UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2005
or
FOR THE TRANSITION PERIOD FROM TO
Commission File Number 001-15663
AMERICAN REALTY INVESTORS, INC.
(Exact Name of Registrant as Specified in Its Charter)
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)
(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
ITEM 1. FINANCIAL STATEMENTS
The accompanying Consolidated Financial Statements have not been audited by independent certified public accountants, but, in the opinion of the management of American Realty Investors, Inc. (“ARI”), all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of consolidated results of operations, consolidated balance sheets and consolidated cash flows at the dates and for the periods indicated, have been included.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands,
except per share)
Real estate held for investment
Less—accumulated depreciation
Real estate held for sale, net of depreciation
Real estate subject to sales contract
Notes and interest receivable
Performing ($44,512 in 2005 and $43,605 in 2004 from affiliates)
Non-performing
Less—allowance for estimated losses
Restaurant equipment
Marketable equity securities, at market value
Cash and cash equivalents
Investments in equity investees
Goodwill, net of accumulated amortization ($1,763 in 2005 and 2004)
Other intangibles, net of accumulated amortization ($571 in 2005 and $871 in 2004)
Other assets ($31,058 in 2005 and $27,704 in 2004 from affiliate)
The accompanying notes are an integral part of these Consolidated Financial Statements.
2
CONSOLIDATED BALANCE SHEETS - Continued
Liabilities
Notes and interest payable ($38,721 in 2005 and $36,298 in 2004 to affiliates)
Liabilities related to assets held for sale
Liabilities subject to sales contract
Margin borrowings
Accounts payable and other liabilities ($1,841 in 2005 and $2,557 in 2004 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, 3,469,326 shares in 2005 and 3,469,350 shares in 2004 (liquidation preference $34,693), including 900,000 shares in 2005 and 2004 held by subsidiaries.
Series E, 50,000 shares in 2005 and 2004 (liquidation preference $500)
Common Stock, $.01 par value, authorized 100,000,000 shares; issued 11,392,272 shares in 2005 and 2004
Treasury stock, at cost, 1,243,272 shares in 2005 and 2004
Paid-in capital
Retained earnings
Accumulated other comprehensive income (loss)
3
CONSOLIDATED STATEMENTS OF OPERATIONS
Property revenue:
Rents ($363 in six months of 2005 and $627 in six months of 2004 from affiliates)
Property operations expenses ($3,306 in six months of 2005 and $2,514 in six months of 2004 to affiliates)
Operating income
Land operations:
Sales
Cost of sales
Deferral of gains on current period sales
Gain on land sales
Restaurant operations:
Gross margin
Income from operations
Other income:
Interest income ($1,685 in six months of 2005 and $1,047 in six months of 2004 from affiliates)
Equity in income (loss) of investees
Gain on foreign currency transaction
Dividends
Other
Other expenses:
Interest ($1,107 in six months of 2005 and $1,335 in six months of 2004 to affiliates)
Depreciation and amortization
Discount on sale of notes receivable
General and administrative ($2,284 in six months of 2005 and $2,386 in six months of 2004 to affiliates)
Advisory fee to affiliate
Net income fee to affiliate
Incentive fee to affiliate
Net income (loss) from continuing operations
Discontinued operations:
Loss from operations
Gain on sale of real estate
Equity in gain on sale of real estate by equity investees
Net income from discontinued operations
Net income (loss)
Preferred dividend requirement
Net income (loss) applicable to Common shares
4
CONSOLIDATED STATEMENTS OF OPERATIONS - Continued
For the Three Months
Ended June 30,
For the Six Months
Basic earnings per share:
Discontinued operations
Diluted earnings per share:
Weighted average Common shares used in computing earnings per share:
Basic
Diluted
Convertible Preferred Stock (2,569,327 shares) and options to purchase 77,750 shares of ARI’s Common Stock were excluded from the computation of diluted earnings per share for the three months ended June 30, 2005, because the effect of their inclusion would be antidilutive.
Convertible Preferred Stock (2,575,370 shares) and options to purchase 101,250 shares of ARI’s Common Stock were excluded from the computation of diluted earnings per share for the three and six months ended June 30, 2004, because the effect of their inclusion would be antidilutive.
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CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
For the Six Months Ended June 30, 2005
Treasury
Stock
Retained
Earnings
Balance, January 1, 2005
Comprehensive income
Unrealized gain on foreign currency translation
Unrealized gain on marketable securities
Net income
Repurchase of Preferred Stock
Preferred dividends
Series A Preferred Stock ($.50 per share)
Series E Preferred Stock ($.30 per share)
Balance, June 30, 2005
The accompanying notes are an integral part of these Consolidated Financial Statements
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CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash Flows From Operating Activities:
Adjustments to reconcile net income to net cash used in operating activities
Gain on sale of land and real estate
Amortization of deferred borrowing costs
Equity in (income) loss of investees
Decrease in accrued interest receivable
Decrease in other assets
Increase (decrease) in accrued interest payable
Decrease in accounts payable and other liabilities
Increase in minority interest
Net cash used in operating activities
Cash Flows From Investing Activities:
Collections on notes receivable
Proceeds from sale of notes receivable
Acquisition of real estate (including $498 in 2004 from affiliates and related parties)
Restaurant equipment purchased
Proceeds from sale of restaurant equipment
Proceeds from sale of real estate
Notes receivable funded
Earnest money/escrow deposits
Investment in real estate entities
Real estate improvements
Distribution from equity investees
Net cash provided by (used in) investing activities
Cash Flows From Financing Activities:
Proceeds from notes payable
Payments on notes payable
Deferred borrowing costs
Net advances from (payments to) affiliates
Repurchase of Common Stock
Margin borrowings (payments), net
Preferred dividends paid
Net cash (used in) provided by financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents, beginning of period
Cash and cash equivalents, end of period
7
CONSOLIDATED STATEMENTS OF CASH FLOWS—Continued
Supplemental Disclosures of Cash Flow Information:
Cash paid for interest
Schedule of non-cash investing and financing activities:
Notes payable assumed by buyer on sale of real estate
Notes receivable from sale of real estate
Acquisition of property in exchange for note receivable
Issuance of Preferred Stock
Note payable paid by affiliate
Refinancing proceeds received by affiliate
Acquisition of property to satisfy debt
Notes payable assumed on purchase of real estate
Purchase of subsidiary from affiliate
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited 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 2004 have been reclassified to conform to the 2005 presentation. Hereafter in this document, American Realty Investors, Inc. is referred to as ARI.
