purchased $1.6 million and sold $1.7 million of equity securities. At September 30, 2003, ARI recognized an unrealized increase in the market value
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of its trading portfolio securities of $7,000. Unrealized and realized gains and losses on trading portfolio securities are included in other income in the accompanying Consolidated Statements of Operations.
In March 2003, ARI obtained a loan in the amount of $5.0 million to acquire equity securities of Realty Korea CR-REIT Co., Ltd. No 1 representing approximately a 9.2% ownership interest. As of May 2003, the loan was paid in full. This investment is considered an available-for-sale security. The change in market value between the date of purchase and September 30, 2003 was not material.
NOTE 6. NOTES PAYABLE
In February 2003, the lender on one of ARI’s hotel properties located in Virginia and three hotel properties in Chicago notified ARI that the loans on the properties were in default, due to ARI’s failure to make timely debt service payments. The balance owed on the loans is $21.2 million. In April 2003, the lender and ARI agreed to terms to cure the default and extend the maturity dates of the loans. In May 2003, ARI failed to satisfy the conditions in the lender’s Loan Modification Offer (the “Offer”), and the Offer was revoked. In August 2003, ARI sold the hotels to a related party (see NOTE 2. “REAL ESTATE”).
In May 2003, the lender on one of ARI’s commercial properties located in Texas notified ARI that the loan on the property was in default, due to ARI’s failure to make timely debt service payments. The balance owed on the loan is $6.5 million. In July 2003, the maturity date of the note was extended to December 2003.
In August 2003, ARI received a loan for $5.0 million that is secured by its investment in equity securities of Realty Korea CR-REIT Co., Ltd. No. 1. The loan is also secured by a second deed of trust on commercial properties in North Carolina and Texas. The loan bears interest at the prime rate plus 1%, currently 5.0%, requires monthly interest only payments and matures in August 2004.
In September 2003, the lender on one of ARI’s commercial properties located in Oklahoma notified ARI that the loan on the property was in default, due to ARI’s failure to make timely debt service payments. The balance owed on the loan is $3.3 million. At November 2003, negotiations with the lender are ongoing.
In October 2003, ARI received a construction loan for $15.5 million for the construction of a new apartment development in Lewisville, Texas.
In 2003, ARI financed/refinanced or obtained second mortgage financing on the following:
Vineyards II
Arlington Place
Bridgeview
Plantation
Industrial Warehouse
Ogden Industrial
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Second Quarter (Continued)
Land (Continued)
Lacy Longhorn
Las Colinas
McKinney Corners II
Thompson
Tomlin
Tree House
Windsor Tower
Rasor
Valwood
In 2002, ARI financed/refinanced or obtained second mortgage financing on the following:
Net
CashReceived/<Paid>
Walker
Plaza on Bachman Creek
Four Hickory Centre
Related Party Transactions. In each of the following transactions, except those footnoted as (6), a related party purchased an entity, which owns the listed property asset, from ARI. ARI 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.
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Debt
Discharged
NetCash
Received
Rosedale Towers
Two Hickory Centre
Confederate Point
Foxwood
Governor Square
Grand Lagoon
Park Avenue
Woodhollow
One Hickory Centre
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
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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.
NOTE 7. MARGIN BORROWINGS
ARI has margin arrangements with various financial institutions and brokerage firms which provide for borrowing of up to 50% of the market value of marketable equity securities. The borrowings under such margin arrangements are secured by equity securities of TCI and ARI’s trading portfolio securities and bear interest rates ranging from 5.00% to 24.0%. Margin borrowing totaled $25.2 million at September 30, 2003.
Sunset Management Loan. In September 2001, ARI obtained a security loan in the amount of $20.0 million from Sunset Management, LLC (“Sunset”). ARI received net cash of $16.1 million after the payment of various closing costs and $3.4 million repayment of principal and accrued interest on an existing loan with the same lender. Of the total loan amount, $19.5 million bears interest at 24% per annum, while the remaining $500,000 bears interest at 20% per annum. The loan is secured by 3,672,305 shares of TCI common stock held by BCM and wholly-owned subsidiaries of ARI. The loan was also secured by a lien on real property owned by ART Williamsburg, Inc. (“AWI”). The loan required monthly payments of interest only and matured in September 2002. In September 2002, $15.0 million in principal was repaid. Sunset orally agreed in September 2002 to extend the maturity date of the loan and accept substitute collateral for the shares of TCI common stock after the $15.0 million paydown. Sunset did not honor the agreement, which resulted in litigation filed in Texas state court during October 2002, styled American Realty Trust, Inc., ART Williamsburg, Inc., Basic Capital Management, Inc. and EQK Holdings, Inc. v. Sunset Management, LLC, et al., Cause No. 02-09433-I in the 162nd Judicial Court of Dallas County, Texas (the “Texas Litigation”).
The Texas Litigation alleged breach of contract, misrepresentation, breach of duty of good faith and fair dealing and slander of title by Sunset and sought certain declaratory relief against Sunset as well as a temporary and permanent anti-suit injunction against Sunset.
During January 2003, without notice to the plaintiffs in the Texas Litigation, Sunset instituted an action in a federal district court in Las Vegas, Nevada against Commonwealth Land Title (“Commonwealth”) seeking disposition of the TCI common stock held by Commonwealth as Pledge Holder. On January 31, 2003, after a Temporary Restraining Order was issued in the Texas Litigation, Sunset instigated a separate lawsuit in state court in Nevada styled Sunset Management, LLC v. American Realty Trust, Inc. et al., Case No. A462587 pending in the District Court of Clark County, Nevada (the “Nevada Litigation”). On February 12, 2003, the Nevada state court held a hearing on Sunset’s request for emergency relief and denied all Sunset’s requested relief and indicated that a
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stay of the Nevada Litigation may be appropriate, which stay of litigation (including claims against TCI) was granted on May 2, 2003. Notwithstanding the stay of the Nevada Litigation, Sunset continued to seek to relitigate the underlying fact issues already determined in the Texas Litigation and the Nevada Litigation through cross-claims and counterclaims in the Texas Litigation and a renewed motion for preliminary injunction and appointment of receiver over TCI in the Nevada Litigation.
