American Realty Investors, Inc. — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended September 30, 2015. Unless otherwise noted, amounts are in millions of dollars. ARL is an externally advised real estate investor; its consolidated portfolio included 45 apartment communities with 7,511 units, 10 commercial properties, and about 4,000 acres of land. TCI and its subsidiaries are consolidated.
Financial performance and position
- Revenue: Rental and other property revenue was $27.8 million in Q3, up from $19.3 million; nine-month revenue was $75.2 million, up from $58.0 million. Management attributed growth mainly to acquired properties; apartment occupancy averaged about 95%.
- Operating results: Reported net operating income was $2.1 million in Q3 versus $0.5 million, and $7.9 million for nine months versus $0.3 million. Property operating costs and depreciation rose with the expanded portfolio.
- Earnings: Net loss attributable to ARL was $5.2 million in Q3 versus $1.3 million. For nine months, ARL reported a $0.7 million net loss versus $3.7 million net income in 2014. The financial statements show common-share loss of $1.6 million, or $0.11 per diluted share, for nine months; the MD&A instead states $2.1 million, or $0.12 per share. This filing inconsistency should be checked.
- Cash flow: Nine-month operating cash use was $28.2 million versus $6.5 million in 2014; investing cash use was $116.3 million versus $2.8 million. Financing provided $144.2 million, principally reflecting new borrowings and refinancing. Cash ended at $12.0 million, down from $12.3 million; restricted cash was $42.2 million.
- Assets, debt and equity: Total assets were $1.087 billion, up from $965.5 million at year-end 2014. Balance-sheet notes and interest payable were $782.6 million versus $638.9 million. The debt note reports $810.2 million including accrued interest, or $790.4 million after unamortized borrowing costs; these are different presentations. Total shareholders’ equity was $178.7 million.
- Liquidity: Management said property operating cash flow would not be enough to meet all obligations as due. It expects to rely on asset sales, refinancings, extensions and additional real-estate-secured borrowing.
Material changes and notable items
- ARL acquired eight apartment complexes and one commercial office building during the first nine months; listed purchase prices totaled about $95.9 million. It also spent $131.2 million on income-producing property acquisitions in investing cash flows.
- ARL sold about 198 acres of land to independent parties for $12.0 million, recording $5.1 million of gains, and recognized $2.7 million of previously deferred gains. A 200-unit Ohio apartment property was transferred to its lender in settlement of debt, generating a $0.7 million gain.
- A new $120 million financing facility closed in May; $84.4 million was advanced at closing. It carries interest at 30-day LIBOR plus 10.75%, is interest-only, and matures in five years. A separate amended $40 million loan bears 12% interest. The company said it was in compliance with the applicable financial covenants at quarter-end.
- Variable-rate debt was $143.3 million at a weighted average rate of 8.68%; a 1-percentage-point rate increase was estimated to reduce annual net income by $1.4 million. Management cited fixed-rate HUD financing as a partial offset.
- Related-party exposure is significant: related parties owned approximately 86.7% of ARL, $121.1 million of performing notes receivable were from related parties, and receivables from a related party rose to $43.3 million from $21.4 million.
Outlook, risks and contingencies
- No quantified earnings or operating guidance was provided. Management described apartment occupancy and leasing demand positively, while planning to sell or refinance assets and seek additional borrowing to meet liquidity needs.
- Management disclosed mortgages on properties sold to a related party that are in default, primarily for nonpayment; the borrower is discussing settlement or cure with lenders. Sales recognition remains deferred, and ARL has assessed the properties for impairment.
- ARL guaranteed a $28.0 million LK-Four Hickory loan, with $22.1 million outstanding, and maintains reserves for potential related obligations.
- Litigation remains a risk. ARL is defending a Clapper Parties complaint and says it believes it has no liability for the separate judgment against former entities ART and ART Midwest. A July 2015 judgment against Dynex Commercial awarded damages to ART and TCI, not directly to ARL; ARL said it was reviewing next steps. Management considered ordinary-course litigation not materially adverse except as disclosed.
- A $96.0 million deferred tax asset is fully valuation-allowanced because realization was not considered more likely than not. Management reported no material environmental liability known to it and no change in risk factors from the 2014 Form 10-K.
- The company adopted revised discontinued-operations guidance in 2015, resulting in fewer property dispositions qualifying for discontinued-operations presentation. Management reported disclosure controls effective and no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Reconcile the nine-month common-share loss and diluted EPS discrepancy between the financial statements and MD&A.
- Review debt maturities, extensions, defaulted property loans, covenants, and the cost and collateral terms of the high-rate financing.
- Assess whether planned property sales, refinancing and new borrowing can cover obligations, given negative operating cash flow and management’s liquidity warning.
- Evaluate related-party receivables, loans and transactions, including collectability, collateral performance and terms.
- Confirm the status and potential recovery from the disclosed litigation and guarantees; distinguish judgments against ART or TCI from direct ARL obligations.