Operating results for the six month period ended June 30, 2005, are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. 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, 2004 (the “2004 Form 10-K”).
At December 31, 2004 and June 30, 2005, ARI subsidiaries owned 82.2% of the outstanding shares of Transcontinental Realty Investors, Inc. (“TCI”). At June 30, 2005, ARI and TCI have the same advisor and Board of Directors.
At December 31, 2004 and June 30, 2005, ARI subsidiaries owned 20.4% of Income Opportunity Realty Investors, Inc. (“IORI”) through TCI’s ownership of 24.9% of IORI shares. One director of ARI (Ted Stokley) also serves as a director of IORI.
Stock-based employee compensation. ARI provides stock options to certain directors. ARI accounts for these stock options using the intrinsic method pursuant to the Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), and related interpretations. In December 2002, the Financial Accounting Standards Board issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure” (“SFAS 148”), which amended SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”). The new standard provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. Additionally, the statement amends the disclosure requirements of SFAS 123 to require prominent disclosures in the annual and interim financial statements for fiscal years ending after December 15, 2002. In compliance with SFAS No. 148, ARI has elected to continue to follow the intrinsic value method in accounting for its stock-based employee compensation arrangement as defined by APB 25. If ARI had elected to recognize compensation cost for the issuance of options to directors of ARI based on the fair value at the grant dates for awards consistent with the fair value method prescribed by SFAS No. 123, net income and income per share would have been impacted as follows:
Net income (loss) applicable to common shares, as reported
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) applicable to common shares
Earnings per share:
Basic, as reported
Basic, pro forma
Diluted, as reported
Diluted, pro forma
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NOTE 2. REAL ESTATE
In 2005, ARI purchased the following properties:
Property
Location
Units /
Sq. Ft./Acres
Purchase
Price
Net Cash
Paid/
(Received)
Debt
Incurred
Interest
Rate
Maturity
Date
First Quarter
Land
Katrina(1)
Keenan Bridge(2)
Mandahl Bay
Mandahl Bay (Gilmore)
Mandahl Bay (Chung)
Apartments
Mission Oaks(4)
Parc at Metro Center(4)
Alliance Airport (formerly Centurion)
Mandahl Bay (Marina)
Mason Goodrich(1)
Southwood(5)
West End(6)
Office Buildings
Park West
Third Quarter
Legends of El Paso(4)
Luna
Senlac
Whorton
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In 2004, ARI purchased the following properties:
288 City Park(1)
Blue Lake Villas II(1)
Bridges on Kinsey(1)
Dakota Arms(1)
Lake Forest(1)
Vistas of Vance Jackson(1)
Lubbock land
Meloy Road
Railroad land
Second Quarter
Treehouse(3)
Wildflower Villas(1)
Cooks Lane(1)
Rogers(1)
In 2005, ARI sold the following properties:
Gain
on Sale
Longwood
Granbury Station
Katrina
Katy
Nashville
Vista Ridge
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Units/Acres/Sq. Ft.
Institute Place
Industrial Warehouses
5700 Tulane
Lemmon Carlisle/Alamo Springs
9033 Wilshire
Bay Plaza
Bay Plaza II
Waters Edge III & IV
Mason Goodrich
In 2004, ARI sold the following properties:
Tiberon Trails
Kelly (Pinewood)
Ogden Industrial
Texstar Warehouse
Allen
Marine Creek
Red Cross
Brandeis(6)
Countryside Harmon
Countryside Retail
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Shopping Centers
K-Mart
Plaza on Bachman Creek
Cliffs of El Dorado(5)
Park Avenue
Sandstone
4135 Beltline
Atrium
At June 30, 2005, ARI had the following properties under construction:
Units
Amount
Expended
AdditionalAmount
to Expend
ConstructionLoan
Funding
Kingsland Ranch
Laguna Vista
Mission Oaks
Parc at Maumelle
Parc at Metro Center
Stonebridge at City Park (formerly 288 City Park)
Vistas of Vance Jackson
For the six months ended June 30, 2005, ARI completed the 70 unit Blue Lake Villas II in Waxahachie, Texas, the 272 unit Bluffs at Vista Ridge in Lewisville, Texas, the 232 unit Bridges on Kinsey in Tyler, Texas, the 208 unit Dakota Arms in Lubbock, Texas, the 240 unit Lake Forest in Houston, Texas and the 220 unit Wildflower Villas in Temple, Texas.
NOTE 3. NOTES AND INTEREST RECEIVABLE
In August 2001, ARI agreed to fund up to $5.6 million secured by a second lien on an office building in Dallas, Texas. The note receivable bore interest at a variable rate (then 9.0% per annum), required monthly interest only payments, and originally matured in January 2003. ARI funded a total of $4.3 million. On January 22, 2003, ARI agreed to extend the maturity date until May 1, 2003. The collateral used to secure ARI’s second lien was seized by the first lien holder. On March 11, 2004, ARI agreed to accept an assignment of claims in litigation as additional security for the note. In December 2004, ARI agreed to a Modification Agreement with the borrower, which was effective November 1, 2003. As of the modified effective date, accrued interest of $582,000 was added to the principal balance of the note, the interest rate fixed at 9.0% per annum and all principal and interest is due November 2005. ARI also received Pledge and Security Agreements in various partnership interests belonging to the borrower and received various Assignments of Proceeds from sales in certain entities owned by the borrower. ARI reduced accrued interest and principal by $1.5
13
million from the receipt of notes receivable assigned to ARI by borrower and by $605,000 from cash received. ARI also received $1.4 million in January 2005 that was applied to accrued interest and principal effective December 30, 2004.