Sunset has sought expedited relief and an expedited hearing of the Texas Litigation, which the court refused to grant. The matter was set for a jury trial on December 8, 2003. In addition, the borrowers on the loan have sought to tender cash collateral to the court in lieu of the TCI stock, which motion was denied. TCI has only recently been added to the Texas Litigation as a party.
Even though the relief sought by Sunset in the Texas Litigation and the Nevada Litigation has either been denied or stayed, on June 10, 2003, an attorney representing Sunset appeared at the Annual Meeting of Shareholders of TCI attempting to vote 3,673,115 Shares of common stock of TCI under purported irrevocable proxies against the election of the four directors nominated in favor of the election of four affiliates of Sunset that Sunset seeks to nominate to serve as directors of TCI. The Inspector of Election at the Annual Meeting advised that Sunset’s attempt to exercise voting rights under proxies for the 3,673,115 shares was improper and would not be allowed, advising that BCM and the ARI subsidiaries held the absolute right to vote the 3,673,115 shares of TCI common stock so long as there was no event of default under the Sunset loan agreement. The Inspector of Election also observed at the Stockholders meeting that no evidence was before the Inspector from a court of law finding an event of default had occurred with respect the Sunset loan documents, and therefore, such proxies would not be honored at that time. Subsequently, representatives of Sunset delivered on July 7, 2003 to TCI a form captioned Schedule 13D for an event occurring June 10, 2003, making certain disclosures, including an allegation that “Sunset acquired voting rights to 3,673,115 shares of TCI to protect the value of Sunset’s security interest in the 3,673,115 shares of TCI pledged as collateral for . . . obligations to Sunset.” Actually, only 3,672,305 shares of TCI common stock were pledged [810 shares less than Sunset alleges]. Such schedule 13D also provides that “Sunset plans to foreclose on the pledged TCI shares as soon as possible.” Such Schedule 13D advises that “Sunset would prefer to replace the four management directors [of TCI] with neutral individuals . . . or if neutral individuals are unavailable, Sunset intends to nominate and [vote] for the election of affiliates of Sunset as directors of TCI on an interim basis until neutral individuals with satisfactory backgrounds and knowledge can be elected as directors.”
On September 10, 2003, AWI removed the Texas Litigation to the bankruptcy court for the Northern District of Texas. On September 25, 2003, the Texas Litigation was transferred to the Eastern District of Texas. A scheduling conference on this matter is set for December 3, 2003.
Security Loans. In August 2003, ARI obtained a security loan in the amount of €5.0 million from a financial institution in Bulgaria. The funds were used for earnest money for a potential property acquisition in Bulgaria. The loan bore interest at 4.33% over the six-month EURIBOR rate, currently 6.583%, and matured in November 2003. Principal and accrued interest were due at maturity. The loan was secured by 825,666 shares of TCI common stock held by ARI. In October 2003, the earnest money was returned to ARI. In November, the loan was repaid.
In September 2003, ARI obtained a security loan in the amount of $12.5 million from a financial institution. The loan bears interest at 12% over the 30-day LIBOR rate, currently 13.12%, requires monthly payments of interest only and matures in September 2004. The loan is secured by 1,656,537 shares of TCI common stock held by ARI.
In September 2003, ARI obtained a security loan in the amount of $1.0 million from a financial institution. The loan bears interest at 12% over the 30-day LIBOR rate, currently 13.12%, requires monthly payments of interest only and matures in September 2004. The loan is secured by 250,000 shares of IORI common stock held by ARI.
In October 2001, ARI obtained a security loan in the amount of $1.0 million from a financial institution. The loan bore interest at 1% over the prime rate, currently 5.00% per annum, required monthly payments of interest only and matured in October 2003. The loan is callable upon 60 days prior notice, and is secured by 250,000 shares of ARI Common Stock held by BCM. In October 2003, the maturity date was extended to December 2003.
NOTE 8. RELATED PARTY TRANSACTIONS
In March 2003, ARI sold the Bridgeview Plaza and Cullman shopping centers to TCI for $10.7 million to satisfy debt. TCI assumed debt of $2.7 million on Cullman. TCI received $5.1 million cash on the subsequent financing of the shopping centers.
In April 2003, ARI paid $2.0 million in principal and accrued interest to IORI, in partial payment of a note payable on the Rosedale Tower Office Building. See NOTE 6. “NOTES PAYABLE.”
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In May 2003, ARI sold the Clarion Kansas City Airport Hotel to One Realco Hotel, a related party, for $5.3 million. No cash was received or paid by ARI, after debt assumption and providing purchase money financing of $400,000. The note bore interest at 12.0% per annum, matured in May 2004 and required quarterly interest payments beginning in June 2003. In August 2003, the hotel was sold through foreclosure proceedings. ARI is pursuing collection of the note from One Realco Hotel. In September 2003, One Realco Hotel filed for bankruptcy protection under Chapter 11.
On June 2, 2003, ARI exchanged all of its 674,971 IORI shares with BCM, receiving 650,000 TCI shares from BCM. In addition, BCM has executed a promissory note in favor of ARI in the amount of $526,000 (see NOTE 3. “NOTES RECEIVABLE”). After the exchange, ARI owned 72.9% of the outstanding shares of TCI. On June 30, 2003, ARI sold a participating interest in $5.8 million of its $15.5 million line of credit receivable from One Realco to BCM, receiving 314,141 TCI shares from BCM (see NOTE 3. “NOTES RECEIVABLE”). After the transaction, ARI owned 76.8% of the outstanding shares of TCI. ARI no longer directly owns any IORI shares. At September 30, 2003, ARI owned 18.4% of IORI through TCI’s ownership of IORI shares. ARI ceased consolidation of IORI’s accounts and operations effective June 2, 2003.
