ITEM 1. BUSINESS
In August 2000, American Realty Investors, Inc. ("ARI"), a Nevada corporation, acquired American Realty Trust, Inc. ("ART"), a Georgia corporation and National Realty, L.P. ("NRLP"), a Delaware partnership.
On November 3, 1999, ART and NRLP jointly announced the agreement of their respective Boards to combine, in a tax-free exchange, under a new company, ARI. Prior to December 31, 1998, ART accounted for its investment in NRLP under the equity method. As of December 31, 1998, upon the election of a wholly-owned subsidiary of ART as general partner of NRLP, ART began consolidation of NRLP's accounts at that date and consolidation of its operations subsequent to that date.
The acquisition transaction was closed on August 2, 2000. NRLP unitholders, except for ART, received one share of ARI Common Stock for each unit of NRLP held. ART stockholders received .91 shares of ARI Common Stock for each share of ART Common Stock held. Each share of ART Preferred Stock was converted into one share of Preferred Stock of ARI, having substantially the same rights as ART's preferred stock. The ART shares of Common Stock ceased trading on the New York Stock Exchange on August 2, 2000. The NRLP units of limited partner interest ceased trading on the American Stock Exchange on August 2, 2000. ARI Common Stock commenced trading on the New York Stock Exchange on August 3, 2000. ART and NRLP became wholly-owned subsidiaries of ARI. For financial reporting purposes, the transaction is treated as the purchase of NRLP by ART; accordingly, the historical information presented for ARI is that of ART.
On October 23, 2001, ARI, Transcontinental Realty Investors, Inc. ("TCI"), and Income Opportunity Realty Investors, Inc. ("IORI") jointly announced a preliminary agreement with the plaintiff's legal counsel of the derivative action entitled Olive et al. V. National Income Realty Trust, et al. for complete settlement of all disputes in the lawsuit (the "Olive Litigation"). In February 2002, the court granted final approval of the proposed settlement (the "Olive Settlement"). Under the Olive Settlement, ARI agreed to either (i) acquire all of the outstanding shares of IORI and TCI not currently owned by ARI for a cash payment or shares of ARI preferred stock or (ii) make a tender offer for all of the outstanding shares of IORI and TCI not currently owned by ARI. On November 15, 2002, ARI commenced the tender offer for the IORI and TCI shares. The tender offer was completed on March 19, 2003. ARI paid $19.00 cash per IORI share and $17.50 cash per TCI share for the stock held by non affiliated stockholders. Pursuant to the tender offer, ARI acquired 265,036 IORI shares and 1,213,226 TCI shares. The completion of the tender offer fulfills the obligations under the Olive Settlement, and the Olive Litigation has been dismissed with prejudice.
After the tender offers, ARI owned 64.8% of the outstanding shares of TCI and 46.9% of the outstanding shares of IORI. ARI has the same advisor as TCI and IORI, and TCI and IORI have the same board of directors. Two of the directors of TCI and IORI also serve as directors of ARI.
Business Plan and Investment Policy
ARI's primary business is investing in equity interests in real estate (including equity securities of real estate-related entities), leases, joint venture development projects and partnerships and, to a lesser extent, financing real estate and real estate activities through investments in mortgage loans, including first, wraparound and junior mortgage loans. Information regarding the real estate and mortgage notes receivable portfolios of ARI is set forth in ITEM 2.
ITEM 2. PROPERTIES
ARI's principal offices are located at 1800 Valley View Lane, Suite 300, Dallas, Texas 75234 and are, in the opinion of management, suitable and adequate for ARI's present operations.
Details of ARI's real estate and mortgage notes receivable portfolios at December 31, 2002, are set forth in Schedules III and IV, respectively, to the Consolidated Financial Statements included at ITEM 8. "CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA." The discussions set forth below under the headings "Real Estate" and "Mortgage Loans" provide certain summary information concerning ARI's real estate and mortgage notes receivable portfolios.
At December 31, 2002, no single asset accounted for 10% or more of total assets. At December 31, 2002, 65% of ARI's assets consisted of real estate, 12% consisted of notes and interest receivable, 11% consisted of investments in equity investees, including IORI and TCI, and 3% consisted of pizza parlor equipment and goodwill. The remaining 9% of ARI's assets were cash, cash equivalents, marketable equity securities, other intangibles and other assets. The percentage of assets invested in any one category is subject to change and no assurance can be given that the composition of ARI's assets in the future will approximate the percentages listed above.
ARI's real estate is geographically diverse. At December 31, 2002, ARI's real estate was located in all geographic regions of the continental United States, other than the Northeast region, as shown more specifically in the table under "Real Estate" below. ARI also holds mortgage notes receivable secured by real estate located in the Southeast, Southwest, Pacific and Midwest regions of the continental United States. See SCHEDULE IV to the Consolidated Financial Statements included at ITEM 8. "FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA" for a detailed description of ARI's notes receivable portfolio.
Geographic Regions
[GEOGRAPHIC REGION MAP]
Northeast region comprised of the states of Connecticut, Delaware, Maryland, Massachusetts, New Hampshire, New Jersey, New York,Pennsylvania, Rhode Island and Vermont, and the District of Columbia. ARI has no properties in this region.
Southeast region comprised of the states of Alabama, Florida, Georgia, Mississippi, North Carolina, South Carolina, Tennessee and Virginia. ARI has 21 apartments, 3 commercial properties and 2 hotels in this region.
Southwest region comprised of the states of Arizona, Arkansas, Louisiana, New Mexico, Oklahoma and Texas. ARI has 9 apartments and 6 commercial properties in this region.
Midwest region comprised of the states of Illinois, Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Missouri, Nebraska, North Dakota, Ohio, South Dakota, West Virginia and Wisconsin. ARI has 5 apartments, 1 commercial properties and 1 hotel in this region.
Mountain region comprised of the states of Colorado, Idaho, Montana, Nevada, Utah and Wyoming. ARI has 2 commercial properties and 1 hotel in this region.
Pacific region comprised of the states of Alaska, California, Hawaii, Oregon and Washington. ARI has 2 commercial properties and 4 hotels in this region.
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Excluded from above are 41 parcels of improved and unimproved land, a hotel in Sofia, Bulgaria and a single family residence, as described below.
Real Estate
At December 31, 2002, 77% of ARI's assets were invested in real estate and the equity securities of IORI and TCI. ARI invests in real estate located throughout the continental United States, either on a leveraged or nonleveraged basis. ARI's real estate portfolio consists of properties held for investment, investments in partnerships, properties held for sale and investments in equity securities of IORI and TCI.
Types of Real Estate Investments. ARI's real estate consists of apartments, commercial properties (office buildings, shopping centers and a merchandise mart), hotels and improved and unimproved land. In selecting real estate for investment, the location, age and type of property, gross rents, lease terms, financial and business standing of tenants, operating expenses, fixed charges, land values and physical condition are among the factors considered. Properties may be purchased subject to debt, or existing debt may be assumed and properties may be mortgaged, pledged or otherwise collateralized to obtain financing. The Board of Directors may alter the types of and criteria for selecting new real estate investments and for obtaining financing without a vote of stockholders.
Although ARI has typically invested in developed real estate, it may also invest in new construction or development either directly or in partnership with nonaffiliated parties or affiliates (subject to approval by the Board of Directors). To the extent that it invests in construction and development projects, such as Four Hickory Centre described below, ARI is subject to business risks, such as cost overruns and construction delays, associated with such higher risk projects.
In the opinion of management, the properties owned by ARI are adequately covered by insurance.
The following table sets forth the percentages, by property type and geographic region, of owned real estate (excluding 41 parcels of improved and unimproved land, a hotel in Sofia, Bulgaria and a single family residence, described below) at December 31, 2002.
The foregoing table is based solely on the number of apartment units, amount of commercial square footage and number of hotel rooms owned and does not reflect the value of ARI's investment in each region. See Schedule III to the Consolidated Financial Statements included in ITEM 8. "FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA" for a detailed description of owned real estate.
Excluded from the table above are a 136 room hotel in Sofia, Bulgaria, a single family residence in Dallas, Texas and 41 parcels of improved and unimproved land consisting of: a 44.4 acre land parcel in Las Colinas, Texas; seven parcels of land in Dallas County, Texas, totaling 392.4 acres; four parcels of land in Irving, Texas, totaling 278.5 acres; an 82.4 acre land parcel in Oceanside, California; four parcels of land in Tarrant County, Texas, totaling 129.8 acres; a 130.6 acre land parcel in Harris County, Texas; a 20.6 acre land parcel in Collin County, Texas; eight parcels of land in Farmers Branch, Texas, totaling 83.5 acres; an 11.8 acre land parcel in Plano, Texas; a 1,150.3 acre land parcel in Austin, Texas; a 199.9 acre parcel of land in Palm Desert, California; a 63.3 acre land parcel in Travis County, Texas; an 84.0 acre parcel of land in Houston, Texas; an 85.2 acre land parcel in Lewisville, Texas; a 7.6 acre land parcel in Carrollton, Texas; a 113.8 acre land parcel in Nashville, Tennessee; a 105.4 acre parcel of land in Denton County, Texas; and five additional land parcels totaling approximately 84.0 acres. See Schedule III to the Consolidated Financial Statements included at ITEM 8. "FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA" for a detailed description of ARI's real estate portfolio.
A summary of the activity in the owned real estate portfolio during 2001 is as follows:
Operating Properties. Set forth below are ARI's operating properties and the monthly rental rate for apartments and the average annual rental rate for commercial properties and the average daily room rate and room revenue divided by total available rooms for hotels and occupancy at December 31, 2002, 2001 and 2000 for apartments and commercial properties and average occupancy during 2002, 2001 and 2000 for hotels:
- -------- * Property was purchased or constructed in 2001 or 2002. ** Property was under construction in 2002.
Occupancy presented above and throughout this ITEM 2. is without reference to whether leases in effect are at, below or above market rates.
In 2002, ARI purchased the following property:
- -------- (1) Property received from BCM, a related party, for forgiveness of debt. The purchase price was determined using a market rate multiple of net operating income. (2) Exchanged with TCI, a related party, for the Oaktree Village Shopping Center, Rasor land parcel and Lakeshore Villas land parcel. (3) Assumed debt of seller.
In 2002, ARI sold the following properties:
- -------- (1) Exchanged for Governor's Square, Grand Lagoon, Park Avenue, Greenbriar, Regency and Westwood Apartments. (2) Exchanged with TCI, a related party, for the Plaza on Bachman Creek Shopping Center. (3) Debt assumed by purchaser. (4) Represents dividends on and redemption of Innovo Preferred Stock. See NOTE 7. "NOTES PAYABLE." (5) Sold to TCI, a related party, to satisfy debt. Gain deferred until sale to unrelated party. (6) Sold to TCI, a related party, to satisfy debt. In September 2002, gain of $34,000 recognized upon sale of 36 acres to unrelated party. Remaining gain of $27,000 deferred until sale to unrelated party.
(7) Sold to Housing for Seniors of Humble, LLC, a related party. Gain deferred until sale to unrelated party. (8) The cash received from the sale was not sufficient to repay the entire amount of the financing obtained from IORI in January 2002. ARI owes $2.1 million to IORI for remaining principal and 12% return. (9) Gain deferred until collection of mortgage note receivable in March 2003. See NOTE 25. "SUBSEQUENT EVENTS." (10) Failure to notify and receive approval from the lender for this transaction may constitute an event of default under the terms of the debt.
In 2002, ARI financed/refinanced or obtained second mortgage financing on the following:
Related Party Transactions. In each of the following transactions, except those footnoted as (6), a related party has purchased an entity, which owns the listed property asset, from ARI. ARI has guaranteed that the asset will produce at least a 12% return on the purchase price for a period of three years from the purchase date. If the asset fails to produce the 12% return, ARI will pay the purchaser any shortfall. In addition, if the asset fails to produce the 12% return for a calendar year, the purchaser may require ARI to repurchase the entity for the purchase price. Management has classified these related party transactions as notes payable.
- -------- (1) Variable interest rate. (2) Single note with all properties as collateral. (3) Maturity date extended to July 2004. (4) IORI purchased 100% of the outstanding common shares of Rosedale Corporation ("Rosedale"), a wholly-owned subsidiary of ARI, for $5.1 million. The purchase price was determined based upon the market value
of the property, using a market rate multiple of net operating income. Rosedale owns the Rosedale Towers Office Building. The business purpose of this transaction was for IORI to make an equity investment in Rosedale, anticipating a profitable return, and for ARI to receive cash for its equity investment. Sold to unrelated buyer in December 2002. ARI owes $2.1 million to IORI for remaining principal and 12% return. (5) TCI purchased 100% of the common shares of ART Two Hickory Corporation ("Two Hickory"), a wholly-owned subsidiary of ARI, for $4.4 million. The purchase price was determined based upon the market value of the property, using a market rate multiple of net operating income. Two Hickory owns the Two Hickory Centre Office Building. The business purpose of this transaction was for TCI to make an equity investment in Two Hickory, anticipating a profitable return, and for ARI to receive cash for its equity investment. (6) Properties sold to partnerships controlled by Metra Capital, LLC ("Metra"). Innovo Group, Inc. ("Innovo") is a limited partner in the partnerships that purchased the properties. Joseph Mizrachi, a Director of ARI, controls approximately 11.67% of the outstanding common stock of Innovo. Management has determined to treat this sale as a refinancing transaction. ARI will continue to report the assets and the new debt incurred by Metra on its financial statements. ARI also received $6.3 million of 8% non-recourse, non-convertible Series A Preferred Stock ("Preferred Shares") of Innovo. The dividend on the Preferred Shares will be funded entirely and solely through member distributions from cash flows generated by the operation and subsequent sale of the sold properties. In the event the cash flows for the properties are insufficient to cover the 8% annual dividend, Innovo will have no obligation to cover any shortfall. The Preferred Shares have a mandatory redemption feature, and are redeemable from the cash proceeds received by Innovo from the operation and sale of the properties. All member distributions that are in excess of current and accrued 8% dividends must be used by Innovo to redeem the Preferred Shares. Since redemption of these shares is subject to the above future events, management has elected to record no basis in the Preferred Shares. (7) TCI purchased all of the general and limited partnership interests in Garden Confederate Point, L.P. ("Confederate Point") from ARI for $1.9 million. The purchase price was determined based upon the market value of the property, using a market rate multiple of net operating income. Confederate Point owns the Confederate Point Apartments. The business purpose of this transaction was for TCI to make an equity investment in Confederate Point, anticipating a profitable return, and to reduce ARI's payable to BCM. Failure to notify and receive approval from the lender for this transaction may constitute an event of default under the terms of the debt. (8) TCI purchased all of the general and limited partnership interests in Garden Foxwood, L.P. ("Foxwood") from ARI for $1.1 million. The purchase price was determined based upon the market value of the property, using a market rate multiple of net operating income. Foxwood owns the Foxwood Apartments. The business purpose of this transaction was for TCI to make an equity investment in Foxwood, anticipating a profitable return, and to reduce ARI's payable to BCM. Failure to notify and receive approval from the lender for this transaction may constitute an event of default under the terms of the debt. (9) TCI purchased all of the general and limited partnership interests in Garden Woodsong, L.P. ("Woodsong") from ARI for $2.5 million. The purchase price was determined based upon the market value of the property, using a market rate multiple of net operating income. Woodsong owns the Woodsong Apartments. The business purpose of this transaction was for TCI to make an equity investment in Woodsong, anticipating a profitable return, and to reduce ARI's payable to BCM. TCI sold the Woodsong Apartments in July 2002. (10) Sold to unrelated buyer in December 2002. (11) TCI purchased 100% of the common shares of ART One Hickory Corporation ("One Hickory"), a wholly-owned subsidiary of ARI, for $4.5 million. The purchase price was determined based upon the market value of the property, using a market rate multiple of net operating income. One Hickory owns the One Hickory Centre Office Building. The business purpose of this transaction was for TCI to make an equity investment in One Hickory, anticipating a profitable return, and to reduce ARI's payable to BCM. Failure to notify and receive approval from the lender for this transaction may constitute an event of default under the terms of the debt. (12) Sold to unrelated party in June 2002. (13) Sold to unrelated party in January 2003. See NOTE 25. "SUBSEQUENT EVENTS."
Land Properties. Set forth below are ARI's land properties, consisting of both improved and unimproved land:
Mortgage Loans
In addition to real estate, a portion of ARI's assets are invested in mortgage notes receivable, secured by income-producing real estate, unimproved land and partnership interests. Management expects that the percentage of ARI's assets invested in mortgage loans will decline, as ARI will no longer seek to fund or acquire new mortgage loans. However, ARI may, in selected instances, originate mortgage loans or it may provide purchase money financing in conjunction with a property sale. Management intends to service and hold for investment the mortgage notes currently in the portfolio. Mortgage notes receivable consist of first mortgage loans.
Types of Properties Subject to Mortgages. The types of properties securing mortgage notes receivable at December 31, 2002, consisted of a commercial building, unimproved land and partnership interests. The type of properties subject to mortgages in which ARI invests may be altered without a vote of stockholders.
As of December 31, 2002, the obligors on $41.3 million or 48% of the mortgage notes receivable portfolio were affiliates of ARI. Also at that date, $7.9 million or 9% of the mortgage notes receivable portfolio was nonperforming.
The following table sets forth the percentages (based on the outstanding mortgage loan balance at December 31, 2002), by geographic region, of the commercial properties that serve as collateral for ARI's mortgage notes receivable. Excluded are $81.5 million of mortgage notes secured by unimproved land and other security. See Schedule IV to the Consolidated Financial Statements included in ITEM 8. "CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA" for additional details of ARI's mortgage notes receivable portfolio.
A summary of the activity in the mortgage notes receivable portfolio during 2002 is as follows:
During 2002, $2.1 million in interest and $15.1 million in principal were collected on mortgage notes receivable.
First Mortgage Loans. These loans generally provide for level periodic payments of principal and interest sufficient to substantially repay the loan at or prior to maturity, but may involve interest-only payments or moderate or negative amortization of principal or all interest and a "balloon" principal payment at maturity. With respect to first mortgage loans, it is ARI's general policy to require that the borrower provide a title policy or an acceptable legal opinion of title as to the validity and the priority of ARI's mortgage lien over all other obligations, except liens arising from unpaid property taxes and other exceptions normally allowed by first mortgage lenders.
The following discussion briefly describes first mortgage loans funded in 2002, as well as events that affected previously funded first mortgage loans during 2002.
In May 2002, ARI sold its leasehold interests in various oil and gas mineral development properties for $1.3 million, receiving a note from the buyer for the purchase price. The note bore interest at 10.0% per annum, matured in May 2004 and required monthly payments of principal and accrued interest. See NOTE 4. "OIL AND GAS OPERATIONS." In November 2002, the note was sold to 10300 Gaywood Trust, a related party, for $1.3 million plus accrued but unpaid interest, to satisfy debt. No cash was received by ARI for the sale of the note.
In August 2002, ARI sold a 14.2 acre tract of its Elm Fork land parcel for $1.5 million, paying $54,000 after payment of closing costs and debt paydown and providing purchase money financing of $763,000. The loan bore interest at 10.0% per annum and matured in October 2002. All principal and interest were due at maturity. In October 2002, the note was collected in full, including accrued but unpaid interest.
In September 2002, ARI sold its Messick land parcel and an 80.0 acre tract of its Katrina land parcel for $12.8 million, paying $1.5 million after payment of closing costs and debt paydown and providing purchase money financing of $9.6 million. The loan bore interest at 8.0% per annum, matured in September 2004 and required quarterly payments of accrued interest. All principal and accrued interest were due at maturity. In February 2003, ARI accepted $7.4 million as full payment for $7.7 million in principal and accrued interest. In March 2003, the remaining $1.9 million loan balance was sold to an unrelated party for $1.8 million plus accrued but unpaid interest. See NOTE 25. "SUBSEQUENT EVENTS."
In October 2002, ARI sold its Varner Road land parcel for $3.7 million, receiving $671,000 after payment of closing costs and providing purchase money financing of $2.8 million. The loan bears interest at 9.0% per annum, matures in October 2004 and requires quarterly interest payments. All principal and accrued but unpaid interest are due at maturity.