In February 2005, ARI sold a 9.9 acre tract of its Katrina land parcel for $2.6 million, receiving $574,000 after payment of closing costs and providing purchase money financing of $2.0 million. The loan bore interest at 8.0%, required quarterly payments of interest, and matured in February 2008. In March 2005, ARI sold the loan for $2.0 million, receiving $2.0 million in cash after payment of closing costs.
In February 2005, ARI sold a 13.6 acre tract of its Katrina land parcel for $3.7 million, receiving $591,000 after payment of closing costs and providing purchase money financing of $2.8 million. The loan bore interest at 8.0%, required quarterly payments of interest, and matured in February 2008. In March 2005, ARI sold the loan for $2.8 million, receiving $2.8 million in cash after payment of closing costs.
In February 2005, ARI sold a 6.5 acre tract of its Katrina land parcel for $1.7 million, receiving $340,000 after payment of closing costs and providing purchase money financing of $1.3 million. The loan bore interest at 8.0%, required quarterly payments of interest, and matured in February 2007. In March 2005, ARI sold the loan for $1.3 million, receiving $1.3 million in cash after payment of closing costs.
In February 2005, ARI sold a 7.4 acre tract of its Katrina land parcel for $2.0 million, receiving $455,000 after payment of closing costs and providing purchase money financing of $1.5 million. The loan bore interest at 8.0%, required quarterly payments of interest, and matured in February 2007. In March 2005, ARI sold the loan for $1.5 million, receiving $1.5 million in cash after payment of closing costs.
In February 2005, ARI sold an 81.2 acre tract of its Katrina land parcel for $19.9 million, paying $814,000 after payment of debt and closing costs and providing purchase money financing of $14.9 million. The loan bore interest at 8.0%, required quarterly payments of interest, and matured in February 2007. In March 2005, ARI sold the loan for $14.9 million, receiving $14.9 million in cash after payment of closing costs.
In March 2005, ARI sold a 24.8 acre tract of its Katrina land parcel for $6.4 million, receiving $1.0 million after payment of closing costs and providing purchase money financing of $4.8 million. The loan bore interest at 8.0%, required quarterly payments of interest, and matured in March 2007. In March 2005, ARI sold the loan for $4.8 million, receiving $4.8 million in cash after payment of closing costs.
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 was sold to an unrelated party in March 2003. 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. In February 2005, the note was exchanged for 23.0 acres of land in Palm Desert, California. See NOTE 2. “REAL ESTATE.”
In March 2005, ARI entered into an agreement to advance a third party $3.2 million for development costs relating to land lots in Austin, Texas. These advances are secured by stock in the borrower and hold a second lien on the undeveloped land. The secured note bears interest at 10.0%, requires semi-annual payments, and matures in March 2008. As of June 30, 2005, ARI had advanced $656,000 to the borrower. ARI also guaranteed, with full recourse to ARI, an $18 million loan for the borrower, which loan is secured by a first lien on the undeveloped land. In June 2005, ARI purchased the subsidiary of a related party for $4.1 million that holds two notes receivable from this third party for $3.0 and $1.0 million, respectively. These notes are secured by approximately 142 acres of undeveloped land and membership interest in the borrowers. These secured notes bear interest at 12.0%, have an interest reserve for payments that is added to the principal balance on a monthly basis, and matured in June 2005. Extension discussions are currently in progress.
In December 2004, ARI sold the Centura Tower office building to a partnership and retained a 1% non-controlling general partner interest and a 4% limited partner interest. ARI has certain obligations to fund the partnership for certain rent abatements, tenant improvements, leasing commissions and other cash shortfalls. Through June 30, 2005, ARI has funded $1.2 million of these obligations and has recorded a note receivable from the partnership. This note has no maturity date, requires no payments, and bears interest at a fixed rate of 7.0% per annum. The note will be paid out of excess cash flow or from sales proceeds, but only after certain partner preferred returns are paid.
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In October 2004, ARI sold the In The Pines apartments to a third party and provided $1.0 million of the purchase price as seller financing in the form of two notes. The first note bears interest at 7.0% per annum, requires monthly interest payments and matured in January 2005. The Purchaser extended this note to March 2005 by paying 1.0% of the outstanding principal balance as an extension fee and then extended the note an additional 30 days to April 2005 by paying an extension fee of 0.5% of the outstanding principal balance. In the event of a default, the note is also secured by membership rights in the purchaser’s entity. The second note is unsecured, bears interest at 8.5% per annum, requires monthly interest payments and matured in January 2005. The Purchaser extended this note to March 2005 by paying 1.0% of the outstanding principal balance as an extension fee and then extended the note an additional 30 days to April 2005 by paying an extension fee of 0.5% of the outstanding principal balance. In April 2005, both loans were extended to October 2005 with the payment of a 2.0% extension fee.
In November 2003, ARI purchased a note receivable from an unrelated party for $1.4 million, including accrued and unpaid interest. The note was secured by a first lien Deed of Trust on 13.0 acres of undeveloped land in Harris County, Texas, bore interest at the default rate of 18.0%, and matured in May 2003. In May 2005, ARI obtained title to the property via a Deed in Lieu of Foreclosure. See NOTE 2. “REAL ESTATE.”
In August 2005, ARI sold a 16.0 acre tract of its Mason Goodrich land parcel for $2.1 million, receiving $935,000 after payment of closing costs and providing purchase money financing of $1.0 million. The secured note bears interest at 8.0%, requires monthly interest payments, and matures in November 2005. All principal and accrued but unpaid interest is due at maturity.
In March 2002, ARI sold the 174,513 sq. ft. Hartford Office Building in Dallas, Texas, for $4.0 million and provided the $4.0 million purchase price as seller financing and an additional $1.4 million line of credit for leasehold improvements in the form of a first lien mortgage note. The note bears interest at a variable interest rate, currently 7.5% per annum, requires monthly interest only payments and matures in March 2007. As of June 2005, ARI has funded $896,000 of the additional line of credit.