In June 2003, ARI received funds of $757,000 from an affiliate reducing the affiliate receivable. The funds paid down a note secured by undeveloped land in Harris County, Texas.
On June 30, 2003, ARI sold its 74.31% interest in RAK to Realty Advisors, a related party. The sales price was $6.0 million. Realty Advisors also paid ARI $600,000, representing 10% interest on the $6.0 million price paid by ARI to purchase the 74.31% interest in RAK in 2002. The $6.0 million sales price reduced ARI’s affiliate debt. The $600,000 interest was received in cash in August 2003.
Effective July 1, 2003, Prime became the advisor to ARI and TCI. Prime is owned by Realty Advisors (79%) and Syntek West, (21%). Syntek West is owned by Gene Phillips. Effective August 18, 2003, Prime changed its name to Prime Income Asset Management, Inc. On October 1, 2003, Prime LLC, which is 100% owned by Prime, replaced Prime as the advisor to ARI and TCI.
In July 2003, ARI sold its interest in MRI to Gruppa, for $18.5 million, receiving $7.4 million in cash after debt assumption and providing purchase money financing of $2.3 million (see NOTE 3. “NOTES RECEIVABLE”). ARI owns 20% of Gruppa, thereby retaining a 20% interest in MRI. ARI remains as the guarantor of $8.7 million of assumed debt and is one of the guarantors of $7.5 million in new debt obtained by Gruppa. Due to the debt guarantees and ARI’s continuing ownership interest in MRI, management has determined that this should be accounted for as a financing transaction. In September 2003, ARI sold the note to Syntek West for $2.3 million, plus accrued but unpaid interest.
In July 2003, ARI paid $3.1 million to BCM for prior year’s legal fees incurred by Gene Phillips. Mr. Phillips is a related party and advisor to ARI.
In October 2003, ARI purchased the Travelers land from IORI for $25.0 million, paying $1.9 million in cash and giving a wrap note payable to IORI for $22.8 million. The note does not have a stated interest rate, requires monthly payments sufficient to pay the installments due on the underlying debt and matures in October 2006. The principal is due at maturity.
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The following table reconciles the beginning and ending balances of accounts payable to affiliates as of September 30, 2003.
Balance, December 31, 2002
Cash transfers to affiliates
Cash transfers from affiliates
Fees and reimbursements payable to Advisor
Other additions
Other repayments
Balance, September 30, 2003 (Update)
Also at September 30, 2003, ARI owed $1.5 million to affiliates related to cash received upon the sale of apartments to Metra.
NOTE 9. OPERATING SEGMENTS
Significant differences among the accounting policies of the operating segments as compared to the Consolidated Financial Statements principally involve the calculation and allocation of administrative expenses. Management evaluates the performance of each of the operating segments and allocates resources to them based on their net operating income and cash flow. Items of income that are not reflected in the segments are equity in loss of investees, equity in gain <loss> on sale of real estate by equity investees, loss on sale of investments in equity investees and other income which totaled $314,000 and $<4.1> million for the three and nine months ended September 30, 2003 and $2.0 million and $858,000 for 2002. Expenses that are not reflected in the segments are discount on sale of notes receivable, general and administrative expenses, minority interest, incentive fees, advisory fees, net income fees, writedown of assets held for sale and discontinued operations which totaled $13.2 million and $35.2 million for the three and nine months ended September 30, 2003 and $6.2 million and $21.1 million for 2002. Excluded from operating segment assets are assets of $93.4 million in 2003 and $125.8 million in 2002, which are not identifiable with an operating segment. There are no intersegment revenues and expenses, and ARI conducted all of its business within the United States, with the exception of Hotel Sofia (Bulgaria), which began operations in 2001 and was sold in March 2003, Realty Advisors Korea, Ltd. (South Korea), which ARI acquired in 2002 and sold in June 2003, and Hotel Academia (Poland), which began operations in 2002.
Presented below are ARI’s reportable segments operating income for the three and nine months ended September 30, 2003 and 2002, and segment assets at September 30, 2003 and 2002.
Three Months EndedSeptember 30, 2003
Operating revenue
Operating expenses
Operating income <loss>
Capital expenditures
Assets
Sales price
Cost of sale
Recognized prior deferred gain
Gain on sale
25
Three Months EndedSeptember 30, 2002
Nine Months Ended
September 30, 2003
Receivables/
Gain <loss> on sale
Nine Months EndedSeptember 30, 2002
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NOTE 10. DISCONTINUED OPERATIONS
Effective January 1, 2002, ARI adopted Financial Accounting Standards Board Statement No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which established a single accounting model for the impairment or disposal of long-lived assets, including discontinued operations. This statement requires that the operations related to properties that have been sold or properties that are intended to be sold be presented as discontinued operations in the statement of operations for all periods presented, and properties intended to be sold are to be designated as “held-for-sale” on the balance sheet.
For the three and nine months ended September 30, 2003 and 2002, income from discontinued operations relates to 23 properties and leasehold interest in oil and gas properties that ARI sold during 2002 and 29 properties that ARI sold during 2003. The following table summarizes revenue and expense information for these properties sold and held-for-sale.
Revenue
Rental
Property operations
Expenses
Net loss from discontinued operations
Equity in gain on sale of real estate by equity investees
Discontinued operations have not been segregated in the consolidated statements of cash flows. Therefore, amounts for certain captions will not agree with respective consolidated statements of operations.
