Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended September 30, 2006, for American Real Estate Partners, L.P. (AREP), a master limited partnership and diversified holding company. The company operates primarily in three continuing segments: Gaming, Real Estate, and Home Fashion. During the quarter, AREP reclassified its Oil and Gas operations and its Atlantic City Gaming property (The Sands) as discontinued operations following agreements to sell these assets to Riata Energy, Inc. and Pinnacle Entertainment, Inc., respectively.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2006 | Nine Months Ended Sep 30, 2006 |
|---|---|---|
| Total Revenues | $373.3 million | $1,102.9 million |
| Operating Income (Loss) | ($13.4 million) | ($62.9 million) |
| Net Earnings (Loss) | $103.1 million | $223.9 million |
| Net Earnings Attributable to LPs | $101.1 million | $219.5 million |
| Diluted EPS | $1.63 | $3.55 |
| Cash and Cash Equivalents | $280.7 million | $280.7 million (Balance Sheet) |
| Total Debt (Long-term + Current) | $1.20 billion | $1.20 billion (Balance Sheet) |
| Investments (Current) | $1.04 billion | $1.04 billion (Balance Sheet) |
Material Changes vs. Prior Period
- Revenue Growth: Consolidated revenues increased 29.0% in the third quarter and 122.1% year-to-date compared to 2005. This surge is primarily driven by the inclusion of the Home Fashion segment (WestPoint International) for the full period in 2006, whereas it was only partially included in 2005.
- Discontinued Operations Impact: Net earnings were significantly boosted by income from discontinued operations ($103.0 million for the quarter; $202.1 million YTD). This contrasts sharply with losses in the prior year periods, driven by $58.3 million in unrealized oil and gas derivative gains (vs. losses in 2005) and a $37.0 million income tax benefit from reversing valuation allowances.
- Continuing Operations Loss: Excluding discontinued operations, the company reported an operating loss of $13.4 million for the quarter and $62.9 million YTD. This is largely due to operating losses in the Home Fashion segment ($24.3 million for the quarter; $110.6 million YTD) caused by restructuring and impairment charges.
- Investment Gains: Other income (expense) swung from a $22.8 million expense in Q3 2005 to a $22.4 million gain in Q3 2006, reflecting net realized and unrealized gains on marketable securities.
Guidance, Outlook, and Risks
- Divestitures: The company anticipates completing the sales of its Oil and Gas unit and Atlantic City gaming property in the fourth quarter of 2006. Proceeds are expected to significantly increase liquid assets.
- Home Fashion Restructuring: Management expects to continue restructuring efforts in the Home Fashion segment throughout 2006 and 2007. Additional restructuring costs of $10.0 million to $15.0 million are expected over the next year. Operating losses are anticipated to continue until restructuring is complete.
- Real Estate Outlook: Property development sales are expected to increase in Q4 2006 but decline in 2007 due to a slowdown in the residential/vacation real estate market.
- Legal Risks:
- GB Holdings Litigation: Creditors of GB Holdings have been granted standing to challenge the 2004 transaction transferring The Sands to AREP's subsidiary. The outcome is uncertain and could impact the sale to Pinnacle.
- WPI Ownership: A court order regarding WestPoint International (WPI) may reduce AREP's ownership stake to less than 50%, potentially requiring the deconsolidation of WPI's financial results.
- Liquidity: The company maintains significant liquidity through cash, investments, and credit facilities. However, debt covenants at subsidiaries (ACEP, WPI, NEG Oil & Gas) restrict the ability to transfer cash to the parent company.
Investor Verification Checklist
- Discontinued Operations Realization: Verify the closing of the Oil and Gas and Atlantic City gaming sales in Q4 2006 and the actual proceeds received versus the estimated $1.5 billion (Oil & Gas) and $250 million (Gaming) values.
- WPI Consolidation Status: Monitor the outcome of the Contrarian Funds Inc. v. WestPoint Stevens, Inc. litigation to determine if AREP retains control (>50%) of WPI and can continue to consolidate its results.
- Home Fashion Turnaround: Track the execution of the restructuring plan, specifically the closure of U.S. plants and the shift to overseas sourcing, to assess if operating losses will stabilize.
- Derivative Exposure: Review the settlement of oil and gas derivative contracts in connection with the Riata sale to confirm the realized gains included in the current period.
- Debt Covenants: Confirm continued compliance with debt covenants at ACEP and NEG Oil & Gas, particularly regarding cash flow to fixed charges and leverage ratios, which restrict dividend distributions.