In July 2002, ARI entered into an agreement to fund up to $300,000 under a revolving line of credit secured by 100% interest in a partnership of the borrower. The line of credit bears interest at 12.0% per annum, requires monthly interest only payments, and matured in June 2005. This loan was extended to June 2006. As of June 2005, ARI has funded the entire $300,000.
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. In March 2000, the borrower made a $1.1 million payment. 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. In August 2005, a settlement agreement was reached. The note will be replaced with a new promissory note, also non-interest bearing, which is secured by a $1.5 million Agreed Judgment. The note calls for 36 monthly payments beginning in January 2006, with a balloon payment of $460,000 due in January 2009. ARI will continue to classify this note as non-performing.
Related Parties.In March 2004, ARI sold a K-Mart in Cary, North Carolina to BCM for $3.2 million, including the assumption of debt. ARI also provided $1.5 million of the purchase price as seller financing. The unsecured note bears interest at the prime rate plus 2.0%, currently 8.5%, and matured in April 2005. In April 2005, the note was extended to April 2008.
In March 2004, ARI sold the Texstar Warehouse in Arlington, Texas to BCM for $2.4 million, including the assumption of debt. ARI also provided $1.3 million of the purchase price as seller financing. The unsecured note bears interest at the prime rate plus 2.0%, currently 8.5%, and matured in April 2005. In April 2005, the note was extended to April 2008.
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NOTE 4. INVESTMENTS IN EQUITY INVESTEES
ARI’s investment in real estate entities at June 30, 2005, was as follows:
Investee
Percentage
of ARI’sOwnership atJune 30, 2005
Carrying
Value of
Investment atJune 30, 2005
Market Value
of Investment atJune 30, 2005
IORI
Garden Centura, L.P.
Set forth below are summarized results of operations of IORI for the six months ended June 30, 2005:
Revenues
Equity in loss of partnership
Property operating expenses
Depreciation
Income before gain on sale of real estate
ARI’s share of equity investees’ income before gains on the sale of discontinued operations was $212,000 for the six months ended June 30, 2005. ARI did not recognize any gain on equity investees’ sale of real estate for the six months ended June 30, 2005.
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.
NOTE 5. MARKETABLE EQUITY SECURITIES
Since 1994, ARI has been purchasing equity securities of entities other than those of IORI and TCI to diversify and increase the liquidity of its margin accounts. Trading and available-for-sale portfolio securities are carried at market value. In the first six months of 2005, ARI did not purchase or sell any marketable securities. At June 30, 2005, ARI recognized an unrealized increase in the market value of its trading portfolio securities of $10,000. Unrealized and realized gains and losses on trading portfolio securities are included in other income in the accompanying Consolidated Statements of Operations. Also at June 30, 2005, ARI recorded an unrealized increase in the market value of its available-for-sale portfolio securities of $926,000. Unrealized gains and losses on available-for-sale portfolio securities are included in accumulated other comprehensive income in the accompanying Consolidated Balance Sheets.
NOTE 6. NOTES PAYABLE
In February 2004, ARI obtained a line of credit facility with a financial institution. The maximum credit available is $10.0 million. The line of credit is secured by land properties in Dallas County and Austin, Texas. Advances made to ARI under this facility bear interest at 7.0% per annum, require monthly interest payments, and mature in February 2007. At June 30, 2005, $56,000 has been advanced to ARI, and letters of credit totaling $8.0 million have been issued under this facility. The available credit is $2.0 million.
In February 2005, ARI received a loan in the amount of $5.0 million. The note bears interest at 8.0% per annum, requires semi-annual interest payments and matures in July 2006. The loan is collateralized by certain partnership interests that hold apartments owned by ARI. Any time prior to maturity, the lender has the option to convert the outstanding loan balance into general and limited partnership units in each of the partnerships, subject to HUD approval.
In July 2005, ARI secured a revolving line of credit for $10.0 million for the acquisition and financing of land tracts. The line of credit bears interest at the prime rate plus 1.0%, currently 7.5%, requires interest only payments, and matures in three years. Each land tract funding has a $2.0 million limit on the loan amount, requires interest only payments at the line of credit’s variable rate, and has a maturity date of 18 months. At June 30, 2005, $4.2 million has been advanced to ARI. The current amount available for use under the line of credit is $5.8 million.
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In 2005, ARI financed/refinanced or obtained second mortgage financing on the following:
Sq.Ft./Rooms/
Units/Acres
Bridgeview Plaza
Dunes Plaza
Autumn Chase
Courtyard
Southgate
Hotels
The Majestic
Alliance Airport(2)
DeSoto Ranch(2)
Elm Fork
West End(2)
In 2004, ARI financed/refinanced or obtained second mortgage financing on the following:
Net CashReceived/
(Paid)
Williamsburg Hospitality House
Centura
Dominion/Hollywood
Centura Tower
Paramount Terrace
Treehouse
17
Lacy Longhorn
Mason/Goodrich
1010 Common
Two Hickory Centre
18
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 8.5% to 24.0%. Margin borrowings totaled $22.6 million at June 30, 2005.