NOTE 11. COMMITMENTS AND CONTINGENCIES
Liquidity. Management expects that excess cash generated from operations during the remainder of 2003 will not be sufficient to discharge all of ARI’s debt obligations as they mature. Therefore, ARI will rely on aggressive land sales, selected income producing property sales and, to the extent necessary, additional borrowings to meet its cash requirements.
Commitments. During 2002, MRI, a then wholly-owned subsidiary of ARI, sold two restaurants to a corporation owned in part by an officer of MRI. In conjunction with the sale of these restaurants, MRI guaranteed the bank debt incurred by the related party. The guaranty applies to all current debt, and to all future debt of the related party until such time as the guaranty is terminated by MRI. The amount of the debt outstanding that is subject to the guaranty is $1.2 million at September 30, 2003. In July 2003, ARI sold its interest in MRI to Gruppa for $18.5 million, receiving $7.4 million in cash after debt assumption and providing purchase money financing of $2.3 million (see NOTE 3. “NOTES RECEIVABLE”). ARI owns 20% of Gruppa, thereby retaining a 20% interest in MRI. ARI remains as the guarantor of $8.7 million of assumed debt and is one of the guarantors of $7.5 million in new debt obtained by Gruppa. Due to the debt guarantees and ARI’s continuing ownership interest in MRI, management has determined that this should be accounted for as a financing transaction. In September 2003, ARI sold the note to Syntek West for $2.3 million, plus accrued but unpaid interest, to reduce affiliate debt.
ARI has entered into an agreement with one of the investors in the Realty Korea CR-REIT Co. Ltd. No. 1 (“REIT”), that is advised by RAK, whereby the investor has been granted the opportunity to require ARI to buy their shares in the REIT twelve months after the closing of the REIT offering for their original investment amount. Their investment is approximately $4.2 million.
Litigation. In August 2002, ARI obtained a favorable jury verdict in the legal action entitled American Realty Trust v. Matisse Partners, L.L.C. (“Matisse”). However, the judge set aside the jury verdict and imposed a judgment against ARI in excess of $6.0 million, including interest. The judgment is being appealed, and, in the opinion of ARI’s management and legal counsel, there is a
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reasonable probability that the adverse judgment will be set aside and the jury verdict reinstated. Therefore, ARI has not recognized any expense nor established any reserve for this judgment. In November 2002, ARI posted a $6.0 million supercedeas bond. In July 2003, ARI obtained a letter of credit, which was substituted for the $6.0 million bond. The $6.0 million cash was returned to ARI. In April 2003, an additional judgment was issued against ARI for $1.4 million in legal fees. ARI is also appealing this judgment and posted a $1.4 million bond in May 2003. ARI has not recognized any expense nor established any reserve for this additional judgment.
In September 2001, ARI obtained a security loan in the amount of $20.0 million from Sunset Management, LLC (“Sunset”). ARI received net cash of $16.1 million after the payment of various closing costs and $3.4 million repayment of principal and accrued interest on an existing loan with the same lender. Of the total loan amount, $19.5 million bears interest at 24% per annum, while the remaining $500,000 bears interest at 20% per annum. The loan is secured by 3,672,305 shares of TCI common stock held by BCM and wholly-owned subsidiaries of ARI. The loan required monthly payments of interest only and matured in September 2002. In September 2002, $15.0 million in principal was repaid. Sunset orally agreed in September 2002 to extend the maturity date of the loan and accept substitute collateral for the shares of TCI common stock after the $15.0 million paydown. Sunset did not honor the agreement, which resulted in litigation filed in Texas state court during October 2002, styled American Realty Trust, Inc., ARTWilliamsburg, Inc., Basic Capital Management, Inc. and EQK Holdings, Inc. v. Sunset Management, LLC, et al., Cause No. 02-09433-I in the 162nd Judicial Court of Dallas County, Texas. See NOTE 7. “MARGIN BORROWINGS.”
In addition to Matisse and Sunset, ARI is involved in various lawsuits arising in the ordinary course of business. In the opinion of management the outcome of these lawsuits will not have a material impact on ARI’s financial condition, results of operations or liquidity.
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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, 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 Trust, et al. for complete settlement of all disputes in the lawsuit (the “Olive Litigation”). In February 2002, the court granted final approval of the proposed settlement (the “Olive Settlement”). Under the Olive Settlement, ARI agreed to either (i) acquire all of the outstanding shares of IORI and TCI not currently owned by ARI for a cash payment or shares of ARI preferred stock or (ii) make a tender offer for all of the outstanding shares of IORI and TCI not currently owned by ARI. On November 15, 2002, ARI commenced the tender offer for the IORI and TCI shares. The tender offer was completed on March 19, 2003. ARI paid $19.00 cash per IORI share and $17.50 cash per TCI share for the stock held by non-affiliated stockholders. Pursuant to the tender offer, ARI acquired 265,036 IORI shares and 1,213,226 TCI shares. The completion of the tender offer fulfills the obligations under the Olive Settlement, and the Olive Litigation has been dismissed with prejudice.
After the tender offer, ARI owned 64.8% of the outstanding shares of TCI and 62.5% of the outstanding shares of IORI (46.9% owned directly by ARI and 15.6% through TCI’s ownership of IORI shares). ARI began consolidation of TCI’s and IORI’s accounts and operations effective March 31, 2003. The effect of consolidating TCI’s and IORI’s operations from the completion of the tender offer through March 31, 2003 was determined to be immaterial. Through June 30, 2003, ARI had the same advisor as TCI and IORI, and TCI and IORI had the same board of directors. Four of the directors of TCI and three of the directors of IORI also serve as directors of ARI. Effective July 1, 2003, ARI and TCI have the same advisor.