In December 2002, ARI sold its Willow Springs land parcel for $9.8 million, paying $1.3 million after payment of closing costs and debt paydown and providing purchase money financing of $7.8 million. The loan bore interest at 8.0% per annum, matured in December 2005 and required periodic interest payments beginning in June 2003. In March 2003, the loan was sold to an unrelated party for $7.5 million plus accrued and unpaid interest. See NOTE 25. "SUBSEQUENT EVENTS."
Also in December 2002, ARI sold a 238.0 acre tract of its Desert Wells land parcel for $23.8 million, receiving $321,000 after payment of closing costs and debt paydown and providing purchase money financing of $21.4 million. The first lien financing of $17.8 million bore interest at 8.0% per annum, matured in December 2004 and required payments beginning in March 2003. In March 2003, the loan was sold to an unrelated party for $17.1 million plus accrued and unpaid interest. See NOTE 25. "SUBSEQUENT EVENTS." The second lien financing of $3.6 million bore interest at 8.0% per annum and matured on March 31, 2003. All principal and interest were due at maturity.
In March 2001, ARI sold a 20.0 acre tract of its Katrina land parcel for $2.8 million, receiving $700,000 in cash and providing purchase money financing of the remaining $2.1 million of the sales price. The loan bore interest at 12.0% per annum and matured in July 2001. All principal and interest were due at maturity. In January 2002, $274,000 in principal and $226,000 in interest was collected. In March 2002, the note was collected in full, including accrued but unpaid interest.
In November 2001, ARI sold a 12.71 acre tract of its Santa Clarita land parcel for $1.9 million, receiving $1.5 million in cash and providing purchase money financing of the remaining $437,000 of the sales price. The loan bore interest at 8.0% per annum and matured in November 2002. In November 2002, the note was collected in full, including accrued but unpaid interest.
Also in November 2001, ARI sold the Blackhawk Apartments for $7.1 million, receiving $1.5 million in cash after the assumption of $4.0 million of mortgage debt and providing purchase money financing of the remaining $1.6 million of the sales price. The loan bore interest at 10.0% per annum and matured in May 2002. Monthly principal and interest payments were required. In April 2002, the note was collected in full, including accrued but unpaid interest.
Junior participations. In December 2002, ARI sold a 171.1 acre tract of its Desert Wells land parcel for $11.9 million, receiving $1.4 million after payment of closing costs and debt paydown and providing purchase money financing of $8.9 million. The loan bore no interest and matured in March 2003. The principal was due at maturity. In December 2002, interest in $7.7 million of the loan was sold to an unrelated party for $7.7 million. ARI retained a junior interest in $1.2 million of the loan. In March 2003, the note was collected in full.
Other. In September 1999, in conjunction with the sale of two apartments in Austin, Texas, $2.1 million in purchase money financing was provided, secured by limited partnership interests in two limited partnerships owned by the buyer. The financing bore interest at 16.0% per annum, required monthly payments of interest only
at 6.0%, beginning in February 2000 and required a $200,000 principal paydown in December 1999, which was not received, and matured in August 2000. ARI had the option of obtaining the buyer's general and limited partnership interests in the collateral partnerships in full satisfaction of the financing. In March 2000, ARI agreed to forbear foreclosing on the collateral securing the note and released one of the partnership interests, in exchange for a payment of $250,000 and executed deeds of trusts on certain properties owned by the buyer. In March 2000, the borrower made a $1.1 million payment, upon receipt of which ARI returned the deeds of trust. The borrower executed a replacement promissory note for the remaining note balance of $1.0 million, which is unsecured, non-interest bearing and matures in April 2003.
In December 1999, a note with a principal balance of $1.2 million, secured by a pledge of a partnership interest in a partnership which owns real estate in Addison, Texas, matured. The maturity date was extended to April 2000 in exchange for an increase in the interest rate to 14.0% per annum. All other terms remained the same. In February 2001, the loan amount was increased to $1.6 million and the maturity date was extended to June 2001. In February 2002, $1.5 million in principal and $87,000 in interest were collected. In July 2002, the note was collected in full, including accrued but unpaid interest.
Related Party. In June 2002, ARI converted $4.5 million of its receivable from BCM, a related party, to a recourse note receivable. This transaction was to provide ARI with additional security over that provided by an unsecured receivable. The note bears interest at 10.0% per annum, matures in March 2004 and requires quarterly payments of principal and accrued interest, beginning in December 2002.
In December 2002, ARI sold the Lakeshore Villas Apartments to Housing for Seniors of Humble, LLC ("Humble"), a related party, for $22.0 million, paying $764,000 after payment of closing costs and debt paydown and providing purchase money financing of $8.4 million. One loan has a principal amount of $2.0 million. The loan is unsecured, and is guaranteed by Unified Housing Foundation, Inc. ("Unified"), a related party. The second loan has a principal amount of $6.4 million, and is secured by a pledge by United of 100% of the Member Interest in Humble. Both loans bear interest at 11.5% per annum, mature in December 2009 and require quarterly payments beginning in March 2003. Richard W. Humphrey, a director of ARI, is the President of Humble and the President and Treasurer of Unified. Ted P. Stokely, Chairman of the Board and a director of ARI, is the General Manager of Unified.
In March 2001, ARI funded $13.6 million of a $15.0 million unsecured line of credit to One Realco Corporation ("One Realco"), which owns approximately 14.7% of the outstanding shares of ARI's Common Stock. One Realco periodically borrows money to meet its cash obligations. The line of credit bears interest at 12.0% per annum. All principal and interest were due at maturity in February 2002. The line of credit is guaranteed by BCM. In June 2001, $394,000 in principal and $416,000 in interest was collected. In December 2001, $21,000 in principal and $804,000 in interest was collected. In February 2002, the line of credit was increased to $18.0 million, accrued but unpaid interest of $217,000 was added to the principal and the maturity date was extended to February 2004. In March 2002, ARI funded an additional $1.8 million, increasing the outstanding principal balance to $15.5 million. In October 2002, $856,900 in interest was collected, by the return of 85,690 shares of ARI Series A Preferred Stock. All principal and interest are due at maturity. Ronald E. Kimbrough, Acting Principal Executive Officer, Executive Vice President and Chief Financial Officer of ARI, is a 10% shareholder of One Realco. During 2001 and 2002, Mr. Kimbrough did not participate in day-to-day operations or management of One Realco.
In December 2000, an unsecured loan with a current principal balance of $1.9 million to Warwick of Summit, Inc. ("Warwick") matured. The loan was made to provide funds to purchase, renovate and expand a shopping center property in Warwick, Rhode Island. All principal and interest were due at maturity. At December 2002, the loan, and $188,000 of accrued interest, remained unpaid. Richard D. Morgan, a Warwick shareholder, served as a director of ARI until October 2001.
In December 2000, a loan with a current principal balance of $1.6 million to Bordeaux Investments Two, L.L.C. ("Bordeaux"), matured. The loan, to provide funds to purchase and renovate a shopping center property in
Oklahoma City, Oklahoma, is secured by (1) a 100% interest in Bordeaux, which owns a shopping center in Oklahoma City, Oklahoma; (2) 100% of the stock of Bordeaux Investments One, Inc., which owns 6.5 acres of undeveloped land in Oklahoma City, Oklahoma; and (3) the personal guarantees of the Bordeaux members. At December 2002, the loan, and $710,000 of accrued interest, remained unpaid. Richard D. Morgan, a Bordeaux member, served as a director of ARI until October 2001.
In March 2000, a loan with a current principal balance of $2.6 million to Lordstown, L.P., matured. The loan, to provide funds to purchase for resale various parcels of land, is secured by a second lien on land in Ohio and Florida, by 100% of the general and limited partner interest in Partners Capital, Ltd., the limited partner of Lordstown, L.P., and a profits interest in subsequent land sales. At December 2002, the loan, and $1.1 million of accrued interest, remained unpaid. A corporation controlled by Richard D. Morgan is the general partner of Lordstown, L.P. Mr. Morgan served as a director of ARI until October 2001.
In October 1999, ARI funded a $4.7 million loan to Realty Advisors, Inc., an affiliate. The loan, to provide funds for acquisitions or working capital needs, was secured by all of the outstanding shares of common stock of American Reserve Life Insurance Company. The loan bore interest at 10.25% per annum, and matured in November 2001. In January 2000, $100,000 was collected. In November 2001, the maturity date was extended to November 2004. The collateral was changed to a subordinate pledge of 850,000 shares of ARI Common Stock owned by BCM. The shares are also pledged to a lender on ARI's behalf. The interest rate was changed to 2% over the prime rate, currently 6.25% per annum, and the accrued but unpaid interest of $984,000 was added to the principal. The new principal balance is $5.6 million. All principal and accrued interest are due at maturity.
Investments in Real Estate Companies and Real Estate Partnerships
Real estate entities. ARI's investment in real estate entities includes the equity securities of two publicly traded real estate companies, IORI and TCI, and interests in real estate joint venture partnerships. BCM, ARI's advisor, also serves as advisor to IORI and TCI.
Since acquiring its initial investments in IORI and TCI in 1989, ARI has made additional investments in the equity securities of both entities through private and open market purchases. The cost with respect to shares of IORI and TCI at December 31, 2002 totaled $64.1 million. The aggregate carrying value (cost plus or minus equity in income or losses and less distributions received) of the equity securities of IORI and TCI was $78.4 million at December 31, 2002 and the aggregate market value was $78.6 million. The aggregate investee book value of IORI and TCI based upon the December 31, 2002 financial statements of each entity was $121.4 million. See ITEM 13. "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS."
The Board of Directors has authorized the expenditure of up to an aggregate of $50.0 million to acquire, in open market purchases, shares of IORI and TCI, excluding private purchase transactions which are separately authorized. As of December 31, 2002, ARI had expended an aggregate of $8.6 million to acquire shares of IORI and TCI, in open market purchases, in accordance with these authorizations. ARI expects to make additional investments in the equity securities of IORI and TCI to the extent its liquidity permits.
On October 3, 2000, ARI and IORI entered into an agreement which provided IORI and ARI with an option to purchase 1,858,900 shares of common stock of TCI from a third party. On October 19, 2000, IORI assigned all of its rights to purchase such shares to ARI. The total cost to purchase the TCI shares was $30.8 million. In October 2000, ARI paid $5.6 million of the option price. In April 2001, the remainder of the option price was paid, and ARI acquired the TCI shares. See ITEM 1. "BUSINESS" for discussion of the tender offer for shares of TCI and IORI Common Stock by ARI.
Pertinent information regarding ARI's investment in the equity securities of the IORI and TCI at December 31, 2002, is summarized below (dollars in thousands):
IORI and TCI each own a considerable amount of real estate, much of which they have held for many years. Because of depreciation, these entities may earn substantial amounts in periods in which they sell real estate and will probably incur losses in periods in which they do not. ARI's reported income or loss attributable to these entities will differ materially from its cash flow attributable to them.
At December 31, 2002, ARI did not have a controlling equity interest in either IORI or TCI; therefore, it could not, acting by itself, determine either the individual investments or the overall investment policies of either of them. However, due to ARI's equity investments in, and the existence of common officers with, each of IORI and TCI and that IORI and TCI have the same advisor as ARI, ARI could be considered to have the ability to exercise significant influence over the operating and investing policies of IORI and TCI. At December 31, 2002, ARI accounted for its investment in IORI and TCI using the equity method. Under the equity method, ARI recognized its proportionate share of the income or loss from the operations of IORI and TCI currently, rather than when realized through dividends or on sale. The carrying value of ARI's investment in IORI and TCI, as set forth in the table above, is the original cost of investment in each adjusted for ARI's proportionate share of IORI's and TCI's income or loss and distributions received.
The following summary description of IORI and TCI is based upon information publicly reported by each entity.
IORI. IORI is a Nevada corporation which was originally organized on December 14, 1984, as a California business trust and commenced operations on April 10, 1985. IORI's business is investing in real estate through direct equity investments and partnerships. IORI holds equity investments in apartments and commercial properties (office buildings) in the Pacific, Southeast and Southwest regions of the continental United States with a concentration in the Southwest region. At December 31, 2002, IORI owned 12 income producing properties located in three states. These properties consisted of seven apartments comprising 777 units and five office buildings with an aggregate of 291,254 sq. ft. In addition, IORI owned two parcels of unimproved land, totaling 205 acres.
IORI reported a net income of $2.1 million in 2002 as compared to net loss of $3.5 million in 2001. IORI's net income in 2002 included gains on sale of real estate of $6.8 million. IORI's cash flow from property operations was $3.4 million in 2002. At December 31, 2002, IORI had total assets of $90.2 million, which consisted of $74.8 million in real estate held for investment, $15.4 million in investments in partnerships and other assets and $10,000 in cash and cash equivalents.
ARI received no dividends from IORI in 2002.
TCI. TCI is a Nevada corporation which was originally organized on September 6, 1983, as a California business trust, and commenced operations on January 31, 1984. On November 30, 1999, TCI acquired, through merger, Continental Mortgage and Equity Trust ("CMET"), both of which, at the time, were equity investees of ARI. Pursuant to the merger agreement, TCI acquired all of the outstanding CMET shares of beneficial interest in a tax-free exchange of shares, issuing 1.181 shares of its common stock for each outstanding CMET share.
TCI has investment policies similar to those of IORI. TCI holds equity investments in apartments, commercial properties (office buildings, industrial warehouses and shopping centers) and hotels throughout the continental United States with a concentration in the Southeast and Southwest regions. At December 31, 2002, TCI owned 103 income producing properties located in 18 states and one income producing property in Poland. These properties consisted of 54 apartments comprising 10,439 units, 26 office buildings with an aggregate of 3.9 million sq. ft., 11 industrial warehouses with an aggregate of 1.7 million sq. ft., seven shopping centers with an aggregate of 668,284 sq. ft., a fitness club with 56,532 sq. ft. and five hotels with a total of 374 rooms. In addition, TCI owned 34 parcels of unimproved land, totaling 1,043 acres. TCI also holds mortgage notes receivable secured by real estate located in the Midwest, Southeast and Southwest regions of the continental United States.
TCI reported net income of $4.9 million in 2002 and $19.8 million in 2001. TCI's net income in 2002 included gains from the sale of real estate of $38.9 million, whereas its net income in 2001 included gains from the sale of real estate of $49.0 million. TCI's cash flow from property operations was $43.9 million in 2002. At December 31, 2002, TCI had total assets of $858.5 million, which consisted of $737.0 million in real estate held for investment, $22.5 million in real estate held for sale, $13.8 million in investments in real estate entities, $27.9 million in notes and interest receivable, $46.7 million in other assets and $10.6 million in cash and cash equivalents. At December 31, 2002, TCI owned 345,728 shares of IORI's common stock, approximately 24.0% of the shares then outstanding.
ARI received no dividends from TCI in 2002.
Realty Advisors Korea, Ltd. On June 30, 2002, ARI obtained 74.31% interest in Realty Advisors Korea, Ltd. ("RAK"), a Korean real estate advisory company, from BCM, a related party, for $6.0 million. The business purpose of the transaction was to reduce the affiliate payable owed by BCM to ARI. ARI's receivable from BCM was reduced by $6.0 million, and no cash was paid by ARI. At the date of acquisition, RAK's assets consisted of $2.3 million in cash, $3.0 million in deposits and marketable securities, and $225,000 in other assets. RAK's net equity was $5.5 million. ARI recorded $1.9 million in goodwill as a result of this transaction.
ART Florida Portfolio II, Ltd. In January 2002, Investors Choice Florida Public Funds II, in which ART Florida Portfolio II, Ltd. owned an interest, sold Villas Continental Apartments. ARI received $1.3 million in cash from the sale. ARI's share of the loss incurred on the sale was $286,000, which is included in loss on sale of investments in equity investees in the Consolidated Statements of Operations.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
ARI is involved in various lawsuits arising in the ordinary course of business. In the opinion of ARI's management the outcome of these lawsuits will not have a material impact on ARI's financial condition, results of operations or liquidity.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
ARI's Common Stock is traded on the New York Stock Exchange using the symbol "ARL". The following table sets forth the high and low sales prices as reported in the consolidated reporting system of the New York Stock Exchange.
As of March 19, 2003, the closing market price of ARI's Common Stock on the New York Stock Exchange was $8.21 per share.
As of March 19, 2003, ARI's Common Stock was held by 5,099 stockholders of record.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table provides information as of December 31, 2002 regarding compensation plans under which equity securities of ARI are authorized for issuance.
See Note 12 to the Consolidated Financial Statements for information regarding the material features of the above plans.
During the second quarter of 1999, the Board of Directors established the policy that dividend declarations on ARI's Common Stock would be determined on an annual basis following the end of each year. In accordance with that policy, the Board determined not to pay any dividends in 2002. Future distributions to Common stockholders will be dependent upon ARI's realized income, financial condition, capital requirements and other factors deemed relevant by the Board.
There are 15,000,000 shares of Series A 10% Cumulative Convertible Preferred Stock authorized, with a par value of $2.00 per share and a liquidation preference of $10.00 per share plus accrued and unpaid dividends. Dividends are payable at the annual rate of $1.00 per share or $.25 per share quarterly to stockholders of record on the last day of each March, June, September and December when and as declared by the Board of Directors.
The Series A Preferred Stock may be converted after August 15, 2003, into Common Stock at 90% of the average daily closing price of ARI's Common Stock for the prior 20 trading days. At December 31, 2002, 3,226,858 shares of Series A Preferred Stock were outstanding and 1,808,879 shares were reserved for issuance as future consideration in various business transactions. Of the outstanding shares, 300,000 shares are owned by ART Edina, Inc., and 600,000 shares are owned by ART Hotel Equities, Inc., wholly-owned subsidiaries of ARI. Dividends are not paid on the shares owned by ARI subsidiaries.
There are 80,000 shares of Series B 10% Cumulative Convertible Preferred Stock authorized, with a par value of $2.00 per share and a liquidation preference of $100.00 per share plus accrued but unpaid dividends. The Series B Preferred Stock bears an annual dividend of $11.00 per share or $2.75 per quarter to stockholders of record on the last day of each March, June, September and December when and as declared by the Board of Directors. The Series B Preferred Stock was reserved for conversion of the Class A limited partner units of Valley Ranch, L.P. In March 1999, an agreement was reached for ARI to acquire the eight million Class A units then outstanding, for $1.00 per unit. At December 31, 2002, all of the Class A units had been repurchased. At December 31, 2002, no Series B Preferred Stock was outstanding.
There are 231,750 shares of Series C Cumulative Convertible Preferred Stock authorized, with a par value of $2.00 per share and liquidation preference of $100.00 per share plus accrued and unpaid dividends. The Series C Preferred Stock bears a quarterly dividend of $.90 per share through June 30, 2001 and $2.50 per share thereafter, to stockholders of record on the last day of March, June, September and December when and as declared by the Board of Directors. The Series C Preferred Stock is reserved for conversion of the Class A limited partner units of ART Palm, L.P. At December 31, 2002, 11,813,750 Class A units were outstanding. The Class A units may be exchanged for Series C Preferred Stock at the rate of 100 Class A units for each share of Series C Preferred Stock. At December 31, 2000, shares of Series C Preferred Stock could be converted into 25,000 shares of ARI Common Stock. At June 30, 2002, additional shares of Series C Preferred Stock could be converted into 16,250 shares of ARI Common Stock. On or after June 30, 2003, additional shares of Series C Preferred Stock may be converted into 16,250 shares of ARI Common Stock. On or after December 31, 2005, additional shares of Series C Preferred Stock may be converted into 16,250 shares of ARI Common Stock. On or after December 31, 2006, all remaining outstanding shares of Series C Preferred Stock may be converted into ARI Common Stock. All conversions of Series C Preferred Stock into ARI Common Stock will be at 90% of the average daily closing price of ARI's Common Stock for the prior 20 trading days. In January 2001, 2.5 million Class A limited partner units of ART Palm, L.P. were redeemed for $2.5 million in cash. In December 2001, 7.2 million Class A limited partner units of ART Palm, L.P. were redeemed for $5.8 million, including $2.5 million in cash. ARI gave a note payable for the remaining $3.3 million. The note bore interest at 10.00% per annum, with a payment of $1.9 million plus accrued but unpaid interest due in June 2002, and the remaining principal and accrued but unpaid interest due at maturity in December 2002. The note was paid in full in January 2003, including accrued but unpaid interest. In July 2002, 1.6 million Class A limited partner units of ART Palm, L.P. were redeemed for $1.6 million in cash. At December 31, 2002, no Series C Preferred Stock was outstanding.