Sunset Management LLC. On October 5, 2004, Sunset Management LLC (“Sunset”) filed a complaint as a purported stockholder’s derivative action on behalf of Transcontinental Realty Investors, Inc. (“TCI”) in the United States District Court for the Northern District of Texas, Dallas Division, against American Realty Investors, Inc., Basic Capital Management, Inc., Prime Income Asset Management, Inc., Prime Income Asset Management LLC, Income Opportunity Realty Investors, Inc., Unified Housing Foundation (“Unified”), Inc., Regis Realty, Inc., TCI, TCI’s current directors and officers and others. Sunset’s complaint filed as Case No. 3:04-CV-02162-B styled Sunset Management LLC, derivatively on behalf of Transcontinental Realty Investors, Inc. v. American Realty Investors, Inc., et al., raises a number of allegations previously raised by Sunset in four other cases which, as rulings have occurred, have resulted in a denial of Sunset’s requested relief. The Defendants on November 8, 2004 filed a Motion to Dismiss pursuant to Rules 12 and 23.1 of the Federal Rules of Civil Procedure on the basis that Sunset’s allegations are insufficient to evade the stringent demand requirement under the futility exceptions for stockholder derivative actions, and that Sunset cannot fairly and adequately represent the interests of other stockholders. One of the individual Defendants also filed on January 4, 2005 a Motion to Disqualify Sunset’s Counsel. On January 4, 2005, the Defendants filed a Motion to Stay Discovery and for Protective Order, which Motion was granted on March 30, 2005 by the issuance of an Order of the Court granting the Motion for Protective Order and staying all discovery in the action pending further Order of the Court, if appropriate, following the Court’s ruling on the Defendants’ Motion to Dismiss. On March 28, 2005, Sunset also filed a Petition for Writ of Mandamus in the United States District Court for the Eastern District of Texas, Sherman Division, seeking a Writ of Mandamus to be issued by the Court directing the bankruptcy judge in the United States Bankruptcy Court for the Eastern District of Texas, Sherman Division, in the case styled In Re: ART Williamsburg, Inc., Case No. 03-43909BTR-11, and American Realty Trust, Inc., et al. v. Sunset Management LLC, Adversary Proceeding No. 03-4256, to rule on pending Motions for Summary Judgment within twenty days thereof. On April 11, 2005, the United States District Court for the Eastern District of Texas, Sherman Division, entered its Order denying Sunset’s Petition for Writ of Mandamus. On May 6, 2005, in the bankruptcy case styled In Re: ART Williamsburg, Inc., Case No. 03-43909BTR-11 pending in the United States Bankruptcy Court for the Eastern District of Texas, Sherman Division, Sunset filed a Motion for Allowance of Claim, Determination of the Value of its Lien, Allowance of Deficiency as an Unsecured Claim and Abandonment of Cash Collateral to Sunset. Such Motion seeks an Order (i) estimating and determining the allowed amount of Sunset’s claim for purposes of distribution, (ii) determining the method of value in Sunset’s secured claim, (iii) determining the value of the lien held by Sunset, (iv) declaring that Sunset’s claim is secured in the amount determined, (v) allowing Sunset a deficiency claim for the unsecured portion of its claim, and (vi) ordering a distribution to Sunset of the proceeds received by the Debtor from a specified note.
At March 31, 2005, ARI’s margin borrowings include $5.0 million payable to Sunset. Interest is accrued at the stated rates of 20.0% and 24.0%. The loan matured in September 2002.
Other Security Loans. In September 2003, ARI obtained a security loan in the amount of $12.5 million from a financial institution. The loan bears interest at 12.0% over the 30-day LIBOR rate, currently 15.5%, requires monthly payments of interest only and matured in September 2004. The loan is secured by 1,656,537 shares of TCI common stock held by ARI. In September 2004, the maturity date was extended to December 2004. In December 2004, the maturity date was extended to March 2005. In March 2005, the maturity date was extended to March 2006.
In September 2003, ARI obtained a security loan in the amount of $1.0 million from a financial institution. The loan bears interest at 12.0% over the 30-day LIBOR rate, currently 15.5%, requires monthly payments of interest only and matured in September 2004. The loan is secured by 250,000 shares of IORI common stock held by ARI. In September 2004, the maturity date was extended to December 2004. In December 2004, the maturity date was extended to March 2005. In March 2005, the maturity date was extended to March 2006.
In October 2001, ARI obtained a security loan in the amount of $1.0 million from a financial institution. The loan bore interest at 1.0% over the prime rate, required monthly payments of interest only, and matured in October 2003. The loan was secured by 250,000 shares of ARI Common Stock held by BCM. In October 2003, the maturity date was extended to December 2003. In February 2004, ARI paid $450,000 in principal, and the maturity date was extended to February 2005. In February 2005, the note was paid in full.
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In May 2005, ARI obtained a security loan in the amount of $4.0 million from a financial institution. The loan bears interest at 2.0% over the prime rate, currently 8.5%, requires monthly payments of interest only, and matures in May 2006. The loan is secured by ARI’s equity holding in Realty Korea CR-REIT Co., Ltd. No. 1 and by equity securities owned by an affiliate.
NOTE 8. RELATED PARTY TRANSACTIONS
In January 2005, an affiliate made a $700,000 note payment on ARI’s behalf, reducing ARI’s affiliate receivable.
In April 2005, ARI purchased from IORI an additional 9.14% interest in a jointly-owned entity for $475,000, to increase ARI’s ownership interest to a level sufficient to allow consolidation by ARI for federal income tax purposes. The consideration paid was based upon the total amount paid by ARI and IORI to acquire the entity initially, with no discount or premium.
In June 2005, ARI purchased a subsidiary of a related party for $4.1 million, reducing ARI’s affiliate receivable.
In August 2005, ARI paid $4.1 million on behalf of a related party, increasing ARI’s affiliate receivable.
In February 2004, ARI recorded the sale of a tract of Marine Creek land originally sold to a related party in December 2003. This transaction was not recorded as a sale for accounting purposes in December 2003 and was recorded as an ARI refinancing transaction in February 2004. ARI received $1.2 million in cash from the related party in February 2004 as payment on the land. ARI retained a note receivable with a balance of $270,000 that bore interest at 12.0% and matured in April 2009. In August 2005, the note was paid in full, including accrued interest. ARI recorded the sale of the Marine Creek land tract due to the payment received on the note receivable.
The following table reconciles the beginning and ending balances of accounts receivable from and (accounts payable to) affiliates as of June 30, 2005.
Balance, December 31, 2004
Cash transfers to affiliates
Cash transfers from affiliates
Payments by affiliates on ARI’s behalf
Repayments through property transfers
Payables clearing through Prime
At June 30, 2005, ARI’s other assets includes $1.2 million due from an affiliate for rent. Also at June 30, 2005, ARI owed $1.0 million to Regis Property Management for management fees and sales commissions, and $819,000 to Prime for advisory fees and reimbursable costs.