On June 2, 2003, ARI exchanged all of its 674,971 IORI shares with Basic Capital Management, Inc. (“BCM”), receiving 650,000 TCI shares from BCM. In addition, BCM has executed a promissory note in favor of ARI in the amount of $526,000 (see NOTE 3. “NOTES RECEIVABLE”). After the exchange, ARI owned 72.9% of the outstanding shares of TCI. On June 30, 2003, ARI sold a participating interest in $5.8 million of its $15.5 million line of credit receivable from One Realco Corporation (“One Realco”) to BCM, receiving 314,141 TCI shares from BCM (see NOTE 3. “NOTES RECEIVABLE”). After the transaction, ARI owned 76.8% of the outstanding shares of TCI. ARI no longer directly owns any IORI shares. At September 30, 2003, ARI owned 18.4% of IORI through TCI’s ownership of IORI shares. ARI ceased consolidation of IORI’s accounts and operations effective June 2, 2003.
On June 30, 2003, ARI sold its 74.31% interest in Realty Advisors Korea, Ltd. (“RAK”) to Realty Advisors, Inc. (“Realty Advisors”), a related party. The sales price was $6.0 million. Realty Advisors also paid ARI $600,000, representing 10% interest on the $6.0 million price paid by ARI to purchase the 74.31% interest in RAK in 2002. The $6.0 million sales price reduced ARI’s affiliate debt. The $600,000 interest was received in cash in August 2003.
In July 2003, ARI sold its interest in Milano Restaurants International Corporation (“MRI”) to Gruppa Florentina, LLC (“Gruppa”), for $18.5 million, receiving $7.4 million in cash after debt assumption and providing purchase money financing of $2.3 million (see NOTE 3. “NOTES RECEIVABLE”). ARI owns 20% of Gruppa, thereby retaining a 20% interest in MRI. ARI remains as the guarantor of $8.7 million of assumed debt and is one of the guarantors of $7.5 million in new debt obtained by Gruppa. Due to the debt guarantees and ARI’s continuing ownership interest in MRI, management has determined that this should be accounted for as a financing transaction. In September 2003, ARI sold the note to Syntek West for $2.3 million, plus accrued and unpaid interest, to reduce affiliate debt.
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.
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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 such information as the nature and age of the receivable, the payment history of the tenant or other debtor, the financial condition of the tenant or other debtor and ARI’s assessment of its ability to meet its lease or interest obligations. ARI’s estimate of the required allowance, which is reviewed on a quarterly basis, is subject to revision as these factors change and is sensitive to the effects of economic and market conditions.
Liquidity and Capital Resources
ARI reported net income of $12.2 million for the nine months ended September 30, 2003, which included the following non-cash charges and credits: depreciation and amortization from real estate held for investment of $18.3 million, gain on sale of real estate of $70.3 million and equity in loss of equity investees of $4.3 million. Net cash used in operating activities amounted to $26.9 million for the nine months ended September 30, 2003, interest receivable increased by $4.0 million due to additional notes receivable from seller financings, other assets decreased by $10.2 million primarily due to reduced escrow deposits, interest payable increased by $269,000 due to an increased balance of notes payable and other liabilities decreased by $759,000 primarily due to a decrease in security deposits and property taxes.
Net cash provided by investing activities of $113.2 million was primarily due to real estate acquisitions of $12.0 million, payments made under interest rate swap contract of $31,000, additional fundings of notes receivable of $615,000, distributions to equity investees of $650,000, real estate improvements of $21.4 million, investments in real estate entities of $24.2 million, earnest money deposits of $13.3 million and purchases of pizza parlor equipment of $1.4 million. These outflows for investing activities were offset by the collection of $26.0 million on notes receivable, $134.5 million from the sale of real estate and $26.3 million from the sale of notes receivable.
Net cash used in financing activities of $87.4 million was comprised of proceeds received from the funding or refinancing of notes payable of $82.3 million and advances from affiliates of $7.8 million; offset by cash payments of $186.1 million to paydown existing notes payable, $5.4 million for financing costs and $1.8 million in dividends on Preferred Stock.
Location
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Liquidity and Capital Resources (Continued)
Lake Chateau
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Solco-Valley
Landings & Marina
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Units/ Acres/Sq. Ft
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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 5.00% to 24.0%. Margin borrowing totaled $25.2 million at September 30, 2003.
Management expects that it will be necessary for ARI to sell $102.0 million, $34.1 million and $1.2 million of its land holdings during each of the next three years to satisfy the debt on such land as it matures. If ARI is unable to sell at least the minimum amount of land to satisfy the debt obligations on such land as it matures, or, if it was not able to extend such debt, ARI would either sell other of its assets to pay such debt or transfer the property to the lender.
Management reviews the carrying values of ARI’s properties and mortgage notes receivable at least annually and whenever events or a change in circumstances indicate that impairment may exist. Impairment is considered to exist if, in the case of a property, the future cash flow from the property (undiscounted and without interest) is less than the carrying amount of the property. For notes receivable, impairment is considered to exist if it is probable that all amounts due under the terms of the note will not be collected. If impairment is found to exist, a provision for loss is recorded by a charge against earnings to the extent that the investment in the note exceeds management’s estimate of the fair value of the collateral property securing each note. The mortgage note receivable review includes an evaluation of the collateral property securing such note. The property review generally includes: (1) selective property inspections; (2) a review of the property’s current rents compared to market rents; (3) a review of the property’s expenses; (4) a review of maintenance requirements; (5) a review of the property’s cash flow; (6) discussions with the manager of the property; and (7) a review of properties in the surrounding area.