There are 91,000 shares of Series D 9.50% Cumulative Preferred Stock authorized, with a par value of $2.00 per share, and a liquidation preference of $20.00 per share. Dividends are payable at the annual rate of $1.90 per year or $.475 per quarter to stockholders of record on the last day of each March, June, September and December when and as declared by the Board of Directors. The Series D Preferred Stock is reserved for the conversion of the Class A limited partner units of Ocean Beach Partners, L.P. The Class A units may be exchanged for Series D Preferred Stock at the rate of 20 Class A units for each share of Series D Preferred Stock. No more than one-third of the Class A units could be exchanged prior to May 31, 2001. Between June 1, 2001 and May 31, 2006 all unexchanged Class A units are exchangeable. At December 31, 2002, no shares of Series D Preferred Stock were outstanding.
There are 500,000 shares of Series E 6% Cumulative Preferred Stock authorized, with a par value $2.00 per share and a liquidation preference of $10.00 per share. Dividends are payable at the annual rate of $.60 per share or $.15 per quarter to stockholders of record on the last day of each March, June, September and December when and as declared by the Board of Directors. At December 31, 2002, 50,000 shares of Series E Preferred Stock were outstanding.
There are 10,000 shares of Series I 8% Cumulative Preferred Stock authorized, with a par value of $2.00 per share and a liquidation preference of $1,000.00 per share. Dividends are payable at the annual rate of $80.00 per share or $20.00 per quarter to stockholders of record on the last date of each March, June, September and December when and as declared by the Board of Directors. At December 31, 2002, no shares of Series I were outstanding. In February 2003, 10,000 shares were issued to ART Morgan, Inc., a wholly-owned subsidiary of ARI. Dividends are not paid on these shares.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Introduction
ARI was organized in 1999. In August 2000, ARI acquired ART and NRLP. ART was organized in 1961 to provide investors with a professionally managed, diversified portfolio of real estate and mortgage loan investments selected to provide opportunities for capital appreciation as well as current income. ART owns a portfolio of real estate and mortgage loan investments. NRLP was organized in 1987, and subsequently acquired all of the assets and assumed all of the liabilities of 35 public and private limited partnerships. NRLP owns a portfolio of real estate and mortgage loan investments.
Critical Accounting Policies
Critical accounting policies are those that are both important to the presentation of ARI's financial condition and results of operations and require management's most difficult, complex or subjective judgements. ARI's critical accounting policies relate to the evaluation of impairment of long-lived assets and the evaluation of the collectibility of accounts and notes receivable.
If events or changes in circumstances indicate that the carrying value of a rental property to be held and used or land held for development may be impaired, management performs a recoverability analysis based on estimated undiscounted cash flows to be generated from the property in the future. If the analysis indicates that the carrying value is not recoverable from future cash flows, the property is written down to estimated fair value and an impairment loss is recognized. If management decides to sell rental properties or land held for development, management evaluates the recoverability of the carrying amounts of the assets. If the evaluation indicates that the carrying value is not recoverable from estimated net sales proceeds, the property is written down to estimated fair value less costs to sell and an impairment loss is recognized within income from continuing operations. ARI's estimates of cash flow and fair values of the properties are based on current market conditions and consider matters such as rental rates and occupancies for comparable properties, recent sales data for comparable properties and, where applicable, contracts or the results of negotiations with purchasers or prospective purchasers. ARI's estimates are subject to revision as market conditions and ARI's assessments of them change. In the third quarter of 2002, ARI recognized asset impairments of $480,000. In the fourth quarter of 2002, ARI recognized asset impairments of $3.7 million.
ARI's allowance for doubtful accounts receivable and notes receivable is established based on analysis of the risk of loss on specific accounts. The analysis places particular emphasis on past due accounts. Management considers such information as the nature and age of the receivable, the payment history of the tenant or other debtor, the financial condition of the tenant or other debtor and ARI's assessment of its ability to meet its lease or interest obligations. ARI's estimate of the required allowance, which is reviewed on a quarterly basis, is subject to revision as these factors change and is sensitive to the effects of economic and market conditions.
Obligations and Commitments
ARI has contractual obligations and commitments primarily with regards to the payment of mortgages.
The following table aggregates ARI's expected contractual obligations and commitments subsequent to December 31, 2002. (Dollars in thousands.)
Effective December 18, 1998, a wholly-owned subsidiary of ART was elected general partner of NRLP. Prior to December 31, 1998, ART accounted for its investment in NRLP under the equity method. As of December 31, 1998, upon the election of its wholly-owned subsidiary as general partner of NRLP, ART began consolidation of NRLP's accounts and has consolidated its operations subsequent to that date.
Liquidity and Capital Resources
General. Cash and cash equivalents at December 31, 2002 totaled $8.4 million, compared with $709,000 at December 31, 2001. Although ARI anticipates that during 2003 it will generate excess cash from operations, as discussed below, such excess cash is not sufficient to discharge all of ARI's debt obligations as they mature. ARI will therefore again rely on externally generated funds, including aggressive land sales, selected sales of income producing properties, borrowings against its investments in various real estate entities, refinancing of properties and, to the extent necessary, borrowings to meet its debt service obligations, pay taxes, interest and other non-property related expenses.
Notes payable totaling $160.7 million are scheduled to mature during 2003. During the first quarter of 2003, ARI either extended, refinanced, paid down, paid off or received commitments from lenders to extend or refinance $39.0 million of the debt scheduled to mature in 2003. See NOTE 2. "REAL ESTATE," NOTE 8. "NOTES AND INTEREST PAYABLE" and NOTE 25. "SUBSEQUENT EVENTS."
ARI expects a further decline in cash from property operations in 2003. This expected decrease results from the reduced number of apartment properties in ARI's real estate portfolio.
Net cash used in operating activities was $52.7 million in 2002 compared to $48.6 million in 2001. Fluctuations in the components of cash from operating activities are discussed in the paragraphs that follow.
Net cash from property operations (rents collected less payments for expenses applicable to rental income) decreased to $21.5 million in 2002 from $26.8 million in 2001. This decrease was primarily attributable to apartment properties sold in 2002 and 2001.
Net cash from pizza operations (sales less cost of sales) decreased to $5.5 million in 2002 from $6.4 million in 2001. The decrease was primarily attributable to increased accounts receivable in 2002.
Interest collected decreased to $1.6 million in 2002 from $1.8 million in 2001. The decrease was attributable to the reduced number of outstanding loans for which interest is due prior to maturity.
No distributions were received from equity investees in 2002, compared to $53,000 in 2001. The decrease was due to the elimination of dividends paid by investees. Distributions from equity investees are expected to be minimal in 2003.
Interest paid decreased to $54.4 million in 2002 from $62.6 million in 2001. The decrease was primarily attributable to the reduction in outstanding loan balances as properties were sold in 2002 and 2001.
Advisory fees paid decreased to $5.4 million in 2002 from $6.7 million in 2001. The decrease was due to the decrease in ARI's gross assets, the basis for such fee.
No incentive fees were paid to affiliates in 2002, compared to $1.6 million in 2001.
Distributions to minority interest holders decreased to $2.6 million in 2002 from $4.1 million in 2001. These distributions represent returns paid to limited partner unitholders of controlled consolidated partnerships. See NOTE 2. "REAL ESTATE."
General and administrative expenses paid decreased to $12.0 million in 2002 from $12.7 million in 2001. The decrease was primarily attributable to a decrease in reimbursements paid to ARI's advisor.
Other cash used in operating activities was $6.9 million in 2002 compared to $4.1 million from other operating activities in 2001. The change was primarily attributable to a $6.0 million bond posted in 2002, pursuant to an appeal of a judgment from a lawsuit. See NOTE 23. "COMMITMENTS AND CONTINGENCIES AND LIQUIDITY."
In 2002, ARI purchased a total of 100.1 acres of land in Austin, Texas and Beaumont, California, in separate transactions for a total of $1.3 million. ARI paid $1.4 million in cash, including closing costs. ARI obtained two apartments, a shopping center and ownership interest in a foreign entity from an affiliate for forgiveness of $20.7 million of debt, in a non-cash transaction. ARI also received a shopping center from an affiliate in exchange for a shopping center and two land parcels.
In 2002, ARI sold a total of 2,589.3 acres of land in Farmers Branch, Fort Worth, Houston, Lewisville, Plano, Collin County, Dallas County, Denton County and Harris County, Texas; Beaumont, Palm Desert and Riverside, California; and Nashville, Tennessee in 32 separate transactions for a total of $128.1 million. ARI received net cash of $2.3 million, after paying off or paying down or assumption by the purchaser of $40.7 million in mortgage debt secured by such land parcels and after providing purchase money financing of $51.2 million. ARI also sold 18 apartments, three office buildings and two shopping centers for a total of $159.2 million. ARI received net cash of $18.4 million, after the payoff or assumption by the purchaser of mortgage debt totaling $114.3 million and after providing purchase money financing of $8.4 million.
In 2001, ARI exchanged 8.9 acres of land in Farmers Branch, Texas and 10.5 acres of land in Lewisville, Texas for a 168 unit apartment in Addison, Texas. See NOTE 2. "REAL ESTATE."
ARI expects that funds from existing cash resources, aggressive sales of land and selected income producing property sales, refinancing of real estate, and borrowings against its real estate will be sufficient to meet the cash requirements associated with ARI's current and anticipated level of operations, maturing debt obligations and existing commitments. To the extent that ARI's liquidity permits or financing sources are available, ARI will make investments in real estate, primarily in improved and unimproved land, will continue making investments in real estate entities and marketable equity securities, and will develop and construct income-producing properties.
ARI expects that it will be necessary for it to sell $62.9 million, $38.3 million and $7.0 million of its land holdings during each of the next three years to satisfy the debt on the land as it matures. If ARI is unable to sell at least the minimum amount of land to satisfy the land debt obligations as they mature, ARI, intends to extend such debt or sell other of its assets, specifically income producing properties, to pay the debt.
Loans Payable. ARI has margin arrangements with various brokerage firms which provide for borrowings of up to 50% of the market value of marketable equity securities. The borrowings under the margin arrangements are secured by the equity securities and bear interest rates ranging from 5.25% to 24.0%. Margin borrowings totaled $8.6 million (approximately 14.7% of market value) at December 31, 2002, compared to $28.0 million at December 31, 2001. See NOTE 9. "MARGIN BORROWINGS."
Equity Investments. During the fourth quarter of 1988, ARI began purchasing shares of IORI and TCI which have the same advisor as ARI. It is anticipated that additional equity securities of IORI and TCI may be acquired in the future through open-market and negotiated transactions to the extent ARI's liquidity permits. See ITEM 1. "BUSINESS" for discussion of the tender offer for shares of TCI and IORI common stock by ARI.
Equity securities of IORI and TCI held by ARI may be deemed to be "restricted securities" under Rule 144 of the Securities Act of 1933 ("Securities Act"). Accordingly, ARI may be unable to sell such equity securities other than in a registered public offering or pursuant to an exemption under the Securities Act for a one year period after they are acquired. Such restrictions may reduce ARI's ability to realize the full fair market value of such investments if ARI attempted to dispose of such securities in a short period of time.
ARI's cash flow from these investments is dependent on the ability of each of IORI and TCI to make distributions. In December 2000, the Boards of IORI and TCI suspended the payment of quarterly dividends. ARI received no distributions from TCI and IORI in 2002, and ARI anticipates receiving no distributions from IORI and TCI in 2003.
In 2002, ARI paid dividends to its Preferred stockholders totaling $2.4 million. ARI paid $25,000 in accumulated back dividends in 2002 on previously unexchanged units of NRLP.
Management reviews the carrying values of ARI's properties and mortgage notes receivable at least annually and whenever events or a change in circumstances indicate that impairment may exist. Impairment is considered to exist if, in the case of a property, the future cash flow from the property (undiscounted and without interest) is less than the carrying amount of the property. For notes receivable impairment is considered to exist if it is probable that all amounts due under the terms of the note will not be collected. If impairment is found to exist, a provision for loss is recorded by a charge against earnings to the extent that the investment in the note exceeds management's estimate of the fair value of the collateral securing such note. The mortgage note receivable review includes an evaluation of the collateral property securing each note. The property review generally includes: (1) selective property inspections; (2) a review of the property's current rents compared to market rents; (3) a review of the property's expenses; (4) a review of maintenance requirements; (5) a review of the property's cash flow; (6) discussions with the manager of the property; and (7) a review of properties in the surrounding area.
Commitments
ARI will rely on externally generated funds, including aggressive land sales, selected sales of income producing properties, refinancing of properties and, to the extent necessary, borrowings to meet these commitments.
Results of Operations
2002 Compared to 2001. ARI reported a net loss of $8.5 million in 2002 compared to net income of $15.1 million in 2001. ARI's net income in 2002 included gains on the sale of real estate of $50.5 million compared to gains on the sale of real estate of $83.4 million in 2001. The primary factors contributing to ARI's net income are discussed in the following paragraphs.
Rents decreased to $89.5 million in 2002 from $101.9 million in 2001. Rent from commercial properties of $28.0 million in 2002 approximated the $27.8 million in 2001, rent from hotels of $31.7 million in 2002 approximated the $32.0 million in 2001 and rent from apartments decreased to $29.1 million in 2002 from $41.2 million in 2001. Apartment rents decreased in 2002 as a result of the sale of 17 apartments in 2001. Rents are expected to decrease in 2003 as a result of continued property sales.
Property operations expense decreased to $67.7 million in 2002 from $76.6 million in 2001. Property operations expense for commercial properties increased to $17.8 million in 2002 from $15.9 million in 2001, hotel expense decreased to $23.9 million in 2002 from $25.2 million in 2001, land expense decreased to $6.0 million in 2002 from $8.6 million expense in 2001 and apartment expense decreased to $19.1 million in 2002 from $26.2 million in 2001. The increase in commercial property operation expense was primarily attributable to increased subleasing costs at three properties. The decrease in hotel operations expense was primarily due to a reduction in property improvement costs. The decrease in land operations expense was primarily due to the sale of 34 land parcels in 2001. The decrease in apartment property operations expense was primarily due to the sale of 17 apartments in 2001. Property operations expense is expected to decrease in 2003 as a result of continued property sales.
Pizza parlor sales and cost of sales increased to $36.7 million and $30.0 million in 2002 from $34.2 million and $27.9 million in 2001. The increases were primarily attributable to same-store sales increases of 7.9% in 2002 from 2001 levels. Pizza parlor gross margin in 2003 is expected to approximate 2002, unless costs change significantly.
Interest income of $3.1 million in 2002 approximated the $2.8 million income in 2001. Interest income is expected to increase in 2003 as a result of the new notes from property sales in late 2002.
Equity in loss of investees decreased to $(20.9) million in 2002, from $(13.4) million in 2001. The decrease was primarily attributable to increased net losses, before gains on sale of real estate, for TCI and IORI in 2002. See NOTE 6. "INVESTMENTS IN EQUITY INVESTEES."
Loss on sale of investments in equity investees improved to $(286,000) in 2002 from $(387,000) in 2001. In 2002, loss on the sale of Villas Continental Apartments was recognized. In 2001, loss on the sale of TCI common stock was recognized.
Equity in gain on sale of real estate by equity investees increased to $24.1 million in 2002, from $22.5 million in 2001. The 2002 results are reported as a component of net income (loss) from discontinued operations, and the 2001 results are reported as a component of net income (loss) from continuing operations. See NOTE 6. "INVESTMENTS IN EQUITY INVESTEES."
Other income increased to $5.4 million in 2002 from a loss of $369,000 in 2001. The increase was primarily due to $2.2 million received in settlement of a lawsuit against a brokerage firm for improper sales in 2000 of TCI common stock owned by ARI and held by the brokerage firm, and $1.4 million received as partial settlement of a lawsuit against a lender for improperly attempting to seize, in 1996, a mortgage note receivable due to ARI. ARI sold the note to BCM in 1999, with the provision that any settlement received in excess of the amount paid by BCM, plus accrued interest, would be returned to ARI.
Interest expense decreased to $57.7 million in 2002 from $65.0 million expense in 2001. The decrease is primarily attributable to property sales in 2002 and 2001. Also in 2002, ARI recognized a $912,000 loss on an interest rate swap contract. See NOTE 21. "DERIVATIVE FINANCIAL INSTRUMENTS."
Depreciation and amortization decreased to $10.2 million in 2002 from $11.7 million in 2001. The decrease was primarily attributable to the sale of properties in 2002 and 2001. Depreciation and amortization expense should decrease in 2003 as a result of continued property sales.
General and administrative expenses of $12.5 million in 2002 approximated the $12.7 million in 2001. General and administrative expenses in 2003 are expected to approximate 2002.
Advisory fees decreased to $5.9 million in 2002 from $6.7 million in 2001. The decrease was attributable to the decrease in ARI's gross assets, the basis for such fee. Advisory fees are expected to decrease in 2003, as ARI's gross asset base is expected to decrease through property sales.
There was no net income fee to affiliate in 2002, compared to $166,000 in 2001. The net income fee payable to ARI's advisor is 10% of the net income for the year, in excess of a 10% return on shareholders' equity. For 2002, ARI's net income was below the 10% return threshold.
There was no incentive fee to affiliate in 2002, compared to $3.8 million in 2001. The incentive fee is only due if ARI is also subject to the net income fee. For 2002, the net income fee requirements were not met; therefore, no incentive fee was due. This fee represents 10% of the excess of net capital gains over net capital losses from sales of operating properties. The amount of the fee, if any, in 2003 will be dependent on the operating properties sold and net capital gains realized.
Writedown of assets held for sale increased to $4.2 million in 2002, from $2.5 million in 2001. In 2002, the carrying values of a shopping center in Fort Worth, Texas, sold in the fourth quarter of 2002 and an 89.3 acre tract of land in Palm Desert, California, sold in the first quarter of 2003, were reduced to their net realizable value. In 2001, the impairment of an asset was recognized.
Minority interest increased to $1.3 million in 2002 from $972,000 in 2001. Minority interest is the earnings attributable to owners other than ARI, of certain controlled entities. Minority interest in 2002 and 2001 was attributable, in part, to the preferred return limited partner units of Ocean Beach Partners, L.P., Valley Ranch, L.P., Grapevine American, L.P., Edina Park Plaza Associates, L.P. and Hawthorne Lakes Associations, L.P., ART Florida Portfolio III and ART Palm, L.L.C. In 2001, minority interest includes, in addition to the preferred returns discussed above, $(429,000) reflecting 20% minority interest in the net loss from the Grand Hotel Sofia.
Gains on sale of real estate decreased to $48.4 million in 2002 from $83.4 million in 2001. In 2002, gains of $28.7 million were recognized on the sale of 14 apartments: Conradi House, Daluce, Grand Lagoon, Lee Hills, Morning Star, Oak Hill, Pheasant Ridge, Pinecrest West, Regency, Stonebridge, Valley Hi, Villas, Westwood Parc and Woodsong; $3.4 million on the sale of two commercial properties: Melrose Business Park and Rosedale Towers; and $18.9 million on the sale of land: 171.1 acres of Desert Wells land, 8.8 acres of Eldorado Parkway land, three tracts totaling 45.4 acres of Elm Fork land, two tracts totaling 3.9 acres of Katrina land, five tracts totaling 69.7 acres of Mason Goodrich land, 61.0 acres of Monterrey land, 1.0 acre of Nashville land, 129.7 acres of Varner Road land and two tracts totaling 13.9 acres of Vista Ridge land. In 2002, losses of $2.6 million were recognized on the sale of Stonegate Apartments, Woodsong Apartments, 10.8 acres of Frisco Bridges land, 80.0 acres of Katrina land, and 0.2 acres of Thompson II land.
