American Realty Investors, Inc. — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 30, 2013. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.
Business context
ARL is an externally advised real estate company with interests in apartments, commercial properties, land and mortgage loans. At quarter-end, it reported 57 income-producing properties: 46 apartment communities with 8,353 units and 11 commercial properties totaling approximately 2.6 million rentable square feet, plus 4,629 acres of land. ARL owns approximately 83.8% of TCI and consolidates TCI and IOT. Approximately 87.4% of ARL’s stock is owned by related parties; ARL has no employees and is managed by external advisor Pillar.
Financial performance and position
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Rental and other property revenue | $27.2 | $27.3 | $54.0 | $53.9 |
| Operating income | $3.9 | $5.5 | $8.0 | $8.7 |
| Continuing operations, net income (loss) | $(1.5) | $1.6 | $(6.2) | $(6.6) |
| Net income (loss) attributable to ARL | $8.4 | $4.7 | $8.7 | $(1.6) |
| Net income (loss) applicable to common shares | $7.7 | $4.1 | $7.5 | $(2.9) |
| Basic and diluted EPS applicable to common shares | $0.67 | $0.35 | $0.65 | $(0.25) |
Reported profits included substantial gains from discontinued property sales: $18.1 million in Q2 and $25.3 million for the six-month period. Without those gains, continuing operations remained loss-making. Six-month property operating expenses declined to $25.6 million from $26.1 million, while general and administrative expense rose to $4.3 million from $3.8 million. Six-month mortgage and loan interest expense decreased to $22.2 million from $24.5 million, mainly following apartment loan refinancings.
Cash flow, six months: Operating activities used $12.6 million, compared with $22.3 million used in 2012. Investing activities provided $72.8 million, including $73.5 million of proceeds from income-producing property sales. Financing activities used $68.0 million, primarily reflecting debt repayments. Cash fell by $7.8 million to $9.3 million.
Balance sheet at June 30: Total assets were $1.059 billion, down from $1.135 billion at year-end 2012. Total equity was $94.2 million. Notes and interest payable were $757.1 million, with a further $21.0 million of debt related to properties subject to sales contracts and $24.8 million of stock-secured notes and margin debt. These categories total approximately $803.0 million of debt obligations. Notes and interest receivable, net of allowance, were $103.7 million; $111.9 million of performing notes were from related parties before allowance and other adjustments.
Variable-rate debt was $118.8 million at a weighted average rate of 4.42%. Management estimated that a 1 percentage-point rate increase would reduce annual net income by $1.2 million, or approximately $0.10 per share.
Material changes and significant transactions
- Revenue was broadly unchanged year over year, but operating income declined in both the quarter and first half.
- For the six months, property sales generated $25.3 million of discontinued-operations gains, versus $8.3 million in the prior-year period. Sales included Verandas at City View, Laguna Vista, Amoco, 225 Baronne and Eton Square.
- Real estate carrying value declined to $873.1 million from $930.4 million at December 31, 2012. Total assets also decreased over that period.
- TCI refinanced several apartment mortgages at 2.50% with 40-year amortization schedules and maturities in 2053; refinancings reduced interest expense but resulted in loan charges and prepayment penalties.
- A proposed sale of nine apartment communities remained subject to HUD approval and was not classified as held for sale at June 30. The buyer was to assume existing loans if the transfer is approved.
Liquidity, outlook, risks and contingencies
Management expects property operations to generate excess cash in 2013 but states that this cash will not be sufficient to meet all obligations as they come due. Its stated plans include selling land and income-producing properties, refinancing or extending debt, and obtaining additional real-estate-secured borrowing. No quantified earnings or revenue guidance is provided.
- Debt and liquidity: The company relies on asset sales, refinancing and borrowing to meet debt service and maturities. Some land mortgages were being modified or extended. Under agreements concerning the Mercer/Travelers and Lamar land loans, IOT faced substantial scheduled payments in 2013, including a $28.7 million lump-sum payment due October 4, subject to an extension option.
- Related-party exposure: The portfolio includes substantial related-party notes and transactions. UHF surplus-cash-flow notes were extended five years in exchange for ending a preferred interest-rate period. Investors should consider collectability, collateral and governance implications.
- Legal matters: Management estimated that potential exposure from certain foreclosure deficiency claims would not exceed approximately $20 million in aggregate, if any, and would arise in future years. A July 2013 settlement with Far East National Bank required ARL to pay $3.7 million in 37 monthly installments of $100,000.
- Dynex litigation: A Texas appellate ruling was favorable to TCI and directed entry of a judgment based on jury findings, including $12.1 million previously awarded to TCI and subsidiaries, plus an additional $0.3 million for lost opportunities. The matter remained subject to further challenges, attorney-fee proceedings and recalculation of interest.
- German development: The 420-acre Olpenitz resort project was affected by alleged mismanagement by a third-party developer and insolvency proceedings. ARL was cooperating with the insolvency manager; recovery of its investment and continuation of development were uncertain.
- Property and financing risks: The filing identifies risks from leasing and occupancy, property values, financing availability and rates, asset-sale timing, development costs, environmental matters and litigation. Management reported no material change to the risk factors in its 2012 Form 10-K.
Management stated that disclosure controls and procedures were effective as of June 30, 2013, with no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- How much of reported earnings and cash generation depends on property-sale gains, and whether sale proceeds are sufficient to support debt repayment and ongoing operations.
- Upcoming debt maturities, the status of land-loan extensions and the funding plan for the Mercer/Travelers and Lamar obligations.
- Collectability and collateral support for related-party notes receivable, including the UHF loans, and the terms of related-party transactions.
- The status and potential financial impact of deficiency claims, Dynex litigation and the Far East National Bank settlement.
- Whether HUD approves the proposed nine-property transfer and whether the Olpenitz insolvency process preserves value for ARL.