Related Party Transactions
In May 2003, ARI sold the Clarion Kansas City Airport Hotel to One Realco Hotel for $5.3 million. No cash was received or paid by ARI, after debt assumption and providing purchase money financing of $400,000. The note bore interest at 12.0% per annum, matured in May 2004 and required quarterly interest payments beginning in June 2003. In August 2003, the hotel was sold through foreclosure proceedings. ARI is pursuing collection of the note from One Realco Hotel. In September 2003, One Realco Hotel filed for bankruptcy protection under Chapter 11.
On June 2, 2003, ARI exchanged all of its 674,971 IORI shares with BCM, receiving 650,000 TCI shares from BCM. In addition, BCM has executed a promissory note in favor of ARI in the amount of $526,000 (see NOTE 3. “NOTES RECEIVABLE”). After the exchange, ARI owned 72.9% of the outstanding shares of TCI. On June 30, 2003, ARI sold a participating interest in $5.8 million of its $15.5 million line of credit receivable from One Realco Corporation (“One Realco”) to BCM, receiving 314,141 TCI shares from BCM (see NOTE 3. “NOTES RECEIVABLE”). After the transaction, ARI owned 76.8% of the outstanding shares of TCI. ARI no longer directly owns any IORI shares. At September 30, 2003, ARI owned 18.4% of IORI through TCI’s ownership of IORI shares. ARI ceased consolidation of IORI’s accounts and operations effective June 2, 2003.
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Related Party Transactions (Continued)
On June 30, 2003, ARI sold its 73.41% interest in RAK to Realty Advisors, a related party. The sales price was $6.0 million. Realty Advisors also paid ARI $600,000, representing 10% interest on the $6.0 million price paid by ARI to purchase the 73.41% interest in RAK in 2002. The $6.0 million sales price reduced ARI’s affiliate debt. The $600,000 interest was received in cash in August 2003.
In July 2003, ARI sold its interest in MRI to Gruppa for $18.5 million, receiving $7.4 million in cash after debt assumption and providing purchase money financing of $2.3 million (see NOTE 1. “BASIS OF PRESENTATION”). The loan bears interest at 10.0% per annum, matures in August 2013 and requires monthly payments of principal and interest beginning in September 2003. ARI owns 20% of Gruppa, thereby retaining a 20% interest in MRI. Due to debt guarantees and ARI’s continuing ownership interest in MRI, management has determined that this should be accounted for as a financing transaction. In September 2003, ARI sold the note to Syntek West for $2.3 million, plus accrued but unpaid interest, to reduce affiliate debt.
In August 2003, ARI sold the City Suites, Majestic and Willows hotels to One Realco Hotel for $13.5 million in a single transaction, receiving $250,000 after debt assumption and providing purchase money financing of $2.7 million. The note bears interest at 12.0% per annum, matures in August 2006 and requires semi-annual payments of principal and interest beginning in June 2004. In September 2003, One Realco Hotel filed for bankruptcy protection under Chapter 11. The parent company of One Realco Hotel has guaranteed the note; therefore, management has not established reserves or classified the note as nonperforming.
In October 2003, ARI advanced $1.6 million to the Class A Limited Partners of Encino Executive Plaza, Ltd., of which ARI is the general partner. The loans bear interest at 8.5% per annum and mature in June 2006. Interest due to ARI will be deducted from the quarterly return owed by ARI to the Class A Limited Partners, eliminating the quarterly payments. The outstanding principle is due at maturity.
In October 2003, ARI purchased the Travelers land from IORI for $25.0 million, paying $1.9 million in cash and giving a wrap note payable to IORI for $22.8 million. The note does not have a stated interest rate, requires monthly payments sufficient to pay the installments due on the underlying debt and matures in October 2006. The principle is due at maturity.
Commitments and Contingencies
ARI has contractual obligations and commitments primarily with regards to payment of mortgages.
Results of Operations
For the nine months ended September 30, 2003, ARI reported net income of $12.2 million, compared to a net loss of $16.7 million for the nine months ended September 30, 2002. The primary factors contributing to ARI’s net income are discussed in the following paragraphs.
Rents increased to $49.9 million and $116.7 million in the three and nine months ended September 30, 2003, from $18.0 million and $52.9 million in 2002. Rents from commercial properties increased to $47.1 million for the nine months ended September 30, 2003, from $17.5 million in 2002, rent from hotels increased to $18.0 million in the nine months ended September 30, 2003, from $15.7 million in 2002 and rent from apartments increased to $49.6 million in the nine months ended September 30, 2003, from $19.3 million in 2002. The increase in rents was primarily attributable to the consolidation of TCI’s operations by ARI effective March 31, 2003,
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Results of Operations (Continued)
following ARI’s acquisition of more than 50% of TCI’s common stock. Without the effect of the consolidation of TCI’s operations, rents increased to $20.0 million and $58.9 million in the three and nine months ended September 20, 2003. The increase was primarily attributable to increased apartment rents, due to the acquisition of two apartments and the construction of an apartment in 2002.
Property operations expense increased to $34.4 million and $80.3 million in the three and nine months ended September 30, 2003, from $13.2 million and $40.5 million in 2002. Property operations expense for commercial properties increased to $26.8 million in the nine months ended September 30, 2003, from $10.5 million in 2002. For hotels, property operations expense increased to $13.3 million in the nine months ended September 30, 2003, from $11.8 million in 2002. For land, property operations expense decreased to $4.7 million in the nine months ended September 30, 2003 from $5.4 million in 2002. For apartments, property operations expense increased to $35.5 million in the nine months ended September 30, 2003, from $12.7 million in 2002. The increase in commercial, hotel and apartment property operations expense was primarily attributable to the consolidation of TCI’s operations by ARI effective March 31, 2003, following ARI’s acquisition of more than 50% of TCI’s common shares. The decrease in land property operations expense was primarily attributable to decreased real estate taxes as a result of land sales in 2002. Without the effect of the consolidation of TCI’s operations, property operations expense increased to $14.6 million and $43.1 million in the three and nine months ended September 30, 2003. The increase was primarily attributable to increased apartment operating expenses, due to the acquisition of two apartments and the construction of one apartment in 2002.
