American Realty Investors, Inc. — Q1 2015 Form 10-Q
Business context and reporting period
Reports unaudited consolidated results for the three months ended March 31, 2015, compared with Q1 2014; balance sheet figures are compared with December 31, 2014. ARL is an externally advised real estate owner and investor, consolidating TCI and IOT. At quarter-end, its portfolio included 38 apartment communities with 6,344 units, nine commercial properties and approximately 4,200 acres of land. ARL reported 47 income-producing properties and said apartment occupancy averaged over 95%.
Key financial metrics
| Metric | Q1 2015 | Q1 2014 / prior date |
|---|---|---|
| Rental and other property revenue | $23.2 million | $19.2 million; up $4.0 million, or about 21% |
| Operating expenses | $21.2 million | $19.0 million |
| Reported net operating income | $2.0 million | $0.2 million |
| Income from continuing operations | $2.6 million | $0.6 million |
| Consolidated net income | $2.8 million | $4.4 million |
| Net income attributable to ARL | $3.3 million | $3.6 million |
| Net income applicable to common shares | $3.0 million | $2.9 million |
| EPS applicable to common shares | Basic $0.21; diluted $0.17 | Basic and diluted $0.25 |
| Operating cash flow | $30.9 million provided | $15.2 million used |
| Investing / financing cash flow | $4.9 million used / $18.6 million used | $14.5 million provided / $2.6 million provided |
| Cash and cash equivalents | $19.7 million | $12.3 million at Dec. 31, 2014 |
| Restricted cash | $36.1 million | $49.3 million at Dec. 31, 2014 |
| Total assets / shareholders’ equity | $945.7 million / $181.7 million | $965.5 million / $179.6 million at Dec. 31, 2014 |
| Debt | $641.3 million, including accrued interest, in the debt schedule | $621.6 million notes and interest payable on the balance sheet, plus separately reported debt for assets held for sale and sales-contract properties |
Q1 2015 reported net operating income was approximately 8.6% of property revenue. The filing does not provide a clear company-wide operating margin measure. Mortgage and loan interest expense was $9.2 million, versus $8.1 million a year earlier. Variable-rate debt was $61.7 million at a weighted average 5.64%; management estimated a 1 percentage-point rate increase would reduce annual net income by about $617,000, or $0.04 per share.
Material changes versus Q1 2014
- Property revenue rose by $4.0 million, reflecting higher apartment revenue ($1.6 million) and commercial revenue ($2.4 million), including contributions from acquired properties and modest same-property growth.
- Operating expenses increased by $2.2 million. Reported net operating income improved to $2.0 million from $0.2 million.
- Other income increased to $4.1 million, primarily due to approximately $3.9 million of debt forgiveness in a commercial-property mortgage settlement. ARL also recorded $2.9 million of gains on land sales, versus $0.8 million in Q1 2014.
- Consolidated net income declined from $4.4 million, when discontinued operations included a $6.1 million property-sale gain. Q1 2015 had no income-producing property sales and no such sale gain in discontinued operations.
- Operating cash flow improved substantially, but the filing attributes much of the increase to balance-sheet movements, including reduced related-party receivables and changes in other obligations; it should not be read as a comparable increase in recurring property cash earnings.
- Debt declined from year-end in the balance-sheet presentation, while cash increased. Restricted cash decreased by $13.1 million.
Outlook, commentary, risks and unusual items
- Liquidity: Management expects excess cash flow from property operations in 2015, but says it will not be sufficient to meet all obligations as they come due. ARL plans to sell land and income-producing property, refinance or extend debt, and obtain additional real-estate-secured borrowings. No quantitative earnings or revenue guidance is provided.
- Debt maturities and defaults: Some land mortgages are being modified or extended. Mortgages on properties sold to a related party with sale recognition deferred are reported as “subject to sales contract”; the borrowers are in default, primarily for nonpayment, and are negotiating with lenders. Those properties may or may not be transferred back, and many loans have corporate guarantees.
- Related-party exposure: Approximately 86.7% of ARL shares were owned by related parties. Performing notes receivable included $136.8 million from related parties, against $153.3 million total performing notes; ARL reported $4.9 million of Q1 interest income from related parties. The company has no employees and relies on external advisor Pillar.
- Contingencies: Management estimates potential exposure from deficiency claims relating to foreclosed assets at up to approximately $20 million in aggregate, if any, in future years. ARL also guarantees a $22.1 million outstanding loan for LK-Four Hickory and maintains reserves for possible obligations. Litigation includes the Clapper-related proceedings and the Dynex dispute; outcomes remain uncertain. Management believes the Clapper litigation does not create ARL liability but fully reserved a $10 million note receivable from the former ART entity.
- Other items: ARL sold 33.39 acres of McKinney, Texas land for $7.3 million and recorded a $2.9 million gain. It spent approximately $0.8 million on apartment construction or predevelopment. On April 9, 2015, conversion of preferred shares resulted in issuance of 1,486,741 common shares. The filing reports effective disclosure controls and no material quarterly change in internal control over financial reporting.
- Management identifies real-estate market and occupancy conditions, access to financing, interest rates, development execution, property-sale timing, environmental and uninsured-loss exposure, and related-party transactions as risks. It reported no changes to the risk factors in its 2014 Form 10-K.
Important facts for investors to verify
- Near-term debt maturities, lender negotiations, refinancing capacity and the amount of restricted cash available for general liquidity.
- Status and potential loss exposure of defaulted mortgages tied to related-party sales-contract properties, including associated guarantees.
- Collectability and concentration of related-party notes receivable, accrued interest and other balances, and the adequacy of related allowances.
- Possible outcomes and financial exposure from deficiency claims, the LK-Four Hickory guarantee and ongoing litigation.
- Effect of the April 2015 preferred-stock conversion and any further conversions on common-share dilution; reconcile basic and diluted EPS when assessing per-share performance.
- Sustainability of operating cash flow after the quarter’s significant working-capital and related-party balance movements, and reliance on asset sales and new borrowing to fund obligations.