In April 2002, ARI, TCI, and IORI sold 28 apartment properties to partnerships controlled by Metra Capital, LLC (“Metra”). Innovo Group, Inc. (“Innovo”) is a limited partner in the partnerships that purchased the properties. Joseph Mizrachi, then a director of ARI, controlled approximately 11.67% of the outstanding common stock of Innovo. Management determined to treat the sales as financing transactions, and ARI and TCI continued to report the assets and the new debt incurred by Metra on their financial statements. The partnership agreements for each of these partnerships stated that the Metra Partners, as defined, receive cash flow distributions at least quarterly in an amount sufficient to provide them with a 15% cumulative compounded annual rate of return on their invested capital, as well as a cumulative compounded annual amount of 0.50% of the average outstanding balance of the mortgage indebtedness secured by any of these properties. These distributions to the Metra Partners had priority over distributions to any other partners. In August 2004, ARI, TCI, and IORI instituted an action in Texas State District Court regarding the transaction. During April 2005, resolution of the litigation occurred, settling all liabilities remaining from the original partnership arrangements which included a return of investor equity, a cessation of any preferential return, prospective asset management fees and miscellaneous fees and transactions costs from the Plaintiffs as a prepayment of a preferred return, along with a delegation of management and corresponding payment of management fees to Prime and a motion to dismiss the action as a part of the resolution. Of the prepayment, ARI recognized expense of $525,000 and a reduction in liabilities of $3.2 million during the second quarter of 2005.
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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 income (loss) of investees, gain on foreign currency transaction, dividends, equity in gain on sale of real estate by equity investees, and other income which totaled $1.3 million and $1.4 million for the three and six months ended June 30, 2005 and $472,000 and $1.7 million for 2004. Expenses that are not reflected in the segments are discount on sale of notes receivable, general and administrative expenses, advisory fees, net income fees, incentive fees, minority interest, and loss from discontinued operations which totaled $7.9 million and $16.3 million for the three and six months ended June 30, 2005 and $7.5 million and $18.1 million for 2004. Excluded from operating segment assets are assets of $120.2 million in 2005 and $78.6 million in 2004, 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 Akademia (Poland), which began operations in 2002.
Presented below are ARI’s reportable segments’ operating income for the three and six months ended June 30, 2005 and 2004, and segment assets at June 30, 2005 and 2004.
Three Months Ended
June 30, 2005
Operating revenue
Interest income
Operating expenses
Operating income (loss)
Capital expenditures
Assets
Property Sales:
Sales price
Cost of sale
Gain on sale
June 30, 2004
Deferred current gain
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Six Months Ended
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NOTE 10. DISCONTINUED OPERATIONS
For the three and six months ended June 30, 2005 and 2004, income from discontinued operations relates to 27 properties ARI sold during 2004 and 17 properties ARI sold or held-for-sale in 2005. The following table summarizes revenue and expense information for these properties sold and held-for-sale.
Revenue:
Rental
Property operations
Expenses:
Loss from discontinued operations
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
Partnership Obligations. ARI is the limited partner in 12 partnerships that are currently constructing residential properties. As permitted in the respective partnership agreements, ARI intends to purchase the interests of the general and any other limited partners in these partnerships subsequent to the completion of these projects. The amounts paid to buyout the non-affiliated partners are limited to development fees earned by the non-affiliated partners, and are set forth in the respective partnership agreements. The total amount of the expected buyouts as of June 30, 2005 is approximately $2.4 million. ARI is a non-controlling general and limited partner in a real estate partnership and is obligated to fund approximately $1.9 million through June 30, 2006 for certain partnership obligations.
Liquidity. Management expects that excess cash generated from operations during the remainder of 2005 will not be sufficient to discharge all of ARI’s debt obligations as they mature. Therefore, ARI will rely on aggressive land sales, selected income producing property sales and, to the extent necessary, additional borrowings to meet its cash requirements.
Commitments. During 2002, Milano Restaurants International, Inc. (“MRI”), then a wholly-owned subsidiary of ARI, sold two restaurants to a corporation owned in part by an officer of MRI. In conjunction with the sale of these restaurants, MRI guaranteed the bank debt incurred by the related party. The guaranty applies to all current debt, and to all future debt of the related party until such time as the guaranty is terminated by MRI. The amount of the debt outstanding that is subject to the guaranty is $872,000 at June 30, 2005.
In June 2005, ARI deposited $1.8 million with a seller for the purchase of partnership and member interests in up to 14 separate apartments and apartment developments located in the Southeast United States. Each partnership or membership purchase will be closed separately, pending lender approval and other conditions. ARI total cash investments can be up to $3.6 million if all interests are purchased.
In June 2005, ARI guaranteed a loan of $1.6 million for a related party. This loan is secured by a first lien on 22.3 acres of land held by the related party.
Litigation. 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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NOTE 12. SUBSEQUENT EVENTS
Events occurring after the date of these financial statements are included within each note, as appropriate.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This quarterly report on Form 10-Q and ARI’s 2004 Form 10-K, referred to herein, contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. These statements concern the intent, belief, or expectations of ARI’s officers with respect to ARI’s ability to lease its properties, tenants’ ability to pay rents, purchase of additional properties, ability to pay interest and debt principal and make distributions, policies and plans regarding investments and financings, and other matters. Also, words such as “believe”, “expect”, “anticipate”, “intend”, “plan”, “estimate”, or similar expressions identify forward-looking statements. Actual results may differ materially from those contained in or implied by the forward-looking statements as a result of various factors. Such factors include, without limitation, the impact of changes in the economy and the capital markets on ARI and its tenants, competition within the real estate industry or those industries in which its tenants operate, and changes in federal, state, and local legislation. For example: some of ARI’s tenants may not renew expiring leases and ARI may be unable to locate new tenants to maintain the historical occupancy rates of the properties, rents which ARI can achieve at its properties may decline, tenants may experience losses and become unable to pay rents, and ARI may be unable to identify or to negotiate acceptable purchase prices for new properties. These results could occur due to many different circumstances, some of which, such as changes in ARI’s tenants’ financial conditions or needs for leased space, or changes in the capital markets or the economy, generally, are beyond ARI’s control. Forward-looking statements are only expressions of ARI’s present expectations and intentions. Forward-looking statements are not guaranteed to occur, and they may not occur. You should not place undue reliance upon forward-looking statements.