Pizza parlor sales and cost of sales of $8.3 million and $6.6 million, respectively, in the three months ended September 30, 2003 and $24.3 million and $19.4 million in the nine months ended September 30, 2003 approximated the $8.2 million and $6.5 million, respectively, in the three months ended September 30, 2002 and $24.0 million and $18.8 million in the nine months ended September 30, 2002.
Interest income increased to $1.8 million and $7.4 million in the three and nine months ended September 30, 2003 from $509,000 and $1.9 million in 2002. The increase was primarily attributable to the addition of $67.5 million of mortgage notes receivable in 2002.
Equity in loss of investees improved to $<204,000> and $<4.3> million in the three and nine months ended September 30, 2003, from $<4.8> million and $<14.0> million in 2002. The improvement was primarily attributable to the consolidation of TCI’s operations by ARI effective March 31, 2003, following ARI’s acquisition of more than 50% of TCI’s common shares. Prior to March 31, 2003, and in 2002, ARI’s equity in loss of investees included equity in TCI’s operations.
Loss on the sale of investments in equity investees was $531,000 for the nine months ended September 30, 2002. See NOTE 4. “INVESTMENTS IN EQUITY INVESTEES.”
Other income of $55,000 and $307,000 in the three and nine months ended September 30, 2003 approximated the $190,000 and $516,000 in the three and nine months ended September 30, 2002.
Interest expense increased to $20.9 million and $51.5 million in the three and nine months ended September 30, 2003 from $12.0 million and $39.2 million in 2002. The increase is primarily attributable to the consolidation of TCI’s operations by ARI effective March 31, 2003, following ARI’s acquisition of more than 50% of TCI’s common shares. Without the effect of consolidation of TCI’s operations, interest expense decreased to $10.0 million and $30.9 million in the three and nine months ended September 30, 2003. The decrease was primarily attributable to reduced balances payable on stock loans and land mortgages.
Depreciation and amortization expense increased to $7.1 million and $16.1 million in the three and nine months ended September 30, 2003, from $2.1 million and $6.0 million in 2002. The increase is primarily attributable to the consolidation of TCI’s operations by ARI effective March 31, 2003, following ARI’s acquisition of more than 50% of TCI’s common shares.
Discount on sale of notes receivable was $1.6 million in the nine months ended September 30, 2003. This represents the discount from the face amount given by ARI to purchasers of notes receivable. See NOTE 3. “NOTES RECEIVABLE.”
General and administrative expenses increased to $6.1 million and $16.9 million in the three and nine months ended September 30, 2003, from $3.3 million and $9.8 million in 2002. The increase is primarily attributable to the consolidation of TCI’s operations by ARI effective March 31, 2003, following ARI’s acquisition of more than 50% of TCI’s common shares. In addition, the three and nine months of 2003 include $3.1 million of one-time reimbursements to BCM for legal fees and $1.0 million for loss on foreign currency transaction.
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Advisory fees increased to $3.7 million and $8.5 million in the three and nine months ended September 30, 2003 from $1.6 million and $4.8 million in 2002. The increase is primarily attributable to the consolidation of TCI’s operations by ARI effective March 31, 2003, following ARI’s acquisition of more than 50% of TCI’s common shares.
Net income fee to affiliate was $675,000 in the three and nine months ended September 30, 2003. The net income fee payable to ARI’s advisor is 10% of the year-to-date net income, in excess of a 10% return on shareholders’ equity.
Incentive fee to affiliate was $1.1 million in the three and nine months ended September 30, 2003. The incentive fee is only due if ARI is also subject to the net income fee. This fee represents 10% of the excess of net capital gains over net capital losses from sales of operating properties. The amount of this fee for the remainder of 2003 will be dependent on the number of operating properties sold, the net capital gains realized and whether the net income fee is due.
Writedown of assets held for sale was $2.4 million in the nine months ended September 30, 2003. The carrying value of an office building in Encino, California, sold in the third quarter of 2003, was reduced to its net realizable value in the second quarter of 2003.
Minority interest decreased to $20,000 and $1.2 million in the three and nine months ended September 30, 2003, from $436,000 and $2.0 million in 2002. The decrease is primarily attributable to reduced minority participation in ARI partnerships and in the consolidation of TCI’s operations by ARI effective March 31, 2003, following ARI’s acquisition of more than 50% of TCI’s common shares.
Net income from discontinued operations decreased to $16.6 million and $30.9 million in the three and nine months ended September 30, 2003 from $21.8 million and $34.1 million in 2002. The net income relates to 23 properties and leasehold interests in oil and gas properties that ARI sold during 2002 and 29 properties that ARI sold in 2003. The following table summarizes revenue and expense information for the properties sold.
Tax Matters
Financial statement income varies from taxable income principally due to the accounting for income and losses of investees, gains and losses from asset sales, depreciation on owned properties, amortization of discounts on notes receivable and payable and the difference in the allowance for estimated losses. ARI had no taxable income after the use of NOL carryforwards or provision for income taxes in the three and nine months ended September 30, 2003 or 2002.
At September 30, 2003, ARI had a net deferred tax asset of $113.8 million due to tax deductions available to it in future years. However, as management cannot determine that it is more likely than not that ARI will realize the benefit of the deferred tax asset, a 100% valuation allowance has been established.
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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.
