American Realty Investors, Inc. — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012. Amounts are in millions of dollars unless noted. The company invests in and operates apartments, commercial real estate and land; it reported 63 income-producing properties, including 48 apartment communities with 8,873 units, 15 commercial properties and 4,799 acres of land. The filing was signed August 14, 2012.
Financial performance and position
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Rental and other property revenue | $31.0 | $29.3 | $60.6 | $56.5 |
| Operating income (loss) | $6.3 | $1.3 | $9.8 | $(3.9) |
| Income (loss) from continuing operations | $2.9 | $3.7 | $(6.5) | $(8.5) |
| Net income (loss) applicable to common shares | $4.1 | $13.8 | $(2.9) | $4.0 |
| Basic / diluted EPS applicable to common shares | $0.35 / $0.16 | $1.20 / $0.80 | $(0.25) / $(0.25) | $0.35 / $0.35 |
Q2 operating income was about 20% of property revenue; the comparable 2011 figure was about 5%. Six-month operating income was about 16% of revenue, versus an operating loss in the prior-year period. These operating results do not include the impact of financing costs, gains on sales or discontinued operations. Q2 net income included $4.7 million of gains on sales from discontinued operations; six-month net income included $8.3 million of such gains. The filing reports six-month land-sale gains of $3.7 million, down from $19.4 million.
- Cash flow: Six-month operating cash flow was $(23.3) million, investing cash flow was $74.5 million, and financing cash flow was $(53.4) million. Cash declined $2.2 million to $18.1 million. Cash interest paid was $25.6 million.
- Balance sheet at June 30: Total assets were $1,160.2 million, down from $1,235.5 million at year-end 2011. Total equity was $91.3 million, including $55.8 million attributable to ARI shareholders.
- Debt: Notes and interest payable were $800.2 million, with an additional $3.9 million related to assets held for sale, $55.5 million related to properties subject to sales contracts, and $26.1 million of stock-secured notes and margin debt. These balances should not be treated as a single maturity schedule.
- Receivables: Notes and interest receivable, net, were $101.2 million, including $118.7 million of performing loans and $5.9 million of non-performing loans before a $23.4 million allowance. $114.6 million of performing notes were from affiliates and related parties.
Changes versus the prior period
- Six-month property revenue rose $4.1 million, chiefly from apartment properties in lease-up and improved same-property apartment revenue; management said apartment occupancy averaged over 95%. Commercial same-property revenue declined $1.4 million.
- General and administrative expense fell $3.4 million for the six months, primarily due to lower professional-services costs and advisor reimbursements. No additional impairment provision was recorded in the first half of 2012, compared with $5.6 million in the prior-year period.
- Interest income increased $6.2 million to $8.1 million, mainly from accrued interest on Unified Housing Foundation cash-flow notes and a change, effective January 1, 2012, to recognize interest as earned on certain surplus-cash notes.
- Interest expense rose $4.3 million to $34.2 million. Management attributed much of the increase to write-offs of deferred financing costs and prepayment penalties on refinanced apartment loans, as well as interest on completed developments no longer eligible for capitalization.
- Cash proceeds from property and land sales were lower than in 2011. The company reported $76.7 million of property sales for the six months, compared with $222.8 million in the segment disclosure for the prior-year period.
Outlook, risks and unusual items
- Management expects property operations to generate excess cash in 2012, but says it will not be enough to meet all obligations as they come due. Its plans include selling land and income-producing properties, refinancing or extending debt, and seeking additional real-estate-secured borrowing. No quantified earnings or revenue guidance is provided.
- During the six months, the company refinanced numerous apartment mortgages, generally into long-amortization loans at stated rates of 2.85%–3.03%; construction loans on three completed apartment projects converted to permanent financing. Refinancing costs and prepayment penalties increased reported interest expense.
- Management disclosed that mortgages on properties sold to related parties with gains deferred under accounting rules are in default, primarily for nonpayment; discussions with lenders are ongoing. Some loans include corporate guarantees, and properties may be transferred back to the seller depending on the outcome of restructuring.
- Related-party exposure is significant: approximately 87.9% of ARI stock was held by affiliated entities. The company reported $13.8 million of affiliate payables and material affiliate note balances and transactions. Management cautions that related-party dealings may not be on arm’s-length terms.
- ARI sold American Realty Trust, Inc. (ART) for a $10 million seller-financed note that is fully reserved; ART subsequently filed for Chapter 11. A roughly $74 million judgment in the Clapper litigation is against ART and ART Midwest, not ARI or its other subsidiaries, according to the filing.
- The German Olpenitz development has disputes with a former local managing partner and is proceeding through bankruptcy protection in Germany. Management believes project value will satisfy creditors and return its investment, but this is uncertain.
- Market-risk disclosure estimates that a 1 percentage-point increase in base rates would reduce annual net income by $1.6 million, or about $0.13 per share, on $155.3 million of variable-rate debt. The company also disclosed a $28 million guarantee related to an investee loan.
- The filing says disclosure controls were effective and there were no material changes in internal control over financial reporting during the quarter. A 100% valuation allowance was maintained against an $85.7 million net deferred tax asset.
Key facts investors should verify
- Near-term debt maturities, refinancing availability, covenant status and whether asset sales or new secured borrowing can cover obligations; management states operating cash alone is insufficient.
- Current status and potential exposure from defaulted mortgages, related-party property transfers, guarantees and lender negotiations.
- Collectability and support for affiliate-related notes and accrued interest, including the fully reserved ART note and the $23.4 million total allowance for note losses.
- How much reported earnings depends on property-sale gains and discontinued operations versus recurring property operations and cash generation.
- Progress and financial exposure in the Olpenitz project, the ART bankruptcy and Clapper litigation, and the $28 million investee-loan guarantee.