In 2001, gains of $73.5 million were recognized on the sale of 15 apartments: Rockborough, Carriage Park, Kimberly Woods, Place One, Shadowood, Bent Tree, Club Mar, Covered Bridge, Crossing at Church, Chalet I, Chalet II, Nora Pines, Timbercreek, Blackhawk, and Woodstock; $2.2 million on the sale of Regency Pointe Shopping Center; and $16.0 million on the sale of land: two tracts totaling 27.2 acres of Chase Oaks land, 10.0 acres of Elm Fork land, 27.8 acres of Frisco Bridges land, 1.7 acres of Las Colinas land, 22.1 acres of Mason Goodrich land, 4.2 acres of Nashville land, 5 tracts totaling 49.7 acres of Katrina land, 6.6 acres of Rasor land, 12.7 acres of Santa Clarita land, 232.8 acres of Scoggins land, 408.0 acres of Scout land, 10.4 acres of Tree Farm land, and 0.4 acres of Waters Edge Apartment land. In 2001, losses of $8.3 million were recognized on the sale of Glenwood Apartments, 12.0 acres of Plano Parkway land, 120.4 acres of Yorktown land, two tracts totaling 3.2 acres of Nashville land, Ashford Apartments, 6.7 acres of Santa Clarita land, 107.0 acres of Elm Fork land, and 27.4 acres of Vista Ridge land.
Net income from discontinued operations was $51.6 million in 2002 compared to net loss from discontinued operations of $(7.4) million in 2001. The net income (loss) relates to 23 properties and leasehold interests in oil and gas properties that ARI sold during 2002 and eight properties that ARI sold in 2003. The following table summarized revenue and expense information for the properties sold.
2001 Compared to 2000. ARI reported net income of $15.1 million in 2001 compared to $2.7 million in 2000. ARI's net income in 2001 included gains on the sale of real estate of $83.4 million compared to gains on the sale of real estate of $96.7 million in 2000. The primary factors contributing to ARI's net income are discussed in the following paragraphs.
Rents decreased to $101.9 million in 2001 from $120.6 million in 2000. Rent from commercial properties of $27.8 million in 2001 approximated the $28.7 million in 2000, rent from hotels decreased to $32.0 million in 2001 from $33.1 million in 2000 and rent from apartments decreased to $43.4 million in 2001 from $57.1 million in 2000. The decrease in rent from hotels was primarily attributable to reduced occupancy. Apartment rents decreased in 2001 as a result of the sale of nine apartments in 2000 and 17 apartments in 2001.
Property operations expense decreased to $76.6 million in 2001 from $81.4 million in 2000. Property operations expense for commercial properties of $15.9 million in 2001 approximated the $16.1 million expense in 2000, hotel expense increased to $25.2 million in 2001 from $24.1 million in 2000, land expense decreased to $8.6 million in 2001 from $9.7 million expense in 2000 and apartment expense decreased to $26.2 million in 2001 from $31.3 million in 2000. The increase in hotel operations expense was primarily due to property improvement costs. The decrease in land operations expense was primarily due to the sale of 26 land parcels in 2000 and 34 land parcels in 2001. The decrease in apartment property operations expense was primarily due to the sale of nine apartments in 2000 and 17 apartments in 2001.
Pizza parlor sales and cost of sales were $34.2 million and $27.9 million in 2001 and $32.6 million and $26.8 million, in 2000. Pizza parlor operations gross margin in 2001 increased over the gross margin in 2000 primarily due to reduced interest costs after refinancing debt in 2001 and reduced occupancy costs.
Interest income of $2.8 million in 2001 approximated the $3.0 million income in 2000.
Equity in loss of investees decreased to $(13.4) million in 2001, from $(4.6) million in 2000. The decrease was primarily attributable to increased net losses, before gains on sale of real estate, for TCI and IORI in 2001. See NOTE 6. "INVESTMENTS IN EQUITY INVESTEES."
Loss on sale of investments in equity investees improved to $(387,000) in 2001, from $(8.7) million in 2000. In 2001, loss on sale of TCI common stock was recognized. In 2000, losses include $(7.6) million on sale of TCI stock, $(246,000) on sale of IORI common stock and $(872,000) on the sale of Vestavia Lakes Apartments.
Equity in gain on sale of real estate by equity investees increased to $22.5 million in 2001, from $18.6 million in 2000. See NOTE 6. "INVESTMENTS IN EQUITY INVESTEES."
Other income improved to a loss of $369,000 in 2001 from a loss of $926,000 in 2000. The increase was primarily due to a reduction in losses on the sale of marketable securities.
Interest expense decreased to $65.0 million in 2001 from $66.5 million expense in 2000. The decrease was primarily attributable to the sale of land parcels and apartments in 2001 and 2000.
Depreciation and amortization decreased to $11.8 million in 2001 from $12.9 million in 2000. The decrease was primarily attributable to the sale of nine apartments in 2000 and 17 apartments in 2001.
General and administrative expenses decreased to $12.7 million in 2001 from $17.1 million in 2000. The decrease was primarily attributable to a decrease in cost reimbursements to ARI's advisor.
Advisory fees increased to $6.7 million in 2001 from $5.9 million in 2000. The increase was attributable to the inclusion of NRLP assets in ARI's gross assets, the basis for such fee.
Net income fee to affiliate in 2001 was $166,000. The income fee payable to ARI's advisor is 10% of the net income for the year, in excess of a 10% return on shareholders' equity. No net income fee was paid in 2000.
Incentive fees increased to $3.8 million in 2001 from $1.6 million in 2000. The increase was attributable to 18 eligible sales in 2001 compared to four eligible sales in 2000. This fee represents 10% of the excess of net capital gains over net capital losses from sales of operating properties.
There was no provision for loss in 2001, compared to $2.0 million in 2000. In 2000, a litigation reserve was established, related to a breach of contract dispute.
Writedown of assets held for sale increased to $2.5 million in 2001, from $248,000 in 2000. In 2001, the impairment of an asset was recognized. In 2000, the carrying value of an 11.3 acre tract of land in Plano, Texas, sold in the first quarter of 2001, was reduced to its net realizable value.
Minority interest decreased to $972,000 in 2001 from $30.7 million in 2000. Minority interest is the earnings attributable to owners, other than ARI, of certain controlled entities. Minority interest in 2001 and 2000 was attributable, in part, to the preferred return limited partner units of Ocean Beach Partners, L.P., Valley Ranch, L.P., Grapevine American, L.P., Edina Park Plaza Associates, L.P. and Hawthorne Lakes Associations, L.P., ART Florida Portfolio III and ART Palm, L.L.C. In 2000, minority interest includes, in addition to the preferred returns discussed above, $29.8 million of earnings attributable to the limited partners in NRLP prior to the merger. Minority interest in 2001 declined due to the 2000 acquisition of NRLP by ARI.
Gains on sale of real estate decreased to $83.4 million in 2001 from $96.7 million in 2000. In 2001, gains of $73.5 million were recognized on the sale of 15 apartments: Rockborough, Carriage Park, Kimberly Woods, Place One, Shadowood, Bent Tree, Club Mar, Covered Bridge, Crossing at Church, Chalet I, Chalet II, Nora Pines, Timbercreek, Blackhawk, and Woodstock; $2.2 million on the sale of Regency Pointe Shopping Center; and $16.0 million on the sale of land: two tracts totaling 27.2 acres of Chase Oaks land, 10.0 acres of Elm Fork land, 27.8 acres of Frisco Bridges land, 1.7 acres of Las Colinas land, 22.1 acres of Mason Goodrich land, 4.2 acres of Nashville land, 5 tracts totaling 49.7 acres of Katrina land, 6.6 acres of Rasor land, 12.7 acres of Santa Clarita land, 232.8 acres of Scoggins land, 408.0 acres of Scout land, 10.4 acres of Tree Farm land, and 0.4 acres
of Waters Edge Apartment land. In 2001, losses of $8.3 million were recognized on the sale of Glenwood Apartments, 12.0 acres of Plano Parkway land, 120.4 acres of Yorktown land, two tracts totaling 3.2 acres of Nashville land, Ashford Apartments, 6.7 acres of Santa Clarita land, 107.0 acres of Elm Fork land, and 27.4 acres of Vista Ridge land.
In 2000, gains of $45.9 million were recognized on the sale of nine apartments: Summerwind, Windtree, The Pines, Whispering Pines, Four Seasons, Sherwood Glen, Fair Oaks, Hidden Valley and Candlelight Square; $21.9 million on the sale of commercial properties: Katella Plaza, Marina Playa, Harbor Plaza and Preston Center; and $30.6 million on the sale of land: 420 acres of Duchesne land, three tracts totaling 166.7 acres of Frisco Bridges land, 749.1 acres of Keller land, 0.02 acres of Katy land, four tracts totaling 41.2 acres of Mason/Goodrich land, 157.9 acres of Mastenbrook land, 82.0 acres of McKinney Corners I, II, III, IV and V land, 20.67 acres of Monterey land, four tracts totaling 8.69 acres of Nashville land, 182.5 acres of Pantex land, two tracts totaling 329.4 acres of Parkfield land, three tracts totaling 89.51 acres of Rasor land, 80.4 acres of Rowlett Creek land, 3.0 acres of Salmon River land, 126.6 acres of Vann Cattle land, 5.4 acres of Vista Business Park land, and 70.3 acres of Wakefield land. In 2000, losses of $1.6 million were recognized on the sale of 14.6 acres of McKinney Corners II land, 377.15 acres of Pioneer Crossing land, 4.79 acres of Plano Parkway land, 22.4 acres of Valley Ranch land, and 36.43 acres of Vista Business Park land.
Loss from discontinued operations improved to $(7.4) million in 2001 from $(9.3) million in 2000. The loss relates to 23 properties and leasehold interests in oil and gas properties that ARI sold during 2002 and eight properties that ARI sold in 2003. The following table summarized revenue and expense information for the properties sold.
Related Party Transactions
Historically, ARI, TCI, IORI and BCM have each engaged in and may continue to engage in business transactions, including real estate partnerships, with related parties. Management believes that all of the related party transactions represented the best investments available at the time and were at least as advantageous to ARI as could have been obtained from unrelated parties.
Operating Relationships
In October 1997, ARI entered into leases with BCM and an affiliate of BCM for space at the One Hickory Centre Office Building, construction of which was completed in December 1998. The BCM leases, effective upon ARI obtaining permanent financing of the building, were for 75,852 sq.ft. (approximately 75% of the building), had terms of ten and fifteen years and provided for annual base rent of $19.25 per sq.ft. for the first year. In January 2001, both leases were terminated, and ARI entered into a new lease with BCM, effective October 1, 2000. The new lease is for 59,463 sq.ft. (approximately 62% of the building), has a term of three years, and provides for annual base rent of $1.3 million or $21.50 per sq.ft. Effective March 1, 2002, the lease was amended to 57,879 sq.ft. (approximately 59% of the building), with an annual base rent of $1.2 million, or $21.50 per sq.ft. In April 2002, ARI sold the subsidiary which owns the building to TCI.
In 2002, ARI paid BCM, its affiliates and a related party $5.9 million in advisory fees, $689,000 in mortgage brokerage and equity refinancing fees, $13,000 in property acquisition fees, $5.4 million in real estate brokerage commissions, $1.9 million in construction supervision fees and $4.2 million in property and construction management fees and leasing commissions, net of property management fees paid to subcontractors, other than affiliates of BCM. In addition, as provided in the Advisory Agreement, BCM received cost reimbursements of $2.5 million.
Partnership Transactions
BCM has entered into put agreements with certain holders of the Class A limited partner units of Ocean Beach Partners, L.P. The Class A units are convertible into Series D Cumulative Preferred Stock of ARI. The put price of the Series D Preferred Stock is $20.00 per share plus accrued but unpaid dividends.
BCM entered into put agreements with the holders of the Class A limited partner units of Valley Ranch, L.P. Such Class A units were convertible into Series B Cumulative Convertible Preferred Stock of ARI which was further convertible into Common Stock of ARI. The put price for the Class A units was $1.00 per unit and the put price for either the Series B Preferred Stock or ARI's Common Stock was 80% of the average daily closing price of ARI's Common Stock for the prior 20 trading days. In March 1999, ARI reached agreement with the Class A unitholders of Valley Ranch, L.P. to acquire their eight million Class A units for $1.00 per unit. In 1999, three million units were purchased. Additionally, one million units were purchased in January 2000 and two million units were purchased in May 2001. ARI purchased the remaining two million units in 2002.
BCM has entered into put agreements with the holders of the Class A units of ART Palm, L.P. Such Class A units are convertible into Series C Cumulative Convertible Preferred Stock of ARI. The put price for the Class A units is $1.00 per unit and the put price for either the Series C Preferred Stock or ARI's Common Stock is 90% of the average daily closing price of ARI's Common Stock for the prior 20 trading days. The put agreement calls for ARI to repurchase the outstanding Class A units as follows: June 30, 2003, 1,625,000 units; December 31, 2005, 1,625,000 units; and December 31, 2006, 8,563,750 units.
Advances and Loans
From time-to-time, ARI and its affiliates have made advances to each other, which have not had specific repayment terms, do not bear interest, are unsecured and have been reflected in ARI's financial statements as other assets or other liabilities. At December 31, 2002, after accounting for affiliate purchases and sales, amounts still owed by ARI were $26.6 million, $6.6 million, $3.5 million and $2.7 million to BCM, TCI, IORI and Regis, respectively.
In March 2000, a loan with a current principal balance of $2.6 million to Lordstown, L.P., matured. The loan, to provide funds to purchase for resale various parcels of land, is secured by a second lien on land in Ohio and Florida, by 100% of the general and limited partner interest in Partners Capital, Ltd., the limited partner of Lordstown, L.P., and a profits interest in subsequent land sales. At December 2002, the loan, and $1.1 million of accrued interest, remained unpaid. A corporation controlled by Richard D. Morgan is the general partner of Lordstown, L.P. Mr. Morgan served as a director of ARI until October 2001.
In October 1999, ARI funded a $4.7 million loan to Realty Advisors, Inc., an affiliate. The loan, to provide funds for acquisitions or working capital needs, was secured by all of the outstanding shares of common stock of American Reserve Life Insurance Company. The loan bore interest at 10.25% per annum, and matured in November 2001. In January 2000, $100,000 was collected. In November 2001, the maturity date was extended to November 2004. The collateral was changed to a subordinate pledge of 850,000 shares of ARI Common Stock owned by BCM. The shares are also pledged to a lender on ARI's behalf. The interest rate was changed to 2% over the prime rate, currently 6.25% per annum, and the accrued but unpaid interest of $984,000 was added to the principal. The new principal balance is $5.6 million. All principal and accrued interest are due at maturity.
In December 2000, an unsecured loan with a current principal balance of $1.8 million to Warwick of Summit, Inc. ("Warwick") matured. The loan was made to provide funds to purchase, renovate and expand a shopping center property in Warwick, Rhode Island. All principal and interest were due at maturity. At December 2002, the loan, and $188,000 of accrued interest, remained unpaid. Richard D. Morgan, a Warwick shareholder, served as a director of ARI until October 2001.
In December 2000, a loan with a current principal balance of $1.6 million to Bordeaux Investments Two, L.L.C. ("Bordeaux"), matured. The loan, to provide funds to purchase and renovate a shopping center in Oklahoma City, Oklahoma, is secured by (1) a 100% interest in Bordeaux, which owns a shopping center in Oklahoma City, Oklahoma; (2) 100% of the stock of Bordeaux Investments One, Inc., which owns 6.5 acres of undeveloped land in Oklahoma City, Oklahoma; and (3) the personal guarantees of the Bordeaux members. At December 2002, the loan, and $710,000 of accrued interest, remained unpaid. Richard D. Morgan, a Bordeaux member, served as a director of ARI until October 2001.
In March 2001, ARI funded $13.6 million of a $15.0 million unsecured line of credit to One Realco Corporation ("One Realco"), which owns approximately 14.7% of the outstanding shares of ARI's Common Stock. One Realco periodically borrows money to meet its cash obligations. The line of credit bears interest at 12.0% per annum. All principal and interest were due at maturity in February 2002. The line of credit is guaranteed by BCM. In June 2001, $394,000 in principal and $416,000 in interest was collected. In December 2001, $21,000 in principal and $804,000 in interest was collected. In February 2002, the line of credit was increased to $18.0 million, accrued but unpaid interest of $217,000 was added to the principal and the maturity date was extended to February 2004. In March 2002, ARI funded an additional $1.8 million, increasing the outstanding principal balance to $15.5 million. In October 2002, $856,900 in interest was collected, by the return of 85,690 shares of ARI Series A Preferred Stock. All principal and interest are due at maturity. Ronald E. Kimbrough, Acting Principal Executive Officer, Executive Vice President and Chief Financial Officer of ARI, is a 10% shareholder of One Realco. During 2001 and 2002, Mr. Kimbrough did not participate in day-to-day operations or management of One Realco.
In June 2002, ARI converted $4.5 million of its receivable from BCM to a recourse note receivable. This transaction was to provide ARI with additional security over that provided by an unsecured receivable. The note bears interest at 10.0% per annum, matures in March 2004 and requires quarterly payments of principal and accrued interest, beginning in December 2002.
Property Transactions
In May 2001, ARI exchanged with TCI two parcels of land, a 10.5 acre tract of Vista Ridge land and an 8.88 acre tract of Hollywood Casino land, for the 168 unit Glenwood Apartments. The business purpose of the transaction was for TCI to construct apartments on the Vista Ridge land and office buildings on the Hollywood Casino land and for ARI to obtain a property that could be sold for cash. ARI received net cash of $3.2 million on the subsequent sale of the apartments. See NOTE 2. "REAL ESTATE."
In December 2001, TCI purchased 100% of the outstanding common shares of National Melrose, Inc. ("NM"), a wholly-owned subsidiary of ARI, for $2.0 million. The purpose of the transaction was for TCI to make an equity investment, anticipating a profitable return, in NM and for ARI to receive cash for its equity investment. NM owns the Executive Court Office Building. ARI has guaranteed that the asset will produce at least a 12% annual return on the purchase price for a period of three years from the purchase date. If the asset fails to produce the annual return, ARI will pay TCI any shortfall. In addition, if the asset fails to produce the 12% return for a calendar year, TCI may require ARI to repurchase the shares of NM for the purchase price. The purchase price was determined based upon the market value of the property exchanged, using a market rate multiple of net operating income. Management has classified this related party transaction as a note payable to TCI.
In January 2002, IORI purchased 100% of the outstanding common shares of Rosedale Corporation ("Rosedale"), a wholly-owned subsidiary of ARI, for $5.1 million. The purchase price was determined based upon the market value of the property exchanged, using a market rate multiple of net operating income. Rosedale owned the Rosedale Towers Office Building. ARI guaranteed that the asset would produce at least a 12% annual return on the purchase price for a period of three years from the purchase date. If the asset failed to produce the 12% return, ARI would pay IORI any shortfall. In addition, if the asset failed to produce the 12% return for a calendar year, IORI could require ARI to repurchase the shares of Rosedale for the purchase price. The business purpose of the transaction was for IORI to make an equity investment in Rosedale, anticipating a profitable return, and for ARI to receive cash for its equity investment. Management classified this related party transaction as a note payable to IORI. IORI sold the Rosedale Towers Office Building to an unrelated buyer in December 2002. ARI owes $2.1 million to IORI for remaining principal and 12% return.
In January 2002, TCI purchased 100% of the common shares of ART Two Hickory Corporation ("Two Hickory"), a wholly-owned subsidiary of ARI, for $4.4 million. The purchase price was determined based upon the market value of the property exchanged, using a market rate multiple of net operating income. Two Hickory owns the Two Hickory Centre Office Building. ARI has guaranteed that the asset will produce at least a 12% annual return on the purchase price for a period of three years from the purchase date. If the asset fails to produce the 12% return, ARI will pay TCI any shortfall. In addition, if the asset fails to produce the 12% return for a calendar year, TCI may require ARI to repurchase the shares of Two Hickory for the purchase price. The business purpose of the transaction was for TCI to make an equity investment in Two Hickory, anticipating a profitable return, and for ARI to receive cash for its equity investment. Management has classified this related party transaction as a note payable to TCI.