At September 30, 2003, ARI’s exposure to a change in interest rates on its debt is as follows:
Notes payable:
Variable rate
Total decrease in ARI’s annual net income
Per share
PART II. OTHER INFORMATION
Matisse. In August 2002, ARI obtained a favorable jury verdict in the legal action entitled American Realty Trust v. Matisse Partners, L.L.C. (“Matisse”). However, the judge set aside the jury verdict and imposed a judgment against ARI in excess of $6.0 million, including interest. The judgment is being appealed, and, in the opinion of ARI’s management and legal counsel, there is a reasonable probability that the adverse judgment will be set aside and the jury verdict reinstated. Therefore, ARI has not recognized any expense nor established any reserve for this judgment. In November 2002, ARI posted a $6.0 million supercedeas bond. In July 2003, ARI obtained a letter of credit, which was substituted for the $6.0 million bond. The $6.0 million cash was returned to ARI. In April 2003,
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an additional judgment was issued against ARI for $1.4 million in legal fees. ARI is also appealing this judgment and posted a $1.4 million bond in May 2003. ARI has not recognized any expense nor established any reserve for this additional judgment.
Sunset Management. In September 2001, ARI obtained a security loan in the amount of $20.0 million from Sunset Management, LLC (“Sunset”). ARI received net cash of $16.1 million after the payment of various closing costs and $3.4 million repayment of principal and accrued interest on an existing loan with the same lender. Of the total loan amount, $19.5 million bears interest at 24% per annum, while the remaining $500,000 bears interest at 20% per annum. The loan is secured by 3,672,305 shares of TCI common stock held by BCM and wholly-owned subsidiaries of ARI. The loan was also secured by a lien on real property owned by ART Williamsburg, Inc. (“AWI”). The loan required monthly payments of interest only and matured in September 2002. In September 2002, $15.0 million in principal was repaid. Sunset orally agreed in September 2002 to extend the maturity date of the loan and accept substitute collateral for the shares of TCI common stock after the $15.0 million paydown. Sunset did not honor the agreement, which resulted in litigation filed in Texas state court during October 2002, styled American Realty Trust, Inc., ART Williamsburg, Inc., Basic Capital Management, Inc. and EQK Holdings, Inc. v. Sunset Management, LLC, et al., Cause No. 02-09433-I in the 162nd Judicial Court of Dallas County, Texas (the “Texas Litigation”).
During January 2003, without notice to the plaintiffs in the Texas Litigation, Sunset instituted an action in a federal district court in Las Vegas, Nevada against Commonwealth Land Title (“Commonwealth”) seeking disposition of the TCI common stock held by Commonwealth as Pledge Holder. On January 31, 2003, after a Temporary Restraining Order was issued in the Texas Litigation, Sunset instigated a separate lawsuit in state court in Nevada styled Sunset Management, LLC v. American Realty Trust, Inc. et al., Case No. A462587 pending in the District Court of Clark County, Nevada (the “Nevada Litigation”). On February 12, 2003, the Nevada state court held a hearing on Sunset’s request for emergency relief and denied all Sunset’s requested relief and indicated that a stay of the Nevada Litigation may be appropriate, which stay of litigation (including claims against TCI) was granted on May 2, 2003. Notwithstanding the stay of the Nevada Litigation, Sunset continued to seek to relitigate the underlying fact issues already determined in the Texas Litigation and the Nevada Litigation through cross-claims and counterclaims in the Texas Litigation and a renewed motion for preliminary injunction and appointment of receiver over TCI in the Nevada Litigation.
On September 10, 2003, AWI removed the Texas Litigation to the bankruptcy court for the Northern Division of Texas. On September 25, 2003, the Texas Litigation was transferred to the Eastern District of Texas. The scheduling conference in this matter is set for December 3, 2003.
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The annual meeting was held on August 26, 2003, at which stockholders were asked to consider and vote upon the election of Directors and a proposal that Article Fourth of the Restated Articles of Incorporation of ARI be amended to eliminate the designation for Series B Convertible Preferred Stock. At the meeting, stockholders elected the following individuals as Directors:
Director
Henry A. Butler
Earl D. Cecil
Ted P. Stokely
Martin L. White
There were no abstentions or broker non-votes on the election of Directors.
Also at the meeting, the shareholders voted on the amendment of Articles of Incorporation:
10,511,605
Description
A Current Report on Form 8-K, dated July 1, 2003, was filed with respect to Item 5. “Other Events” and Item 7. “Financial Statements and Exhibits,” which reports the termination of ARI’s Advisory Agreement with BCM, the establishment of ARI’s Advisory Agreement with Prime Asset Management, Inc., the resignation of Richard W. Humphrey from the ARI Board of Directors and the election of Henry A. Butler and Martin L. White as directors of ARI.
A Current Report on Form 8-K, dated July 7, 2003, was filed with respect to Item 5. “Other Events,” which reports the current litigation filed in Texas styled American Realty Trust, Inc., ART Williamsburg, Inc., Basic Capital Management, Inc. and EQK Holdings, Inc. v. Sunset Management, LLC, et al., Cause No. 02-09433-I pending in the 162nd Judicial District Court of Dallas County, Texas.
A Current Report on Form 8-K, dated July 14, 2003, was filed with respect to Item 5. “Other Events,” which reports the resignation of Joseph Mizrachi from the ARI Board of Directors.
A Current Report on Form 8-K, dated August 11, 2003, was filed with respect to Item 2. “Acquisition or Disposition of Assets” and Item 7. “Financial Statements and Exhibits,” which reports the disposition of 10 apartments, one commercial property, three hotels and five land parcels.
A Current Report on Form 8-K, dated October 1, 2003, was filed with respect to Item 5. “Other Events” and Item 7. “Financial Statements and Exhibits,” which reports the assignment of ARI’s Advisory Agreement with Prime to Prime LLC effective October 1, 2003.
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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.
Ronald E. Kimbrough
Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer and
Acting Principal Executive Officer)
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EXHIBITS TO
QUARTERLY REPORT ON FORM 10-Q
For the Quarter ended September 30, 2003
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