American Realty Investors, Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. Amounts are in U.S. dollars; financial statement amounts are generally in millions unless noted. ARL is an externally advised real estate company whose consolidated portfolio includes TCI and its subsidiaries.
Business context
At June 30, ARL owned or had interests in 57 income-producing properties: 48 apartment communities with 8,083 units, eight commercial properties totaling about 2.0 million rentable square feet, a golf course, and 3,759 acres of land. Eight apartment projects were in development. Related parties owned approximately 86.7% of ARL’s stock.
Financial results and position
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Rental and other property revenue | $30.8 | $24.2 | $60.0 | $47.4 |
| Net operating income, as reported | $4.6 | $3.9 | $7.9 | $5.9 |
| Mortgage and loan interest expense | $14.0 | $9.8 | $28.2 | $21.4 |
| Net income (loss) attributable to ARL | $2.5 | $1.2 | $(0.7) | $4.5 |
| Net income (loss) applicable to common shares | $2.4 | $0.9 | $(1.3) | $3.8 |
| Basic EPS | $0.16 | $0.06 | $(0.08) | $0.26 |
Q2 results included $5.2 million gain on an apartment sale and $1.7 million gain on land sales. For the first half, gains were $4.9 million on income-producing property sales and $3.4 million on land sales. Excluding these gains, reported pretax results were pressured by higher operating costs and interest expense.
Six-month cash flow was $34.4 million provided by operating activities, $50.8 million used in investing, and $20.3 million provided by financing. Cash and cash equivalents were $19.2 million at June 30, up from $15.2 million at year-end; restricted cash was $30.2 million. Operating cash flow benefited materially from a $21.8 million decrease in related-party receivables. The cash-flow statement in the supplied filing text contains a “TO BE UPDATED” heading despite presenting figures; investors should verify the figures against the filed statements.
Total assets were $1.132 billion, total liabilities $955.7 million, and shareholders’ equity $176.0 million. Notes and interest payable on the balance sheet were $820.9 million. The debt note reports $827.4 million of debt after deferred borrowing costs, including $40.4 million of variable-rate debt. Notes and interest receivable, net of allowance, were $123.9 million; cash plus restricted cash totaled $49.3 million.
Changes versus prior period
- Q2 property revenue rose $6.6 million, mainly from apartment acquisitions and a Houston commercial building; operating expenses rose $3.9 million. Management attributed the growth largely to portfolio expansion rather than same-property performance.
- First-half revenue increased $12.6 million, while operating expenses increased $7.4 million and depreciation and amortization increased $1.9 million.
- First-half interest expense rose $6.8 million, primarily from mezzanine financing and apartment acquisitions. First-half common-share results shifted from $3.8 million income to a $1.3 million loss.
- During the first half, the company acquired one apartment community for $32.1 million and three land parcels for $8.9 million; it sold an apartment community, an industrial warehouse, and 53.1 acres of land. Investing outflows were lower than in 2015, when acquisitions were substantially larger.
Outlook, risks and unusual items
- Management expected excess cash flow from property operations in 2016 but stated it would not be sufficient to meet all obligations as they come due. Planned liquidity sources include asset sales, refinancing or extensions, and additional real-estate-secured borrowing. No quantified earnings or revenue guidance was provided.
- Some land and property sales to related parties remain accounted for under the deposit or deferred-sale method; the Mercer Crossing transaction includes a $50 million subordinated seller note, and proceeds allocation remains unresolved pending development commitments and collection.
- Certain mortgages on properties sold to related parties are in default, primarily for nonpayment; ARL reported active lender discussions to cure or settle defaults. A separate guarantee remains on a $22.1 million outstanding loan for LK-Four Hickory. ARL is also primary guarantor of a $60.35 million UHF mezzanine loan; UHF was covenant-compliant at quarter-end.
- Management cited financing availability and terms, debt maturities, property demand and occupancy, development delays or cost overruns, interest rates, asset-sale timing, environmental exposure, and related-party dealings as risks. Management stated ordinary-course litigation was not expected to materially affect ARL, except as otherwise disclosed.
- A 100% valuation allowance was recorded against a $63.5 million net deferred tax asset because realization was not considered more likely than not. Management estimated a 100-basis-point increase in variable rates would raise annual interest costs by about $0.4 million and reduce EPS by $0.03.
Investor verification priorities
- Confirm the cash-flow statement amounts, given the “TO BE UPDATED” marker in the supplied filing text, and assess how much operating cash flow depended on related-party balance movements.
- Review debt maturities, refinancing progress, and the status and consequences of mortgages in default, including any recourse or guarantees.
- Assess collectability and concentration of related-party notes receivable, including UHF and Foundation for Better Housing exposures, and the related allowance.
- Verify the status, consideration, seller financing, and deferred revenue recognition for Mercer Crossing and other related-party property sales.
- Separate recurring property performance from acquisition effects, interest costs, and property-sale gains when evaluating earnings and liquidity.