In March 2002, ARI received $520,000 and exchanged with TCI a 24.5 acre tract of Rasor land, a 16.89 acre tract of Lakeshore Villas Apartments land and the 45,623 sq.ft. Oaktree Village Shopping Center for the 80,278 sq.ft. Plaza on Bachman Creek Shopping Center. The exchange value prices for the shopping centers were determined using a market rate multiple of net operating income, and the values of the land parcels were determined using appraised rates. The business purpose of the transaction was for TCI to construct apartments on the Rasor and Lakeshore Villas land. To give ample value for the property TCI exchanged, the Oaktree Village Shopping Center was added to the transaction. ARI received $4.4 million on the subsequent financing of the shopping center.
In April 2002, TCI purchased all of the general and limited partnership interest in Garden Confederate Point, L.P. ("Confederate Point") from ARI for $1.9 million. The purchase price was determined based on the market value of the property exchanged using a market rate multiple of net operating income. Confederate Point owns the Confederate Point Apartments. ARI has guaranteed that the asset will produce at least a 12% annual return on the purchase price for a period of three years from the purchase date. If the asset fails to produce the 12% return for a calendar year, TCI may require ARI to repurchase the interests in Confederate Point for the purchase price. The business purpose of this transaction was for TCI to make an equity investment in Confederate Point anticipating a profitable return and to reduce ARI's payable to BCM. Management has classified this related party transaction as a note payable to TCI. Failure to notify and receive approval from the lender for this transaction may constitute an event of default under the terms of the debt assumed by TCI.
In April 2002, TCI purchased all of the general and limited partnership interests in Garden Foxwood, L.P. ("Foxwood") from ARI for $1.1 million. The purchase price was determined based on the market values of the property exchanged, using a market rate multiple of net operating income. Foxwood owns the Foxwood Apartments. ARI has guaranteed that the asset will produce at least a 12% annual return on the purchase price for a period of three years from the purchase date. If the asset fails to produce the 12% return, ARI will pay TCI any shortfall. In addition, if the asset fails to produce the 12% return for a calendar year, TCI may require ARI to repurchase the interests in Foxwood for the purchase price. The business purpose for the transaction was for TCI to make an equity investment in Foxwood anticipating a profitable return and to reduce ARI's payable to BCM. Management has classified this related party transaction as a note payable to TCI. Failure to notify and receive
approval from the lender for this transaction may constitute an event of default under the terms of the debt assumed by TCI.
In April 2002, TCI purchased all of the general and limited partnership interests in Garden Woodsong, L.P. ("Woodsong") from ARI for $2.5 million. The purchase price was determined based on the market value of the property exchanged, using a market rate multiple of net operating income. Woodsong owns the Woodsong Apartments. ARI has guaranteed that the asset will produce at least a 12% annual return on the purchase price for a period of three years from the purchase date. If the asset fails to produce the 12% return, ARI will pay TCI any shortfall. In addition, if the asset fails to produce the 12% return for a calendar year, TCI may require ARI to repurchase the interests in Woodsong for the purchase price. The business purpose for the transaction was for TCI to make an equity investment in Woodsong anticipating a profitable return and to reduce ARI's payable to BCM. Management has classified this related party transaction as a note payable to TCI. In July 2002, the Woodsong Apartments was sold for $9.1 million. TCI received $2.6 million from the proceeds of $2.8 million as payment of principal and accrued but unpaid interest on the loan.
In April 2002, TCI purchased 100% of the common shares of ARI One Hickory Corporation ("One Hickory"), a wholly-owned subsidiary of ARI, for $4.5 million. The purchase price was determined based on the market value of the property exchanged, using a market rate multiple of net operating income. One Hickory owns the One Hickory Centre Office Building. ARI has guaranteed that the asset will produce at least a 12% annual return on the purchase price for a period of three years from the purchase date. If the asset fails to produce the 12% return, ARI will pay TCI any shortfall. In addition, if the asset fails to produce the 12% return for a calendar year, TCI may require ARI to repurchase the interests in One Hickory for the purchase price. The business purpose for the transaction was for TCI to make an equity investment in One Hickory anticipating a profitable return and to reduce ARI's payable to BCM. Management has classified this related party transaction as a note payable to TCI. Failure to notify and receive approval from the lender for this transaction may constitute an event of default under the terms of the debt assumed by TCI.
In June 2002, TCI purchased Centura Tower, Ltd. partnership, which owns the Centura Tower Office Building, from ARI for $50.0 million. See NOTE 2. "REAL ESTATE." The purchase price for the Centura Tower was determined based on appraised value and replacement cost. The business purpose of the transaction was for TCI to acquire a Class A office building with significant upside potential anticipating a profitable return and for ARI to satisfy debt.
In June 2002, TCI purchased five parcels of unimproved land from ARI for $30.0 million: the Hollywood Casino, Marine Creek, Mason Park, Nashville and Monterrey land parcels. See NOTE 2. "REAL ESTATE." The purchase price of the Hollywood Casino land was determined based on an appraised value of $9.10 per square foot. The business purpose of the transaction was for TCI to consolidate its holdings within the Mercer Crossing development. The purchase price for the Marine Creek, Mason Park, Nashville and Monterrey land parcels was determined based on appraised rates. The business purpose of the transaction was for TCI to develop apartments on these four tracts of land and for ARI to satisfy debt. Failure to notify and receive approval from the lender for this transaction may constitute an event of default under the terms of the debt assumed by TCI.
In June 2002, ARI purchased all the general and limited partnership interests in Chalet North, L.P. ("Chalet North") from BCM for $3.0 million. Chalet North owns the Pinecrest Apartments. The purchase price was determined based on the market value of the property exchanged, using a market rate multiple of net operating income. ARI assumed debt of $1.4 million. ARI's receivable from BCM was reduced by $1.6 million, and no cash was paid by ARI. The business purpose of the transaction was to reduce the affiliate payable owed by BCM to ARI.
In June 2002, ARI purchased the Tiberon Trails Apartments from BCM for $12.3 million. The purchase price was determined based on the market value of the property exchanged, using a market rate multiple of net operating income. ARI assumed debt of $6.4 million. ARI's receivable from BCM was reduced by $5.9 million,
and no cash was paid by ARI. The business purpose of the transaction was to reduce the affiliate payable owed by BCM to ARI.
In June 2002, ARI purchased the Alta Mesa Shopping Center from BCM for $3.8 million. The purchase price was determined based on the market value of the property exchanged, using a market rate multiple of net operating income. ARI assumed debt of $1.8 million. ARI's receivable from BCM was reduced by $2.0 million, and no cash was paid by ARI. The business purpose of the transaction was to reduce the affiliate payable owed by BCM to ARI.
On June 30, 2002, ARI obtained 74.31% interest in RAK from BCM for $6.0 million. The business purpose of the transaction was to reduce the affiliate payable owed by BCM to ARI. ARI's receivable from BCM was reduced by $6.0 million, and no cash was paid by ARI. At the date of the acquisition, RAK's assets consisted of $2.3 million in cash, $3.0 million in deposits and marketable securities, and $225,000 in other assets. RAK's net equity was $5.5 million. ARI recorded $1.9 million in goodwill as a result of this transaction.
In December 2002, ARI sold the Lakeshore Villas Apartments to Housing for Seniors of Humble, LLC ("Humble"), a related party, for $22.0 million, paying $764,000 after payment of closing costs and debt paydown and providing purchase money financing of $8.4 million. One loan has a principal amount of $2.0 million. The loan is unsecured, and is guaranteed by Unified Housing Foundation, Inc. ("Unified"), a related party. The second loan has a principal amount of $6.4 million, and is secured by a pledge by Unified of 100% of the Member Interest in Humble. Both loans bear interest at 11.5% per annum, mature in December 2009 and require quarterly payments beginning in March 2003. Richard W. Humphrey, a director of ARI, is the President of Humble and the President and Treasurer of Unified. Ted P. Stokely, Chairman of the Board and a director of ARI, is the General Manager of Unified.
In December 2002, TCI purchased the NLP/CH, Ltd. partnership, which owns the Centura Holdings, Clark and Woolley land parcels, from ARI for $13.3 million. See NOTE 2. "REAL ESTATE." The purchase price was determined based on an appraised rate of $34.89 per share foot. The business purpose of the transaction was for TCI to construct apartments on the land and for ARI to satisfy debt.
In March 2003, TCI purchased the Bridgeview Plaza and Cullman shopping centers from ARI for $8.7 million and $2.0 million, respectively. The business purpose of the transaction was for ARI to satisfy debt. The purchase price was determined using a market rate multiple of net operating income.
Environmental Matters
Under various federal, state and local environmental laws, ordinances and regulations, ARI may be potentially liable for removal or remediation costs, as well as certain other potential costs relating to hazardous or toxic substances (including governmental fines and injuries to persons and property) where property-level managers have arranged for the removal, disposal or treatment of hazardous or toxic substances. In addition, certain environmental laws impose liability for release of asbestos-containing materials into the air, and third parties may seek recovery for personal injury associated with such materials.
Management is not aware of any environmental liability relating to the above matters that would have a material adverse effect on ARI's business, assets or results of operations.
Inflation
The effects of inflation on ARI's operations are not quantifiable. Revenues from property operations tend to fluctuate proportionately with inflationary increases and decreases in housing costs. Fluctuations in the rate of inflation also affect the sales values of properties and the ultimate gains to be realized from property sales. To the extent that inflation affects interest rates, earnings from short-term investments and the cost of new financings as well as the cost of variable interest rate debt will be affected.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES REGARDING MARKET RISK
ARI's future operations, cash flow and fair values of financial instruments are partially dependent upon the then existing market interest rates and market equity prices. Market risk is the changes in the market rates and prices and the affect of the changes on the future operations. Market risk is managed by matching a property's anticipated net operating income to an appropriate financing.
The following table contains only those exposures that existed at December 31, 2002. Anticipation of exposures of risk on positions that could possibly arise was not considered. ARI's ultimate interest rate risk and its effect on operations will depend on future capital market exposures, which cannot be anticipated with a probable assurance level. Dollars in thousands.
ITEM 8.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
All other schedules are omitted because they are not required, are not applicable or the information required is included in the Consolidated Financial Statements or the notes thereto.
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors of American Realty Investors, Inc.
We have audited the accompanying consolidated balance sheets of American Realty Investors, Inc. and Subsidiaries as of December 31, 2002 and 2001 and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2002. We have also audited the schedules listed in the accompanying index. These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and schedules are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and schedules. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedules. We believe our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of American Realty Investors, Inc. and Subsidiaries as of December 31, 2002 and 2001, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America.
Also, in our opinion, the schedules referred to above present fairly, in all material respects, the information set forth therein.
As described in Note 20, American Realty Investors, Inc.'s management has indicated its intent to sell both land and operating properties and refinance or extend debt coming due, to meet its liquidity needs.
As discussed in Note 1, ARI adopted the provisions of SFAS 144, Accounting for Impairment of Long Lived Assets, in 2001.
As discussed in Note 24, ARI adopted the provision of SFAS 142, Goodwill and Other Intangible Assets, in 2002.
BDO SEIDMAN, LLP
Dallas, Texas April 11, 2003
AMERICAN REALTY INVESTORS, INC.
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these Consolidated Financial Statements.
AMERICAN REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Options to purchase 105,750, 183,750 and 210,750 shares of ARI's Common Stock were excluded from the computation of diluted earnings per share for 2002, 2001 and 2000, respectively, because the effect of their inclusion would be antidilutive.
The accompanying notes are an integral part of these Consolidated Financial Statements.
AMERICAN REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
The accompanying notes are an integral part of these Consolidated Financial Statements.
AMERICAN REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these Consolidated Financial Statements.
AMERICAN REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS--(Continued)
The accompanying notes are an integral part of these Consolidated Financial Statements.
AMERICAN REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS--(Continued)
The accompanying notes are an integral part of these Consolidated Financial Statements.
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The accompanying Consolidated Financial Statements of American Realty Investors, Inc. and consolidated subsidiaries have been prepared in conformity with accounting principles generally accepted in the United States of America, the most significant of which are described in NOTE 1. "SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES." These, along with the remainder of the Notes to Consolidated Financial Statements, are an integral part of the Consolidated Financial Statements. The data presented in the Notes to Consolidated Financial Statements are as of December 31 of each year and for the year then ended, unless otherwise indicated. Dollar amounts in tables are in thousands, except per share amounts.
Certain balances for 2000 and 2001 have been reclassified to conform to the 2002 presentation.
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and business. In November 1999, American Realty Investors, Inc. ("ARI"), a Nevada corporation, was formed, and in August 2000, ARI acquired American Realty Trust, Inc. ("ART"), a Georgia corporation and National Realty, L.P. ("NRLP"), a Delaware partnership that primarily invests in real estate and real estate-related entities and purchases and originates mortgage loans.
The acquisition of ART and NRLP by ARI was completed on August 2, 2000. NRLP unitholders, except for ART, received one share of ARI Common Stock for each unit of NRLP held. ART stockholders received .91 shares of ARI Common Stock for each share of ART Common Stock held. Each share of ART Preferred Stock was converted into one share of Preferred Stock of ARI, having substantially the same rights as ART's Preferred Stock. The ART shares of Common Stock ceased trading on the New York Stock Exchange on August 2, 2000. The NRLP units of limited partner interest ceased trading on the American Stock Exchange on August 2, 2000. ARI Common Stock commenced trading on the New York Stock Exchange on August 3, 2000.
On October 23, 2001, ARI, Transcontinental Realty Investors, Inc. ("TCI"), and Income Opportunity Realty Investors, Inc. ("IORI") jointly announced a preliminary agreement with the plaintiff's legal counsel of the derivative action entitled Olive et al. V. National Income Realty Trust, et al. for complete settlement of all disputes in the lawsuit (the "Olive Litigation"). In February 2002, the court granted final approval of the proposed settlement (the "Olive Settlement"). Under the Olive Settlement, ARI agreed to either (i) acquire all of the outstanding shares of IORI and TCI not currently owned by ARI for a cash payment or shares of ARI preferred stock or (ii) make a tender offer for all of the outstanding shares of IORI and TCI not currently owned by ARI. On November 15, 2002, ARI commenced the tender offer for the IORI and TCI shares. The tender offer was completed on March 19, 2003. ARI paid $19.00 cash per IORI share and $17.50 cash per TCI share for the stock held by non-affiliated stockholders. Pursuant to the tender offer, ARI acquired 265,036 IORI shares and 1,213,226 TCI shares. The completion of the tender offer fulfills the obligations under the Olive Settlement and the Olive Litigation has been dismissed with prejudice. ARI has the same advisor as TCI and IORI, and TCI and IORI have the same board of directors. Two of the directors of TCI and IORI also serve as directors of ARI.
Basis of consolidation. The Consolidated Financial Statements include the accounts of ARI, and all controlled subsidiaries and partnerships. All significant intercompany transactions and balances have been eliminated.
Accounting estimates. In the preparation of these Consolidated Financial Statements, in conformity with accounting principles generally accepted in the United States of America it is necessary for management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the Consolidated Financial Statements and the reported amounts of revenues and expense for the year then ended. Actual results could differ materially from these estimates.
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Nonperforming notes receivable. ARI considers a note receivable to be nonperforming when the maturity date has passed without principal repayment and the borrower is not making interest payments. Any new note receivable that results from a modification or extension of a note considered nonperforming will also be considered nonperforming, without regard to the borrower's adherence to payment terms.
Interest recognition on notes receivable. Interest income is not recognized on notes receivable that have been delinquent for 60 days or more. In addition, accrued but unpaid interest income is only recognized to the extent that the net realizable value of the underlying collateral exceeds the carrying value of the receivable.
Allowance for estimated losses. A valuation allowance is provided for estimated losses on notes receivable considered to be impaired. Impairment is considered to exist when it is probable that all amounts due under the terms of the note will not be collected. Valuation allowances are provided for estimated losses on notes receivable to the extent that the investment in the note exceeds management's estimate of fair value of the collateral securing such note.
Recent Accounting pronouncements. In April 2002, the FASB issued Statement 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Correction" ("SFAS No. 145"). Statement 4, "Reporting Gains and Losses from Extinguishment of Debt" ("SFAS No. 4"), required that gains and losses from the extinguishment of debt that were included in the determination of net income be aggregated and, if material, classified as an extraordinary item. The provisions of SFAS No. 145 related to the rescission of SFAS No. 4 will require ARI to reclassify prior period items that do not meet the extraordinary classification. The provisions of SFAS No. 145 that relate to the rescission of SFAS No. 4 become effective in fiscal years beginning after May 15, 2002. The adoption of SFAS No. 145 is not expected to have a material impact on the consolidated financial position or results of operations of ARI.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which addresses accounting for restructuring and similar costs. SFAS No. 146 supersedes previous accounting guidance, principally Emerging Issues Task Force ("EITF") Issued 94-3. ARI will adopt the provisions of SFAS No. 146 for restructuring activities initiated after December 31, 2002. SFAS No. 146 requires that the liability costs associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF No. 94-3, a liability for an exit cost was recognized at the date of a company's commitment to an exit plan. SFAS No. 146 also established that the liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing future restructuring costs as well as the amount recognized.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation, Transition and Disclosure, an amendment of FASB No. 123." SFAS No. 148 provides alternative methods of transition for an entity that voluntarily changes to the fair value method of accounting for stock-based employee compensation. It also amends the disclosure provisions of SFAS No. 123 to require prominent disclosure about the effects on reported net income of an entity's accounting policy decisions with respect to stock-based employee compensation. Finally, this statements amends APB Opinion No. 28, "Interim Financial Reporting," to require disclosure about those effects in interim financial information. Management currently believes that the adoption of SFAS No. 148 will not have a material impact on the financial statements, as ARI will continue to account for stock-based compensation using the intrinsic value method.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others," which disclosures are effective for financial statements issued after December 15, 2002. While ARI has various guarantees included in
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
contracts in the normal course of business, these guarantees would not represent significant commitments or contingent liabilities of the indebtedness of entities outside of the consolidated company.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"), which requires the consolidation of variable interest entities, as defined. FIN 46 is applicable to financial statements to be issued by ARI after 2003; however, disclosures are required currently if ARI expects to consolidate any variable interest entities. ARI does not currently believe that any entities will be consolidated as a result of FIN 46.
Real estate held for investment and depreciation. Real estate held for investment is carried at cost. Statement of Financial Accounting Standards No. 144 ("SFAS No. 144") requires that a property be considered impaired, if the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the property. If impairment exists, an impairment loss is recognized, by a charge against earnings, equal to the amount by which the carrying amount of the property exceeds the fair value less cost to sell the property. If impairment of a property is recognized, the carrying amount of the property is reduced by the amount of the impairment, and a new cost for the property is established. Such new cost is depreciated over the property's remaining useful life. Depreciation is provided by the straight-line method over estimated useful lives, which range from five to 40 years.
Real estate held for sale. Foreclosed real estate is initially recorded at new cost, defined as the lower of original cost or fair value minus estimated costs of sale. SFAS No. 144 also requires that properties held for sale be reported at the lower of carrying amount or fair value less costs of sale. If a reduction in a held for sale property's carrying amount to fair value less costs of sale is required, a provision for loss is recognized by a charge against earnings. Subsequent revisions, either upward or downward, to a held for sale property's estimated fair value less costs of sale is recorded as an adjustment to the property's carrying amount, but not in excess of the property's carrying amount when originally classified as held for sale. A corresponding charge against or credit to earnings is recognized. Properties held for sale are not depreciated.
Investments in equity investees. ARI may be considered to have the ability to exercise significant influence over the operating and investment policies of certain of its investees. Those investees are accounted for using the equity method. Under the equity method, an initial investment, recorded at cost, is increased by a proportionate share of the investee's operating income and any additional investment and decreased by a proportionate share of the investee's operating losses and distributions received.