Introduction
ARI was organized in 1999. In August 2000, ARI acquired ART and NRLP. ART was organized in 1961 to provide investors with a professionally managed, diversified portfolio of real estate and mortgage loan investments selected to provide opportunities for capital appreciation as well as current income. ART owns a portfolio of real estate and mortgage loan investments. NRLP was organized in 1987, and subsequently acquired all of the assets and assumed all of the liabilities of 35 public and private limited partnerships. NRLP also owns a portfolio of real estate and mortgage loan investments.
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 judgments. ARI’s critical accounting policies relate to the evaluation of impairment of long-lived assets and the evaluation of the collectibility of accounts and notes receivable.
If events or changes in circumstances indicate that the carrying value of a rental property to be held and used or land held for development may be impaired, management performs a recoverability analysis based on estimated undiscounted cash flows to be generated from the property in the future. If the analysis indicates that the carrying value is not recoverable from future cash flows, the property is written down to estimated fair value and an impairment loss is recognized. If management decides to sell rental properties or land held for development, management evaluates the recoverability of the carrying amounts of the assets. If the evaluation indicates that the carrying value is not recoverable from estimated net sales proceeds, the property is written down to estimated fair value less costs to sell and an impairment loss is recognized within income from continuing operations. ARI’s estimates of cash flow and fair values of the properties are based on current market conditions and consider matters such as rental rates and occupancies for comparable properties, recent sales data for comparable properties, and, where applicable, contracts or the results of negotiations with purchasers or prospective purchasers. ARI’s estimates are subject to revision as market conditions and ARI’s assessments of them change.
ARI’s allowance for doubtful accounts receivable and notes receivable is established based on analysis of the risk of loss on specific accounts. The analysis places particular emphasis on past due accounts. Management considers 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.
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ARI’s management periodically discusses criteria for estimates and disclosures of its estimates with the Audit Committee of its Board of Directors.
Liquidity and Capital Resources
ARI reported net income of $18.0 million for the six months ended June 30, 2005, which included the following non-cash charges and credits: depreciation and amortization from real estate held for investment of $12.0 million, amortization of deferred borrowing cost of $3.8 million, gain on sale of real estate of $44.2 million, equity in income of equity investees of $212,000, and gain on foreign currency transaction of $228,000. Net cash used in operating activities amounted to $13.5 million for the six months ended June 30, 2005, interest receivable decreased by $1.5 million primarily due to payments received, other assets decreased by $932,000 primarily due to a reduction in escrows, interest payable decreased by $2.3 million due to a decreased balance of notes payable, and other liabilities decreased by $2.7 million primarily due to a decrease in accrued expenses.
Net cash provided by investing activities of $44.7 million was primarily due to real estate improvements of $26.5 million, acquisitions of real estate of $23.6 million, earnest money deposits of $4.3 million, funding of notes receivable of $2.0 million, investment in real estate entities of $475,000, and purchases of restaurant equipment of $476,000. These outflows for investing activities were offset by the collection of $3.7 million on notes receivable, $70.7 million from the sale of real estate, $27.2 million from the sale of notes receivable, $278,000 from the sale of restaurant equipment, and $313,000 distributed from equity investees.
Net cash used in financing activities of $41.0 million was comprised of proceeds received from the funding or refinancing of notes payable of $61.6 million and net borrowings on stock loans of $4.0 million, offset by cash payments of $79.4 million to paydown existing notes payable, $2.5 million for financing costs, payments to affiliates of $24.3 million, and $398,000 in dividends on Preferred Stock.
In the first six months of 2005, ARI purchased two apartment developments, one office building, and ten parcels of unimproved land for a total of $28.1 million. ARI paid $12.8 million in cash, including various closing costs, and incurred $10.8 million in debt. ARI also expended $21.8 million on property construction, of which $20.8 million was funded by debt. For the remainder of 2005 and the first half of 2006, ARI expects to spend an additional $61.2 million on property construction projects, of which $57.9 million will be funded by debt.
In the first six months of 2005, ARI sold one apartment property, 14 land parcels, one industrial warehouse, and four office building for a total of $107.4 million, receiving $28.7 million in cash, and discharging debt of $44.0 million after the payment of various closing costs and providing seller financing of $27.2 million.
In the first six months of 2005, ARI financed or refinanced one land parcel, two shopping centers, 3 apartments, and one hotel for a total of $25.6 million, discharging $12.5 million in debt and receiving $11.4 million in cash.
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 8.5% to 24.0%. Margin borrowing totaled $22.6 million at June 30, 2005.
Management expects that it will be necessary for ARI to sell $28.4 million, $52.0 million, and $16.0 million of its land holdings during the remainder of 2005, 2006, and 2007, respectively, to satisfy the debt on such land as it matures. If ARI is unable to sell at least the minimum amount of land to satisfy the debt obligations on such land as it matures, or, if it is not able to extend such debt, ARI intends to sell other of its assets, specifically income producing properties, to pay the debt.
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.
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Related Party Transactions
In February 2004, ARI recorded the dale of a tract of Marine Creek land originally sold to a related party in December 2003. This transaction was not recorded as a sale for accounting purposes in December 2003 and was recorded as an ARI refinancing transaction in February 2004. ARI received $1.2 million in cash from the related party in February 2004 as payment on the land. ARI retained a note receivable with a balance of $270,000 that bore interest at 12.0% and matured in April 2009. In August 2005, the note was paid in full, including accrued interest. ARI recorded the sale of the Marine Creek land tract due to the payment received on the note receivable.
Commitments and Contingencies
ARI has contractual obligations and commitments primarily with regards to payment of mortgages.
Results of Operations
For the six months ended June 30, 2005, ARI reported net income of $18.0 million compared to a net loss of $8.1 million for the six months ended June 30, 2004. The primary factors contributing to ARI’s net income are discussed in the following paragraphs.
Rents (dollars in thousands)
Commercial
The decrease in commercial rents was primarily attributable to reduced occupancy. The increase in apartment rents was primarily attributable to completed construction. Rents are expected to increase in 2005, as a result of completed apartment construction.