Present value premiums/discounts. Present value premiums and discounts are provided on notes receivable or payable that have interest rates that differ substantially from prevailing market rates and such premiums and discounts are amortized by the interest method over the lives of the related notes. The factors considered in determining a market rate for notes receivable include the borrower's credit standing, nature of the collateral and payment terms of the note.
Revenue recognition on the sale of real estate. Sales of real estate are recognized when and to the extent permitted by Statement of Financial Accounting Standards No. 66, "Accounting for Sales of Real Estate" ("SFAS No. 66"). Until the requirements of SFAS No. 66 for full profit recognition have been met, transactions are accounted for using either the deposit, the installment, the cost recovery, or the financing method, whichever is appropriate.
Operating segments. Management has determined reportable operating segments to be those that are used for internal reporting purposes, which disaggregates operations by type of real estate.
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Fair value of financial instruments. The following assumptions were used in estimating the fair value of its notes receivable, marketable equity securities and notes payable. For performing notes receivable, the fair value was estimated by discounting future cash flows using current interest rates for similar loans. For nonperforming notes receivable the estimated fair value of ARI's interest in the collateral property was used. For marketable equity securities fair value was based on the year end closing market price of each security. For notes payable the fair value was estimated using current rates for mortgages with similar terms and maturities.
Cash equivalents. For purposes of the Consolidated Statements of Cash Flows, all highly liquid investments purchased with an original maturity of three months or less are considered to be cash equivalents.
Earnings (loss) per share. Income (loss) per share is presented in accordance with Statement of Financial Accounting Standards No. 128, "Earnings Per Share". Income (loss) per share is computed based upon the weighted average number of shares of Common Stock outstanding during each year.
Employee stock option plans. Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees," and related Interpretations are utilized by management in accounting for the option plans. All share options issued have exercise prices equal to the market price of the shares at the dates of grant. Accordingly, no compensation cost has been recognized for the option plans. Had compensation cost for the option plans been determined based on the fair value at the grant dates consistent with the method of Statement of Financial Accounting Standards No. 123 "Accounting for Stock-Based Compensation," net income (loss) and net income (loss) per share would have been the pro forma amounts indicated below.
The fair value of each option is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
The weighted average fair value per share of options granted in 2002 was $6.08.
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 2. REAL ESTATE
In 2002, ARI purchased the following property:
- -------- (1) Property received from Basic Capital Management, Inc. ("BCM"), a related party, for forgiveness of debt. The purchase price was determined using a market rate multiple of net operating income. (2) Exchanged with Transcontinental Realty Investors, Inc. ("TCI"), a related party, for the Oaktree Village Shopping Center, Rasor land parcel and Lakeshore Villas land parcel. (3) Assumed debt of seller.
In 2001, ARI purchased the following property:
- -------- (1) 8.88 acres of Hollywood Casino land and 10.5 acres of Vista Ridge land given as consideration. Exchanged with TCI, a related party. (2) Assumed debt of seller. Exchanged with TCI, a related party.
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In 2002, ARI sold the following properties:
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
- -------- (1) Exchanged for Governor's Square, Grand Lagoon, Park Avenue, Greenbriar, Regency and Westwood Apartments. (2) Exchanged with TCI, a related party, for the Plaza on Bachman Creek Shopping Center. (3) Debt assumed by purchaser. (4) Represents dividends on and redemption of Innovo Preferred Stock. See NOTE 7. "NOTES PAYABLE." (5) Sold to TCI, a related party, to satisfy debt. Gain deferred until sale to unrelated party. (6) Sold to TCI, a related party, to satisfy debt. In September 2002, gain of $34,000 recognized upon sale of 36 acres to unrelated party. Remaining gain of $27,000 deferred until sale to unrelated party. (7) Sold to Housing for Seniors of Humble, LLC, a related party. Gain deferred until sale to unrelated party. (8) The cash received from the sale was not sufficient to repay the entire amount of the financing obtained from IORI in January 2002. ARI owes $2.1 million to IORI for remaining principal and 12% return. (9) Gain deferred until collection of mortgage note receivable in March 2003. See NOTE 25. "SUBSEQUENT EVENTS." (10) Failure to notify and receive approval from the lender for this transaction may constitute an event of default under the terms of the debt.
In 2001, ARI sold the following properties:
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
- -------- (1) Debt assumed by purchaser. (2) Gain deferred until 2002, when ARI-provided financing was collected. (3) Sold to TCI, a related party. Gain of $65 deferred until sale to unrelated party.
NOTE 3. NOTES AND INTEREST RECEIVABLE
Interest income is recognized on nonperforming notes receivable on a cash basis. For the years 2002, 2001 and 2000 unrecognized interest income on such nonperforming notes receivable totaled $706,000, $233,000 and $316,000, respectively.
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Notes receivable at December 31, 2002, mature from 2000 to 2009 with interest rates ranging from 0.00% to 14.0% per annum and a weighted average rate of 9.3% per annum. Notes receivable are generally collateralized by real estate or interests in real estate and personal guarantees of the borrower. A majority of the notes receivable provide for principal to be paid at maturity. Scheduled principal maturities of $5.8 million are due in 2003.
In May 2002, ARI sold its leasehold interests in various oil and gas mineral development properties for $1.3 million, receiving a note from the buyer for the purchase price. The note bore interest at 10.0% per annum, matured in May 2004 and required monthly payments of principal and accrued interest. See NOTE 4. "OIL AND GAS OPERATIONS." In November 2002, the note was sold to 10300 Gaywood Trust, a related party, for $1.3 million plus accrued but unpaid interest, to satisfy debt. No cash was received by ARI for the sale of the note.
In August 2002, ARI sold a 14.2 acre tract of its Elm Fork land parcel for $1.5 million, paying $54,000 after payment of closing costs and debt paydown and providing purchase money financing of $763,000. The loan bore interest at 10.0% per annum and matured in October 2002. All principal and interest were due at maturity. In October 2002, the note was collected in full, including accrued but unpaid interest.
In September 2002, ARI sold its Messick land parcel and an 80.0 acre tract of its Katrina land parcel for $12.8 million, paying $1.5 million after payment of closing costs and debt paydown and providing purchase money financing of $9.6 million. The loan bears interest at 8.0% per annum, matures in September 2004 and requires quarterly payments of accrued interest. All principal and accrued interest are due at maturity. In February 2003, ARI accepted $7.4 million as full payment for $7.7 million in principal and accrued interest. In March 2003, the remaining $1.9 million loan balance was sold to an unrelated party for $1.8 million plus accrued and unpaid interest. See NOTE 25. "SUBSEQUENT EVENTS."
In October 2002, ARI sold its Varner Road land parcel for $3.7 million, receiving $671,000 after payment of closing costs and providing purchase money financing of $2.8 million. The loan bears interest at 9.0% per annum, matures in October 2004 and requires quarterly interest payments. All principal and accrued but unpaid interest are due at maturity.
In December 2002, ARI sold its Willow Springs land parcel for $9.8 million, paying $1.3 million after payment of closing costs and debt paydown and providing purchase money financing of $7.8 million. The loan bore interest at 8.0% per annum, matured in December 2005 and required periodic interest payments beginning in June 2003. In March 2003, the loan was sold to an unrelated party for $7.5 million plus accrued and unpaid interest. See NOTE 25. "SUBSEQUENT EVENTS."
Also in December 2002, ARI sold a 238.0 acre tract of its Desert Wells land parcel for $23.8 million, receiving $321,000 after payment of closing costs and debt paydown and providing purchase money financing of $21.4 million. The first lien financing of $17.8 million bore interest at 8.0% per annum, matured in December 2004 and required payments beginning in March 2003. In March 2003, the loan was sold to an unrelated party for $17.1 million plus accrued and unpaid interest. See NOTE 25. "SUBSEQUENT EVENTS." The second lien financing of $3.6 million bore interest at 8.0% per annum and matured on March 31, 2003. All principal and interest were due at maturity.
In December 2002, ARI sold a 171.1 acre tract of its Desert Wells land parcel for $11.9 million receiving $1.4 million after payment of closing costs and debt paydown and providing purchase money financing of $8.9 million. The loan bore no interest and matured in March 2003. The principal was due at maturity. In December 2002, interest in $7.7 million of the loan was sold to an unrelated party for $7.7 million. ARI retained a junior interest in $1.2 million of the loan. In March 2003, the note was collected in full.
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In March 2001, ARI sold a 20.0 acre tract of its Katrina land parcel for $2.8 million, receiving $700,000 in cash and providing purchase money financing of the remaining $2.1 million of the sales price. The loan bore interest at 12.0% per annum and matured in July 2001. All principal and interest were due at maturity. In January 2002, $274,000 in principal and $226,000 in interest was collected. In March 2002, the note was collected in full, including accrued but unpaid interest.
In April 2001, ARI sold a 20.0 acre tract of its Katrina land parcel for $2.9 million, receiving $700,000 in cash and providing purchase money financing of the remaining $2.2 million of the sales price. The loan bore interest at 10.0% per annum and matured in June 2001. In May 2001, ARI sold an 80% senior interest in the note to a financial institution. In June 2001, the interest rate was increased to 12.0% and the maturity date was extended to August 2001. All principal and accrued but unpaid interest were due at maturity. In July 2001, the note was collected in full, including accrued but unpaid interest.
In November 2001, ARI sold a 12.71 acre tract of its Santa Clarita land parcel for $1.9 million, receiving $1.5 million in cash and providing purchase money financing of the remaining $437,000 of the sales price. The loan bore interest at 8.00% per annum and matured in November 2002. In November 2002, the note was collected in full, including accrued but unpaid interest.
Also in November 2001, ARI sold the Blackhawk Apartments for $7.1 million receiving $1.5 million in cash after the assumption of $4.0 million of mortgage debt and providing purchase money financing of the remaining $1.6 million of the sales price. The loan bore interest at 10.00% per annum and matured in May 2002. Monthly principal and interest payments were required. In April 2002, the note was collected in full, including accrued but unpaid interest.
In July 2000, ARI sold a 749.1 acre tract of its Keller land parcel for $10.0 million, receiving $8.7 million in cash and providing purchase money financing of the remaining $1.3 million of the sales price. The loan bore interest at 12.0% per annum. A payment of $500,000 principal and interest was collected in September 2000 and all remaining principal and interest was due July 31, 2001. The loan was secured by 100% of the shares of DM Development, Inc. and an assignment of proceeds. In March 2001, $850,000 in principal and interest was collected. In June 2001, the loan was collected in full, including accrued but unpaid interest.
In September 1999, in conjunction with the sale of two apartments in Austin, Texas, $2.1 million in purchase money financing was provided, secured by limited partnership interests in two limited partnerships owned by the buyer. The financing bore interest at 16.0% per annum, required monthly payments of interest only at 6.0% per annum, beginning in February 2000 and required a $200,000 principal paydown in December 1999, which was not received, and matured in August 2000. ARI had the option of obtaining the buyer's general and limited partnership interests in the collateral partnerships in full satisfaction of the financing. In March 2000, ARI agreed to forbear foreclosing on the collateral securing the note and released one of the partnership interests, in exchange for a payment of $250,000 and executed deeds of trusts on certain properties owned by the buyer. In March 2000, the borrower made a $1.1 million payment, upon receipt of which ARI returned the deeds of trust. The borrower executed a replacement promissory note for the remaining note balance of $1.0 million, which is unsecured, non- interest bearing and matures in April 2003. In April 2000, ARI funded a $100,000 loan to the borrower. The loan was secured by five second lien deeds of trust, was non-interest bearing and matured in September 2001. Payment was not received at maturity, and ARI began accruing default interest. In December 2001, the $100,000 loan was collected in full, including accrued but unpaid interest.
In December 1999, a note with a principal balance of $1.2 million and secured by a pledge of a partnership interest in a partnership which owns real estate in Addison, Texas, matured. The maturity date was extended to April 2000 in exchange for an increase in the interest rate to 14.0% per annum. All other terms remained the
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
same. In February 2001, the loan amount was increased to $1.6 million and the maturity date was extended to June 2001. In February 2002, $1.5 million in principal and $87,000 in interest was collected. In July 2002, the note was collected in full, including accrued but unpaid interest.
In August 1998, a $635,000 loan was funded to La Quinta Partners, LLC. The loan was secured by interest bearing accounts prior to their being used as escrow deposits toward the purchase of 956 acres of land in La Quinta, California, and the personal guarantee of the manager of the borrower. The loan had an extended maturity date of November 1999. All principal and interest were due at maturity. In November and December 1998, $250,000 in principal paydowns were received. In the second quarter of 1999, the loan was modified, increasing the interest rate to 15.0% per annum and extending the maturity to November 1999. Accrued but unpaid interest was added to the principal balance, increasing it by $42,000 to $402,000. In the fourth quarter of 1999, an additional $2,000 was funded, increasing the loan balance to $404,000. In March 2000, $25,000 in interest was collected and the loan's maturity date was further extended to April 2000. The borrower did not repay the loan at maturity. In March 2001, a settlement was reached, whereby ARI collected $410,000 in full satisfaction of the note.
Related Party. In June 2002, ARI converted $4.5 million of its receivable from BCM, a related party, to a recourse note receivable. This transaction was to provide ARI with additional security over that provided by an unsecured receivable. The note bears interest at 10.0% per annum, matures in March 2004 and requires quarterly payments of principal and accrued interest, beginning in December 2002.
In December 2002, ARI sold the Lakeshore Villas Apartments to Housing for Seniors of Humble, LLC ("Humble"), a related party, for $22.0 million, paying $764,000 after payment of closing costs and debt paydown and providing purchase money financing of $8.4 million. One loan has a principal amount of $2.0 million. The loan is unsecured, and is guaranteed by Unified Housing Foundation, Inc. ("Unified"), a related party. The second loan has a principal amount of $6.4 million, and is secured by a pledge by United of 100% of the Member Interest in Humble. Both loans bear interest at 11.5% per annum, mature in December 2009 and require quarterly payments beginning in March 2003. Richard W. Humphrey, a director of ARI, is the President of Humble and the President and Treasurer of Unified. Ted P. Stokely, Chairman of the Board and a director of ARI, is the General Manager of Unified.
In March 2001, ARI funded $13.6 million of a $15.0 million unsecured line of credit to One Realco Corporation ("One Realco"), which owns approximately 14.7% of the outstanding shares of ARI's Common Stock. One Realco periodically borrows money to meet its cash obligations. The line of credit bears interest at 12.0% per annum. All principal and interest were due at maturity in February 2002. The line of credit is guaranteed by BCM. In June 2001, $394,000 in principal and $416,000 in interest was collected. In December 2001, $21,000 in principal and $804,000 in interest was collected. In February 2002, the line of credit was increased to $18.0 million, accrued but unpaid interest of $217,000 was added to the principal and the maturity date was extended to February 2004. In March 2002, ARI funded an additional $1.8 million, increasing the outstanding principal balance to $15.5 million. In October 2002, $856,900 in interest was collected, by the return of 85,690 shares of ARI Series A Preferred Stock. All principal and interest are due at maturity. Ronald E. Kimbrough, Acting Principal Executive Officer, Executive Vice President and Chief Financial Officer of ARI, is a 10% shareholder of One Realco. During 2001 and 2002, Mr. Kimbrough did not participate in the day-to-day operations or management of One Realco.
In December 2000, an unsecured loan with a current principal balance of $1.9 million to Warwick of Summit, Inc. ("Warwick") matured. The loan was made to provide funds to purchase, renovate and expand a shopping center property in Warwick, Rhode Island. All principal and interest were due at maturity. At
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 2002, the loan, and $188,000 of accrued interest, remained unpaid. Richard D. Morgan, a Warwick shareholder, served as a director of ARI until October 2001.
In December 2000, a loan with a current principal balance of $1.6 million to Bordeaux Investments Two, L.L.C. ("Bordeaux"), matured. The loan, to provide funds to purchase and renovate a shopping center property in Oklahoma City, Oklahoma, is secured by (1) a 100% interest in Bordeaux, which owns a shopping center in Oklahoma City, Oklahoma; (2) 100% of the stock of Bordeaux Investments One, Inc., which owns 6.5 acres of undeveloped land in Oklahoma City, Oklahoma; and (3) the personal guarantees of the Bordeaux members. At December 2002, the loan, and $710,000 of accrued interest, remained unpaid. Richard D. Morgan, a Bordeaux member, served as a director of ARI until October 2001.
In March 2000, a loan with a current principal balance of $2.6 million to Lordstown, L.P., matured. The loan, to provide funds to purchase for resale various parcels of land, is secured by a second lien on land in Ohio and Florida, by 100% of the general and limited partner interest in Partners Capital, Ltd., the limited partner of Lordstown, L.P., and a profits interest in subsequent land sales. At December 2002, the loan, and $1.1 million of accrued interest, remained unpaid. A corporation controlled by Richard D. Morgan is the general partner of Lordstown, L.P. Mr. Morgan served as a director of ARI until October 2001.
In October 1999, ARI funded a $4.7 million loan to Realty Advisors, Inc., an affiliate. The loan, to provide funds for acquisitions or working capital needs, was secured by all of the outstanding shares of common stock of American Reserve Life Insurance Company. The loan bore interest at 10.25% per annum, and matured in November 2001. In January 2000, $100,000 was collected. In November 2001, the maturity date was extended to November 2004. The collateral was changed to a subordinate pledge of 850,000 shares of ARI Common Stock owned by BCM. The shares are also pledged to a lender on ARI's behalf. The interest rate was changed to 2% over the prime rate, currently 6.25% per annum, and the accrued but unpaid interest of $984,000 was added to the principal. The new principal balance is $5.6 million. All principal and accrued interest are due at maturity.
NOTE 4. ALLOWANCE FOR ESTIMATED LOSSES
Activity in the allowance for estimated losses was as follows:
NOTE 5. OIL AND GAS OPERATIONS
In May 2001, ARI purchased the leasehold interests in 37 oil and gas mineral development properties, which included 131 drilled wells. The total proved reserves were 6.5 million barrels of oil and 3.3 billion cubic feet of natural gas. The total purchase price was $4.7 million, plus a 40% profit participation. The Operator's Interest was purchased for $375,000, with $25,000 cash paid at closing. ARI gave a note payable for the remaining $350,000. The note bore no interest, and matured in May 2002. Monthly principal payments of $25,000 were required. The Working Interests were purchased for $4.3 million, with $125,000 cash paid at closing. ARI gave a note payable for $250,000. The note bore no interest, and matured in November 2001. One-half of the principal was paid in August 2001. The remaining $4.0 million was paid by issuing 3,968.75 shares of ARI Series F Preferred Stock, which was redeemable quarterly in an amount equal to 20% of net cash flow from the oil and gas operations. The stock had a liquidation value of $1,000 per share, and paid no dividends.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In May 2002, ARI sold the leasehold interests for $1.3 million, receiving a note from the buyer for the purchase price. The note bore interest at 10.0% per annum, matured in May 2004 and required monthly payments of principal and accrued interest. As part of the sale, the notes payable given by ARI for the purchase of the Operator's Interest, ($350,000) and the Working Interests ($250,000) were canceled. The 3,968.75 shares of ARI Series F Preferred Stock were also returned to ARI and canceled.
In November 2002, the note was sold to 10300 Gaywood Trust, a related party, for $1.3 million plus accrued but unpaid interest, to satisfy debt. No cash was received by ARI for the sale of the note.
NOTE 6. INVESTMENTS IN EQUITY INVESTEES
Investments in equity investees at December 31, 2002, consisted of two publicly traded real estate companies, IORI and TCI and interests in real estate joint venture partnerships. BCM, ARI's advisor, serves as advisor to IORI and TCI.
The investments in IORI, TCI and the joint venture partnerships are accounted for using the equity method as more fully described in NOTE 1. "SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Investments in equity investees."
A significant portion of ARI's investment in IORI and TCI is pledged as collateral for borrowings. See NOTE 8. "NOTES AND INTEREST PAYABLE" and NOTE 9. "MARGIN BORROWINGS."
Investments in equity investees consisted of the following:
On October 3, 2000, ARI and IORI entered into an agreement which provided IORI and ARI with an option to purchase 1,858,900 shares of common stock of TCI from a third party. On October 19, 2000, IORI assigned all of its rights to purchase such shares to ARI. The total cost to purchase the TCI shares was $30.8 million. In October 2000, ARI paid $5.6 million of the option price. In April 2001, the remainder of the option price was paid, and ARI acquired the TCI shares.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
On November 15, 2002, ARI commenced a tender offer for the IORI and TCI shares not already owned by ARI. The tender offer was completed on March 19, 2003. ARI paid $19.00 cash per IORI share and $17.50 cash per TCI share for the stock by non-affiliated stockholders. Pursuant to the tender offer, ARI acquired 265,036 IORI shares and 1,213,226 TCI shares. After the tender offers, ARI owned 64.8% of the outstanding shares of TCI and 62.5% of the outstanding shares of IORI (46.9% owned directly by ARI and 15.6% through TCI's ownership of IORI shares). ARI will consolidate TCI's and IORI's accounts and operations beginning January 1, 2003.
ART Florida Portfolio II, Ltd. In January 2002, Investors Choice Florida Public Funds II, in which ART Florida Portfolio II, Ltd. owned an interest, sold Villas Continental Apartments. ARI received $1.3 million in cash from the sale. ARI's share of the loss incurred on the sale was $286,000, which is included in loss on sale of investments in equity investees in the Consolidated Statements of Operations.
Elm Fork Ranch, L.P. In June 2000, ARI sold its partnership interests for $2.0 million in cash, retaining an option to repurchase its interests. In January 2001, ARI purchased 100% of the partnership interests for $9.2 million, including financing of $9.0 million.
Set forth below are summary financial data for equity investees:
In 2001, ARI received $53,000 from TCI in accumulated dividends on shares of CMET that should have been exchanged for TCI common stock in 1999.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The cash flow from IORI and TCI is dependent on the ability of each of them to make distributions. IORI and TCI ceased making quarterly distributions in the fourth quarter of 2000.
ARI initially acquired its investment in IORI and TCI in 1989.
NOTE 7. MARKETABLE EQUITY SECURITIES--TRADING PORTFOLIO
Since 1994, ARI has purchased equity securities of entities other than those of the IORI and TCI to diversify and increase the liquidity of its margin accounts and its trading portfolio. The acquisition of RAK added $1.4 million in marketable securities of which $1.3 million were sold in 2002. Trading portfolio securities are carried at market value. In 2001, ARI did not purchase or sell any trading portfolio securities. At December 31, 2002, ARI recognized an unrealized decline in the market value of trading portfolio securities of $25,000. In 2002, ARI realized no gains or losses from the sale of trading portfolio securities and received no dividends. At December 31, 2001, ARI recognized an unrealized decline in the market value of trading portfolio securities of $55,000. In 2001, ARI realized no gains or losses from the sale of trading portfolio securities and received no dividends. At December 31, 2000, ARI recognized an unrealized decline in the market value of trading portfolio securities of $305,000. In 2000, ARI realized a net loss of $747,000 from the sale of trading portfolio securities and received $3,000 in dividends. Unrealized and realized gains and losses in trading portfolio securities are included in other income in the accompanying Consolidated Statements of Operations.
NOTE 8. NOTES AND INTEREST PAYABLE
Notes and interest payable consisted of the following:
Scheduled principal payments on notes payable are due as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Stated interest rates on notes payable ranged from 5.0% to 16.9% per annum at December 31, 2002, and matured in varying installments between 2003 and 2043. At December 31, 2002, notes payable were collateralized by deeds of trust on real estate with a net carrying value of $458.0 million.
In January 2002, the lender on three of ARI's residential properties located in Florida commenced foreclosure actions, due to ARI's failure to pay the loans at maturity on January 1, 2002. ARI has filed counterclaims asserting the lender had abruptly withdrawn from discussions for refinancing. The balance owed on the three loans is $7.2 million. In May 2002, the lender's claims were dismissed voluntarily.
In February 2003, the lender on one of ARI's hotel properties located in Virginia notified ARI that the loan on the property was in default, due to ARI's failure to timely make debt service payments. The balance owed on the loan is $11.6 million. In April 2003, the lender notified ARI that acceptance of terms to cure the default and extend the maturity date of the loan would be recommended to the lender's management for approval.
In 2002, ARI financed/refinanced or obtained second mortgage financing on the following:
Related Party Transactions. In each of the following transactions, except those footnoted as (6), a related party has purchased an entity, which owns the listed property asset, from ARI. ARI has guaranteed that the asset will produce at least a 12% return on the purchase price for a period of three years from the purchase date. If the asset fails to produce the 12% return, ARI will pay the purchaser any shortfall. In addition, if the asset fails to produce the 12% return for a calendar year, the purchaser may require ARI to repurchase the entity for the purchase price. Management has classified these related party transactions as notes payable.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
- -------- (1) Variable interest rate. (2) Single note with all properties as collateral. (3) Maturity date extended to July 2004. (4) IORI purchased 100% of the outstanding common shares of Rosedale Corporation ("Rosedale"), a wholly-owned subsidiary of ARI, for $5.1 million. The purchase price was determined based upon the market value of the property, using a market rate multiple of net operating income. Rosedale owned the Rosedale Towers Office Building. The business purpose of this transaction was for IORI to make an equity investment in Rosedale, anticipating a profitable return, and for ARI to receive cash for its equity investment. The property was sold to an unrelated buyer in December 2002. ARI owes $2.1 million to IORI for remaining principal and 12% return. (5) TCI purchased 100% of the common shares of ART Two Hickory Corporation ("Two Hickory"), a wholly-owned subsidiary of ARI, for $4.4 million. The purchase price was determined based upon the market value of the property, using a market rate multiple of net operating income. Two Hickory owns the Two Hickory Centre Office Building. The business purpose of this transaction was for TCI to make an equity investment in Two Hickory, anticipating a profitable return, and for ARI to receive cash for its equity investment. (6) Properties sold to partnerships controlled by Metra Capital, LLC ("Metra"). Innovo Group, Inc. ("Innovo") is a limited partner in the partnerships that purchased the properties. Joseph Mizrachi, a Director of ARI, controls approximately 11.67% of the outstanding common stock of Innovo. Management has determined to treat this sale as a refinancing transaction. ARI will continue to report the assets and the new debt incurred by Metra on its financial statements. ARI also received $6.3 million of 8% non-recourse, non-convertible Series A Preferred Stock ("Preferred Shares") of Innovo. The dividend on the Preferred Shares will be funded entirely and solely through member distributions from cash flows generated by the operation and subsequent sale of the sold properties. In the event the cash flows for the properties are insufficient to cover the 8% annual dividend, Innovo will have no obligation to cover any shortfall. The Preferred Shares have a mandatory redemption feature, and are redeemable from the cash proceeds received by Innovo from the operation and sale of the properties. All member distributions that are in excess of current and accrued 8% dividends must be used by Innovo to redeem the Preferred Shares. Since redemption of these shares is subject to the above future events, management has elected to record no basis in the Preferred Shares. (7) TCI purchased all of the general and limited partnership interests in Garden Confederate Point, L.P. ("Confederate Point") from ARI for $1.9 million. The purchase price was determined based upon the market value of the property, using a market rate multiple of net operating income. Confederate Point owns the Confederate Point Apartments. The business purpose of this transaction was for TCI to make an equity investment in Confederate Point, anticipating a profitable return, and to reduce ARI's payable to BCM. Failure to notify and receive approval from the lender for this transaction may constitute an event of default under the terms of the debt. (8) TCI purchased all of the general and limited partnership interests in Garden Foxwood, L.P. ("Foxwood") from ARI for $1.1 million. The purchase price was determined based upon the market value of the property, using a market rate multiple of net operating income. Foxwood owns the Foxwood Apartments. The business purpose of this transaction was for TCI to make an equity investment in Foxwood, anticipating a profitable return, and to reduce ARI's payable to BCM. Failure to notify and receive approval from the lender for this transaction may constitute an event of default under the terms of the debt.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(9) TCI purchased all of the general and limited partnership interests in Garden Woodsong, L.P. ("Woodsong") from ARI for $2.5 million. The purchase price was determined based upon the market value of the property, using a market rate multiple of net operating income. Woodsong owns the Woodsong Apartments. The business purpose of this transaction was for TCI to make an equity investment in Woodsong, anticipating a profitable return, and to reduce ARI's payable to BCM. TCI sold the Woodsong Apartments in July 2002. (10) Sold to unrelated buyer in December 2002. (11) TCI purchased 100% of the common shares of ART One Hickory Corporation ("One Hickory"), a wholly-owned subsidiary of ARI, for $4.5 million. The purchase price was determined based upon the market value of the property, using a market rate multiple of net operating income. One Hickory owns the One Hickory Centre Office Building. The business purpose of this transaction was for TCI to make an equity investment in One Hickory, anticipating a profitable return, and to reduce ARI's payable to BCM. Failure to notify and receive approval from the lender for this transaction may constitute an event of default under the terms of the debt. (12) Sold to unrelated party in June 2002. (13) Sold to unrelated party in January 2003. See NOTE 25. "SUBSEQUENT EVENTS."
In 2001, ARI financed/refinanced or obtained second mortgage financing on the following:
- -------- (1) Single note, with all properties as collateral.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(2) Single note, with all properties as collateral. (3) Also secured by 1,846,000 shares of TCI Common Stock. (4) Single note, with all properties as collateral. (5) Variable interest rate. (6) Paid off in September 2001. (7) Extended to April 2002. (8) Extended to April 2002. (9) In December 2001, TCI, a related party, purchased 100% of the outstanding common shares of National Melrose, Inc. ("NM"), a wholly-owned subsidiary of ARI, for $2.0 million. The purchase price was determined based upon the market value of the property, using a market rate multiple of net operating income. NM owns the Executive Court Office Building. The business purpose of this transaction was for TCI to make an equity investment in NM, anticipating a profitable return, and for ARI to receive cash for its equity investment. ARI has guaranteed that the asset will produce at least a 12% annual return on the purchase price for a period of three years from the purchase date. If the asset fails to produce the annual return, ARI will pay TCI any shortfall. In addition, if the asset fails to produce 12% return for a calendar year, TCI may require ARI to repurchase the shares of NM for the purchase price. Management has classified this related party transaction as a note payable to TCI.
NOTE 9. MARGIN BORROWINGS
ARI has margin arrangements with various financial institutions and brokerage firms which provide for borrowings of up to 50% of the market value of marketable equity securities. The borrowings under such margin arrangements are secured by the equity securities of IORI and TCI and ARI's trading portfolio securities and bear interest rates ranging from 5.25% to 24.0% per annum. Margin borrowings were $8.6 million at December 31, 2002 and $28.0 million at December 31, 2001, representing 14.7% and 39.2%, respectively, of the market values of the equity securities at those dates.
In June 2000, 1.6 million shares of TCI common stock and 54,000 shares of IORI common stock held as collateral on margin loans were sold to satisfy margin calls resulting in losses totaling $7.9 million. These losses are included in loss on sale of investments in equity investees in the Consolidated Statements of Operations. See NOTE 6. "INVESTMENTS IN EQUITY INVESTEES."
In March 2001, ARI obtained a security loan in the amount of $3.5 million from a financial institution. The loan bore interest at 16.0% per annum. In April and May 2001, a total of $2.0 million in principal paydowns were made. In July 2001, the loan was repaid in full, including accrued but unpaid interest. The loan was secured by 472,000 shares of TCI common stock owned by ARI and 128,000 shares of ARI Common Stock owned by One Realco.
In September 2001, ARI obtained a security loan in the amount of $20.0 million from a financial institution. ARI received net cash of $16.1 million after the payment of various closing costs and $3.4 million repayment of principal and accrued interest on an existing loan with the same lender. Of the total loan amount, $19.5 million bears interest at 24% per annum, while the remaining $500,000 bears interest at 20% per annum. The loan required monthly payments of interest only and matured in September 2002. In September 2002, $15.0 million in principal was repaid. The loan is secured by 2,751,798 shares of TCI common stock held by ARI and 920,507 shares of TCI common stock held by BCM, ARI's advisor. The lender has informed ARI that the loan is in default. ARI continues to pay monthly interest.
In October 2001, ARI obtained a security loan in the amount of $1.0 million from a financial institution. The loan bears interest at 1% over the prime rate, currently 5.25% per annum, requires monthly payments of interest only and matures in October 2003. The loan is callable upon 60 days prior notice, and is secured by 200,000 shares of ARI Common Stock held by BCM, ARI's advisor.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In April 2000, ARI obtained a security loan in the amount of $5.0 million from a financial institution. ARI received net cash of $4.6 million after payment of various closing costs. The loan bore interest at 1% over the prime rate, currently 5.25% per annum, required monthly payments of interest only and matured September 2002. The loan was secured by 1,050,000 shares of ARI Common Stock held by BCM, ARI's advisor. In December 2002, the loan was paid in full, including accrued but unpaid interest.
NOTE 10. RELATED PARTY TRANSACTIONS
In January 2002, IORI purchased 100% of the outstanding common shares of Rosedale Corporation ("Rosedale"), a wholly-owned subsidiary of ARI, for $5.1 million. The purchase price was determined based upon the market value of the property exchanged, using a market rate multiple of net operating income. Rosedale owned the Rosedale Towers Office Building. ARI guaranteed that the asset would produce at least a 12% annual return on the purchase price for a period of three years from the purchase date. If the asset failed to produce the 12% return, ARI would pay IORI any shortfall. In addition, if the asset failed to produce the 12% return for a calendar year, IORI could require ARI to repurchase the shares of Rosedale for the purchase price. The business purpose of the transaction was for IORI to make an equity investment in Rosedale, anticipating a profitable return, and for ARI to receive cash for its equity investment. Management classified this related party transaction as a note payable to IORI. IORI sold the Rosedale Towers Office Building to an unrelated buyer in December 2002. ARI owes $2.1 million to IORI for remaining principal and 12% return.
In January 2002, TCI purchased 100% of the common shares of ART Two Hickory Corporation ("Two Hickory"), a wholly-owned subsidiary of ARI, for $4.4 million. The purchase price was determined based upon the market value of the property exchanged, using a market rate multiple of net operating income. Two Hickory owns the Two Hickory Centre Office Building. ARI has guaranteed that the asset will produce at least a 12% annual return on the purchase price for a period of three years from the purchase date. If the asset fails to produce the 12% return, ARI will pay TCI any shortfall. In addition, if the asset fails to produce the 12% return for a calendar year, TCI may require ARI to repurchase the shares of Two Hickory for the purchase price. The business purpose of the transaction was for TCI to make an equity investment in Two Hickory, anticipating a profitable return, and for ARI to receive cash for its equity investment. Management has classified this related party transaction as a note payable to TCI.
In March 2002, ARI received $520,000 and exchanged with TCI a 24.5 acre tract of Rasor land, a 16.89 acre tract of Lakeshore Villas Apartments land and the 45,623 sq.ft. Oaktree Village Shopping Center for the 80,278 sq.ft. Plaza on Bachman Creek Shopping Center. The exchange value prices for the shopping centers were determined using a market rate multiple of net operating income, and the values of the land parcels were determined using appraised rates. The business purpose of the transaction was for TCI to construct apartments on the Rasor and Lakeshore Villas land. To give ample value for the property TCI exchanged, the Oaktree Village Shopping Center was added to the transaction. ARI received $4.4 million on the subsequent financing of the shopping center.
In April 2002, TCI purchased One Hickory Corporation, Garden Confederate Point, L.P., Garden Foxwood, L.P. and Garden Woodsong, L.P. for $4.5 million, $1.9 million and $2.5 million, respectively. These transactions were treated as financings. The transactions reduced ARI's payable to BCM. See NOTE 8. "NOTES AND INTEREST PAYABLE." Failure to notify and receive approval from the lender for these transactions may constitute an event of default under the terms of the debt assumed by TCI.
In June 2002, TCI purchased Centura Tower, Ltd. partnership, which owns the Centura Tower Office Building, from ARI for $50.0 million. See NOTE 2. "REAL ESTATE." The purchase price for the Centura Tower was determined based on appraised value and replacement cost. The business purpose of the transaction was for TCI to acquire a Class A office building with significant upside potential anticipating a profitable return and for ARI to satisfy debt.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In June 2002, TCI purchased five parcels of unimproved land from ARI for $30.0 million: the Hollywood Casino, Marine Creek, Mason Park, Nashville and Monterrey land parcels. See NOTE 2. "REAL ESTATE." The purchase price of the Hollywood Casino land was determined based on an appraised value of $9.10 per square foot. The business purpose of the transaction was for TCI to consolidate its holdings within the Mercer Crossing development. The purchase price for the Marine Creek, Mason Park, Nashville and Monterrey land parcels was determined based on appraised rates. The business purpose of the transaction was for TCI to develop apartments on these four tracts of land and for ARI to satisfy debt. Failure to notify and receive approval from the lender for this transaction may constitute an event of default under the terms of the debt assumed by TCI.
In June 2002, ARI purchased all the general and limited partnership interests in Chalet North, L.P. ("Chalet North") from BCM for $3.0 million. Chalet North owns the Pinecrest Apartments. The purchase price was determined based on the market value of the property exchanged, using a market rate multiple of net operating income. ARI assumed debt of $1.4 million. ARI's receivable from BCM was reduced by $1.6 million, and no cash was paid by ARI. The business purpose of the transaction was to reduce the affiliate payable owed by BCM to ARI.
In June 2002, ARI purchased the Tiberon Trails Apartments from BCM for $12.3 million. The purchase price was determined based on the market value of the property exchanged, using a market rate multiple of net operating income. ARI assumed debt of $6.4 million. ARI's receivable from BCM was reduced by $5.9 million, and no cash was paid by ARI. The business purpose of the transaction was to reduce the affiliate payable owed by BCM to ARI.
In June 2002, ARI purchased the Alta Mesa Shopping Center from BCM for $3.8 million. The purchase price was determined based on the market value of the property exchanged, using a market rate multiple of net operating income. ARI assumed debt of $1.8 million. ARI's receivable from BCM was reduced by $2.0 million, and no cash was paid by ARI. The business purpose of the transaction was to reduce the affiliate payable owed by BCM to ARI.
On June 30, 2002, ARI obtained 74.31% interest in RAK from BCM for $6.0 million. The business purpose of the transaction was to reduce the affiliate payable owed by BCM to ARI. ARI's receivable from BCM was reduced by $6.0 million, and no cash was paid by ARI. At the date of acquisition, RAK's assets consisted of $2.3 million in cash, $3.0 million in deposits and marketable securities, and $225,000 in other assets. RAK's net equity was $5.5 million. ARI recorded $1.9 million in goodwill as a result of this transaction.
In December 2002, ARI sold the Lakeshore Villas Apartments to Housing for Seniors of Humble, LLC ("Humble"), a related party, for $22.0 million, paying $764,000 after payment of closing costs and debt paydown and providing purchase money financing of $8.4 million. One loan has a principal amount of $2.0 million. The loan is unsecured, and is guaranteed by Unified Housing Foundation, Inc. ("Unified"), a related party. The second loan has a principal amount of $6.4 million, and is secured by a pledge by Unified of 100% of the Member Interest in Humble. Both loans bear interest at 11.5% per annum, mature in December 2009 and require quarterly payments beginning in March 2003. Richard W. Humphrey, a director of ARI, is the President of Humble and the President and Treasurer of Unified. Ted P. Stokely, Chairman of the Board and a director of ARI, is the General Manager of Unified.
In December 2002, TCI purchased the NLP/CH, Ltd. partnership, which owns the Centura Holdings, Clark and Woolley land parcels, from ARI for $13.3 million. See NOTE 2. "REAL ESTATE." The purchase price was determined based on an appraised rate of $34.89 per share foot. The business purpose of the transaction was for TCI to construct apartments on the land and for ARI to satisfy debt.