Property Operations Expenses (dollars in thousands)
The decrease in commercial operations expense was primarily attributable to lower occupancy and decreased management fees. The increase in apartment operations expense was primarily attributable to completed apartment construction. Property operations expenses are expected to increase in 2005, as a result of completed apartment construction.
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Restaurant sales and cost of sales increased to $9.4 million and $7.1 million, respectively, in the three months ended June 30, 2005 and $18.0 million and $13.9 million in the six months ended June 30, 2005 from $8.8 million and $6.9 million, respectively, in the three months ended June 30, 2004 and $17.0 million and $13.1 million in the six months ended June 30, 2004. The increase was primarily attributable to a 2.1% increase in same store sales. Also, two new concepts were not open during the 2004 period.
Interest income from notes receivable of $1.2 million and $2.8 million in the three and six months ended June 30, 2005 approximated the $1.6 million and $2.7 million in 2004.
Equity in income (loss) of investees improved to $152,000 and $212,000 in the three and six months ended June 30, 2005, from $(55,000) and $(201,000) in 2004. IORI recognized income from continuing operations for the six months ended June 30, 2005, compared to losses from continuing operations in 2004.
Gain on foreign currency transaction was $228,000 in the three and six months ended June 30, 2005, compared to $1.2 million in 2004, due to continued strengthening of the Polish zloty against the euro for Hotel Akademia during 2005. Hotel Akademia’s long-term debt is denominated in euros, and the impact of the translation of euros into zlotys prior to translation into US dollars is recorded as a gain or loss in the Consolidated Statements of Operations.
Interest Expense (dollars in thousands)
Restaurants
The decrease in commercial interest expense was primarily attributed to reduced mortgage interest rates. The increase in apartment interest expense was primarily attributable to completed apartment construction. The decrease in land interest expense was primarily attributable to reduced principal balances payable on land mortgages.
Depreciation and Amortization (dollars in thousands)
The increase in apartment depreciation expense is primarily attributable to completed construction.
Discount on sale of notes receivable was $398,000 in the six months ended June 30, 2004. This represents the discount from the face amount given by ARI to purchasers of notes receivable.
General and administrative expenses increased to $4.9 million and decreased to $7.7 million in the three and six months ended June 30, 2005, from $4.2 million and $8.9 million in 2004. The changes were primarily attributable to increased legal fees in 2005 and the timing of state tax accruals in 2004.
Advisory fees of $2.7 million and $5.6 million in the three and six months ended June 30, 2005, approximated the $2.4 million and $5.2 million in 2004.
Net income fee to affiliate was $(663,000) and $814,000 in the three and six months ended June 30, 2005, compared to $(79,000) in the three months ended June 30, 2004. 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.
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Minority interest decreased to $(174,000) and $746,000 in the three and six months ended June 30, 2005, from $445,000 and $1.6 million in 2004. The changes are primarily attributable to reduced net income of non-wholly-owned consolidated entities.
Net income from discontinued operations decreased to $3.0 million and $13.7 million in the three and six months ended June 30, 2005 from $6.2 million and $19.5 million in 2004. The net income relates to 27 properties that ARI sold during 2004 and 11 properties that ARI sold or held-for-sale in 2005. The following table summarizes revenue and expense information for the properties sold and held-for-sale.
Tax Matters
Financial statement income varies from taxable income principally due to the accounting for income and losses of investees, gains and losses from asset sales, depreciation on owned properties, amortization of discounts on notes receivable and payable and the difference in the allowance for estimated losses. ARI had a loss for federal income tax purposes, after the use of net operating loss carryforwards, for the first six months of 2005 and had a loss for federal income tax purposes in the first six months of 2004; therefore, it recorded no provision for income taxes.
At June 30, 2005, ARI had a net deferred tax asset of $66.2 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.
TCI had a loss for federal income tax purposes in the first six months of 2005 and a loss for federal income tax purposes, after the use of net operating loss carryforwards, in the first six months of 2004; therefore, it recorded no provision for income taxes.
At June 30, 2005, TCI had a net deferred tax asset of $41.4 million due to tax deductions available to it in future years. However, as management cannot determine that it is more likely than not that TCI will realize the benefit of the deferred tax assets, a 100% valuation allowance has been established.
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.
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Inflation
The effects of inflation on ARI’s operations are not quantifiable. Revenues from apartment operations fluctuate proportionately with inflationary increases and decreases in housing costs. Fluctuations in the rate of inflation also affect the sales values of properties and the ultimate gains to be realized from property sales. To the extent that inflation affects interest rates, earnings from short-term investments and the cost of new borrowings as well as the cost of variable interest rate debt will be affected.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
At June 30, 2005, ARI’s exposure to a change in interest rates on its debt is as follows:
WeightedAverage
Interest Rate
Effect of 1%Increase In
Base Rates
Notes payable:
Variable rate
Total decrease in ARI’s annual net income
Per share
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ITEM 4. CONTROLS AND PROCEDURES
Based upon their most recent evaluation, which was completed as of the end of the period covered by this report, the Acting Principal Executive Officer and Acting Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective at June 30, 2005, to ensure that information required to be disclosed in reports that the Company files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized, and reported within the time period specified in Securities and Exchange Commission rules and forms. There were no changes in the Company’s internal controls over financial reporting during the quarter ended June 30, 2005, that have materially affected or are reasonably likely to materially affect the Company’s internal controls over financial reporting.
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PART II. OTHER INFORMATION
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During the period of time covered by this report, ARI did not repurchase any of its equity securities. The following table sets forth a summary, by month, for the quarter indicating no repurchases were made, and that, at the end of the period covered by this report, a specified number of shares may yet be purchased under the program specified below:
Period
April 2005
May 2005
June 2005
Total
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ITEM 6. EXHIBITS
The following exhibits are filed herewith or incorporated by reference as indicated below:
Description
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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.
/s/ Ted P. Stokely
/s/ Allen M. Wilson, Jr.
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EXHIBITS TO
QUARTERLY REPORT ON FORM 10-Q
For the Quarter ended June 30, 2005
Page
Number
34