In January 2003, ARI's Board of Directors approved the payment to BCM of a 6% construction management fee on all construction projects in process at December 31, 2002, to be applied to all labor and
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
materials costs incurred to date on each project. The resulting calculation of $1.9 million was treated as an increase in the affiliate payable balance to BCM.
During 2002, ARI's Board of Directors authorized ARI's Chief Financial Officer to advance funds either to or from ARI, through BCM, in an amount up to $10.0 million and, subsequent to that, authorized ARI's Chief Financial Officer to make additional advances, on the condition that such advances shall be repaid in cash or transfers of assets within 90 days.
In June 2002, BCM partially repaid its affiliate payable to ARI by transferring Alta Mesa Shopping Center, Pinecrest Apartments, Tiberon Trails Apartments and Realty Advisors Korea, Ltd. to ARI.
Also in June 2002, BCM converted $4.5 million of its unsecured payable to ARI to a note payable.
During 2002, ARI's payable to BCM was increased by advisory fees, reimbursable expenses and insurance reimbursements of $549,000, $517,000 and $435,000, respectively.
During 2002, ARI made payments on BCM's and TCI's behalf of $2.2 million and $2.8 million, respectively, while BCM made payments on ARI's behalf of $4.1 million.
In November 2002, ARI sold its note receivable from the sale of leasehold interest in oil and gas mineral development properties to 10300 Gaywood Trust for a reduction of the affiliate payable to BCM in the amount of $1.3 million.
In July 2002, ARI sold Garden Woodsong to an unrelated party. The proceeds of $2.8 million increased ARI's affiliate payable to TCI.
In December 2002, ARI sold the Rosedale Towers to an unrelated party. The proceeds of $3.5 million increased ARI's affiliate payable with IORI.
The following table reconciles the beginning and ending balances of accounts payable to affiliates as of December 31, 2002.
Also at December 31, 2002, ARI owed $2.8 million to affiliates for unbilled loan arrangement fees and real estate brokerage commissions, and $1.6 million to affiliates related to cash received upon the sale of apartments to Metra.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Returns on Metra Properties. As described more fully in NOTE 8. "NOTES AND INTEREST PAYABLE," ARI sold nine of its properties during 2002 to partnerships controlled by Metra. The partnership agreement for each of these partnerships states that the Metra Partners, as defined, receive cash flow distributions at least quarterly in an amount sufficient to provide them with a 15% cumulative compounded annual rate of return on their invested capital, as well as a cumulative compounded annual amount of 0.50% of the average outstanding balance of the mortgage indebtedness secured by any of these residential properties. These distributions to the Metra Partners have priority over distributions to any of the other partners.
NOTE 11. DIVIDENDS
During the second quarter of 1999, ARI's Board of Directors established a policy that dividend declarations on Common Stock would be determined on an annual basis following the end of each year. No dividends on Common Stock were declared for 2001 or 2002. Future distributions to Common stockholders will be dependent upon ARI's income, financial condition, capital requirements and other factors deemed relevant by the Board.
NOTE 12. PREFERRED STOCK
There are 15,000,000 shares of Series A 10% Cumulative Convertible Preferred Stock authorized, with a par value of $2.00 per share and liquidation preference of $10.00 per share plus accrued and unpaid dividends. Dividends are payable at the annual rate of $1.00 per share or $.25 per share quarterly to stockholders of record on the last day of each March, June, September and December when and as declared by the Board of Directors. The Series A Preferred Stock may be converted after August 15, 2003, into ARI Common Stock at 90% of the average daily closing price of ARI's Common Stock for the prior 20 trading days. At December 31, 2002, 3,226,858 shares of Series A Preferred Stock were outstanding and 1,808,879 shares were reserved for issuance as future consideration in various business transactions. Of the outstanding shares, 300,000 shares are owned by ART Edina, Inc., and 600,000 are owned by ART Hotel Equities, Inc., wholly-owned subsidiaries of ARI. Dividends are not paid on the shares owned by ARI subsidiaries.
There are 80,000 shares of Series B 10% Cumulative Convertible Preferred Stock authorized, with a par value of $2.00 per share and a liquidation preference of $100.00 per share plus accrued but unpaid dividends. The Series B Preferred Stock bears an annual dividend of $11.00 per share or $2.75 per quarter to stockholders of record on the last day of each March, June, September and December when and as declared by the Board of Directors. The Series B Preferred Stock was reserved for conversion of the Class A limited partner units of Valley Ranch, L.P. In March 1999, an agreement was reached for ARI to acquire the eight million Class A units for $1.00 per unit. At December 31, 2002, all of the Class A units had been repurchased. At December 31, 2002, no Series B Preferred Stock was outstanding.
There are 231,750 shares of Series C Cumulative Convertible Preferred Stock authorized, with a par value of $2.00 per share and liquidation preference of $100.00 per share plus accrued and unpaid dividends. The Series C Preferred Stock bears a quarterly dividend of $2.25 per share through June 30, 2001 and $2.50 per share thereafter, to stockholders of record on the last day of March, June, September and December when and as declared by the Board of Directors. The Series C Preferred Stock is reserved for conversion of the Class A limited partner units of ART Palm, L.P. At December 31, 2002, 11,813,750 Class A units were outstanding. The Class A units may be exchanged for Series C Preferred Stock at the rate of 100 Class A units for each share of Series C Preferred Stock. At December 31, 2000, shares of Series C Preferred Stock could be converted into 25,000 shares of ARI Common Stock. At June 30, 2002, additional shares of Series C Preferred Stock could be converted into 16,250 shares of ARI Common Stock. On or after June 30, 2003, additional shares of Series C Preferred Stock may be converted into 16,250 shares of ARI Common Stock. On or after December 31, 2005, additional shares of Series C Preferred Stock may be converted into 16,250 shares of ARI Common Stock. On or after December 31, 2006, all remaining outstanding shares of Series C Preferred Stock may be converted into
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
ARI Common Stock. All conversions of Series C Preferred Stock in ARI Common Stock will be at 90% of the average daily closing price of ARI's Common Stock for the prior 20 trading days. In January 2001, 2.5 million Class A limited partner units of ART Palm, L.P. were redeemed for $2.5 million in cash. In December 2001, 7.2 million Class A limited partner units of ART Palm, L.P. were redeemed for $5.8 million, including $2.5 million in cash. ARI gave a note payable for the remaining $3.3 million. The note bore interest at 10.0% per annum, with a payment of $1.9 million plus accrued but unpaid interest due in June 2002, and the remaining principal and accrued but unpaid interest due at maturity in December 2002. The note was paid in full in January 2003, including accrued but unpaid interest. In July 2002, 1.6 million Class A limited partner units of ART Palm, L.P. were redeemed for $1.6 million cash. At December 31, 2002, no Series C Preferred Stock was outstanding.
There are 91,000 shares of Series D 9.50% Cumulative Preferred Stock authorized, with a par value of $2.00 per share, and a liquidation preference of $20.00 per share. Dividends are payable at the annual rate of $1.90 per year or $.475 per quarter to stockholders of record on the last day of each March, June, September and December when and as declared by the Board of Directors. The Series D Preferred Stock is reserved for the conversion of the Class A limited partner units of Ocean Beach Partners, L.P. The Class A units may be exchanged for Series D Preferred Stock at the rate of 20 Class A units for each share of Series D Preferred Stock. No more than one-third of the Class A units could be exchanged prior to May 31, 2001. Between June 1, 2001 and May 31, 2006 all unexchanged Class A units are exchangeable. At December 31, 2002, no shares of Series D Preferred Stock were outstanding.
There are 500,000 shares of Series E 6% Cumulative Preferred Stock authorized, with a par value $2.00 per share and a liquidation preference of $10.00 per share. Dividends are payable at the annual rate of $.60 per share or $.15 per quarter to stockholders of record on the last day of each March, June, September and December when and as declared by the Board of Directors. At December 31, 2002, 50,000 shares of Series E Preferred Stock were outstanding.
There are 10,000 shares of Series I 8% Cumulative Preferred Stock authorized, with a par value of $2.00 per share and a liquidation preference of $1,000.00 per share. Dividends are payable at the annual rate of $80.00 per share or $20.00 per quarter to stockholders of record on the last date of each March, June, September and December when and as declared by the Board of Directors. At December 31, 2002, no shares of Series I were outstanding. In February 2003, 10,000 shares were issued to ART Morgan, Inc., a wholly-owned subsidiary of ARI. Dividends are not paid on these shares.
NOTE 13. STOCK OPTIONS
In January 1998, stockholders approved the 1997 Stock Option Plan (the "Option Plan"). Under the Option Plan, options have been granted to certain ARI officers and key employees of BCM and its affiliates. The Option Plan provides for options to purchase up to 300,000 shares of Common Stock. All grants are determined by the Option Committee of the Board of Directors. Options granted pursuant to the Option Plan are exercisable, based upon vesting of 20% per year, beginning one year after the date of grant and expire the earlier of three months after termination of employment or ten years from the date of grant. At December 31, 2002, 76,600 options were exercisable at an exercise price of $16.35 per Common share and 2,400 shares were exercisable at an exercise price of $18.53 per Common share.
In January 1999, stockholders approved the Director's Stock Option Plan (the "Director's Plan") which provides for options to purchase up to 40,000 shares of Common Stock. Options granted pursuant to the Director's Plan are immediately exercisable and expire on the earlier of the first anniversary of the date on which a Director ceases to be a Director or ten years from the date of grant. Each Independent Director was granted an option to purchase 1,000 Common shares at an exercise price of $17.71 per Common share on January 11, 1999, the date stockholders approved the plan. On January 1, 2000, 2001, 2002 and 2003, each Independent Director
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
was granted an option to purchase 1,000 Common shares at exercise prices of $18.53, $13.625, $9.87 and $8.09 per Common share, respectively. Each Independent Director will be awarded an option to purchase an additional 1,000 Common shares on January 1 of each year. At December 31, 2002, 6,000 options were exercisable at prices ranging from $9.87 to $18.53 per Common share.
NOTE 14. ADVISORY AGREEMENT
Although the Board of Directors is directly responsible for managing the affairs of ARI and for setting the policies which guide it, the day-to-day operations of ARI are performed by BCM, a contractual advisor under the supervision of the Board. The duties of the advisor include, among other things, locating, investigating, evaluating and recommending real estate and mortgage loan investment and sales opportunities as well as financing and refinancing sources. BCM as advisor also serves as a consultant in connection with the preparation of ARI's business plan and investment policy decisions made by the Board.
BCM, an affiliate, has been providing advisory services to ARI or ART since February 6, 1989. BCM is indirectly owned by a trust for the children of Gene E. Phillips. Mr. Phillips is not an officer or director of BCM, but serves as a representative of the trust, is involved in daily consultation with the officers of BCM and has significant influence over the conduct of BCM's business, including the rendering of advisory services and the making of investment decisions for itself and for ARI.
The Advisory Agreement provides that BCM shall receive base compensation at the rate of 0.0625% per month (0.75% on an annualized basis) of ARI's Average Invested Assets.
In addition to base compensation, the Advisory Agreement provides that BCM, or an affiliate of BCM, receive an acquisition fee for locating, leasing or purchasing real estate for ARI's benefit; a disposition fee for the sale of each equity investment in real estate; a loan arrangement fee; an incentive fee equal to 10% of net income for the year in excess of a 10% return on stockholders' equity, and 10% of the excess of net capital gains over net capital losses, if any; and a mortgage placement fee, on mortgage loans originated or purchased.
The Advisory Agreement further provides that BCM shall bear the cost of certain expenses of its employees not directly identifiable to ARI's assets, liabilities, operations, business or financial affairs; and miscellaneous administrative expenses relating to the performance of its duties under the Advisory Agreement.
If and to the extent that BCM or any director, officer, partner or employee of BCM, shall be requested to render services to ARI other than those required to be rendered by BCM under the Advisory Agreement, such additional services, if performed, will be compensated separately on terms agreed upon between each party from time to time.
The Advisory Agreement automatically renews from year to year unless terminated in accordance with its terms. Management believes that the terms of the Advisory Agreement are at least as fair as could be obtained from unaffiliated third parties.
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 15. PROPERTY MANAGEMENT
Affiliates of BCM provided property management services to ARI. Currently, Triad Realty Services, Ltd. ("Triad"), an affiliate, and Carmel Realty, Inc. ("Carmel") provide property management services to ARI's properties for a fee of 5% or less of the monthly gross rents collected on the residential properties under its management and 3% or less of the monthly gross rents collected on the commercial properties under its management. Triad and Carmel subcontract with other entities for property-level management services at various rates. The general partner of Triad is BCM. The limited partner of Triad is Highland Realty Services, Inc. ("Highland"), a related party. Until December 2002, Triad subcontracted the property-level management and leasing of 12 of ARI's commercial properties (shopping centers, office buildings and a merchandise mart) and eight of its hotels to Regis Realty, Inc. ("Regis"), a related party, which was a company owned by GS Realty Services, Inc. ("GS Realty"). Regis was entitled to receive property and construction management fees and leasing commissions in accordance with the terms of its property-level management agreement with Triad. Since January 1, 2003, Regis Realty I, LLC ("Regis I"), has provided these services. Regis I is owned by Highland. Regis Hotel Corporation, a related party, managed ARI's eight hotels, until December 2002. Since January 1, 2003, Regis Hotel I, LLC, has managed ARI's eight hotels. The sole member of Regis I and Regis Hotel I, LLC is Highland. Carmel is a company owned by First Equity Properties, Inc., which is a company affiliated with BCM.
NOTE 16. ADVISORY FEES, PROPERTY MANAGEMENT FEES, ETC.
Fees and cost reimbursements to BCM and its affiliates were as follows:
Fees paid to Triad, an affiliate, and GS Realty and Highland, related parties:
- -------- * Net of property management fees paid to subcontractors, other than affiliates of BCM.
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 17. INCOME TAXES
ARI had a loss for federal income tax purposes after the use of net operating loss carryforwards in 2002 and losses for federal income tax purposes for 2001 and 2000; therefore, it recorded no provision for income taxes. ARI's tax basis in its net assets differs from the amount at which its net assets are reported for financial statement purposes, principally due to the accounting for gains and losses on property sales, the difference in the allowance for estimated losses, depreciation on owned properties, and investments in equity method real estate entities. At December 31, 2002, ARI's tax basis in its net real and personal property assets was exceeded by their basis for financial statement purposes by $19.2 million. This amount is more than offset by notes payable and deferred revenue which have a financial statement basis that exceeds their tax basis by $118.7 million. As a result, aggregate future income for income tax purposes will be less than such amount for financial statement purposes. Additionally, at December 31, 2002, ARI had carryforward capital and net operating losses of $132.1 million expiring through the year 2021. Certain of the net operating and capital loss carryforwards may be subject to limitation under the current tax laws.
At December 31, 2002, ARI had a net deferred tax asset of $62.6 million due to tax deductions available to it in future years. However, as management cannot determine that it is more likely than not that ARI will realize the benefit of the deferred tax asset, a 100% valuation allowance has been established.
NOTE 18. RENTS UNDER OPERATING LEASES
ARI's operations include the leasing of commercial properties (office buildings, shopping centers and a merchandise mart). The leases thereon expire at various dates through 2012. The following is a schedule of minimum future rents under non-cancelable operating leases as of December 31, 2002:
Milano Restaurants International, Inc. ("MRI") conducts its operations from leased facilities which include office space, a warehouse, and 58 pizza parlor locations for which a lease was signed and the pizza parlor was either open at December 31, 2002 or scheduled to open thereafter. The leases expire over the next 19 years. MRI also leases vehicles under operating leases.
The following is a schedule of minimum future rent commitments under operating leases as of December 31, 2002:
Total facilities and automobile rent expense relating to these leases was $2.5 million in 2002, $2.2 million in 2001 and $2.5 million in 2000.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 19. OPERATING SEGMENTS
Significant differences among the accounting policies of the operating segments as compared to the Consolidated Financial Statements principally involve the calculation and allocation of administrative expenses. Management evaluates the performance of each of the operating segments and allocates resources to them based on their net operating income and cash flow. Items of income that are not reflected in the segments are equity in loss of investees, loss on sale of investments in equity investees, equity in gain on sale of real estate by equity investees and other income which totaled $8.3 million in 2002, $8.4 million in 2001 and $4.3 million in 2000. Expenses that are not reflected in the segments are general and administrative expenses, minority interest, incentive fees, advisory fees, net income fees, litigation settlement expenses, provision for loss, writedown of assets held for sale and discontinued operations, which totaled $29.0 million in 2002, $34.4 million in 2001 and $66.9 million in 2000. Excluded from operating segment assets are assets of $141.2 million in 2002, $118.7 million in 2001 and $97.8 million in 2000 which are not identifiable with an operating segment. There are no intersegment revenues and expenses and ARI conducted all of its business within the United States, with the exception of Hotel Sofia (Bulgaria), which began operations in 2001 and Realty Advisors Korea, Ltd. (South Korea), which ARI acquired in 2002. See NOTE 2. "REAL ESTATE" and NOTE 3. "NOTES AND INTEREST RECEIVABLE."
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Presented below is the operating income of each operating segment and each segment's assets for 2002, 2001 and 2000.
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 20. DISCONTINUED OPERATIONS
Effective January 1, 2002, ARI adopted Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which established a single accounting model for the impairment or disposal of long-lived assets, including discontinued operations. This statement requires that the operations related to properties that have been sold or properties that are intended to be sold be presented as discontinued operations in the statement of operations for all periods presented, and properties intended to be sold are to be designated as "held-for-sale" on the balance sheet.
For 2002, 2001 and 2000, income (loss) from discontinued operations relates to 23 properties and leasehold interests in oil and gas properties that ARI sold during 2002 and eight properties that ARI sold during 2003 that are classified as held-for-sale at December 31, 2002. The following table summarizes revenue and expense information for these properties sold and held-for-sale.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Discontinued operations have not been segregated in the consolidated statements of cash flows. Therefore, amounts for certain captions will not agree with respective consolidated statements of operations.
NOTE 21. QUARTERLY RESULTS OF OPERATIONS
The following is a tabulation of quarterly results of operations for the years 2002 and 2001 (unaudited):
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 22. DERIVATIVE FINANCIAL INSTRUMENTS
During the first quarter of 2002, ARI entered into an interest rate swap agreement with a bank. This agreement contained a notional amount of $13.1 million and required ARI to pay the bank a fixed rate of 4.3%, and required the bank to pay to ARI based on the 30 day LIBOR rate. This agreement was entered into in order to effectively fix the rate on ARI's debt associated with the Lakeshore Villas property. The swap agreement expires on December 25, 2004.
ARI did not designate the interest rate swap agreement as a hedge, as defined within Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," and, as such, changes in the fair value of the swap agreement were recognized in earnings during the period of change and reflected in the statement of operations as interest expense.
Amounts paid or received under the swap agreement were settled monthly and were reflected as a reduction in the liability when paid. Interest expense for 2002 was increased by $912,000, representing both amounts paid to the bank under the agreement and changes in the fair value of the related liability.
In December 2002, ARI sold the Lakeshore Villas property to Housing for Seniors of Humble, LLC, a related party. See NOTE 2. "REAL ESTATE." The swap agreement was assumed by the purchaser.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 23. COMMITMENTS AND CONTINGENCIES AND LIQUIDITY
Liquidity. Although management anticipated that ARI would generate excess cash from operations in 2002, such excess cash did not materialize and, therefore, was not sufficient to discharge all of ARI's debt obligations as they became due. ARI relied on additional borrowings, and sales of land and income producing properties to meet its cash requirements. In 2003, ARI will rely on aggressive land sales, selected income producing property sales and, to the extent necessary, additional borrowings to meet its cash requirements.
Commitments. In March 1999, an agreement was reached with the Class A unitholders of Valley Ranch, L.P. to acquire their eight million Class A units for $1.00 per unit. In 1999, three million units were purchased. Additionally one million units were purchased in January 2000 and two million units were purchased in May 2001. ARI purchased the remaining two million units in 2002. See NOTE 11. "PREFERRED STOCK."
On October 3, 2000, ARI and IORI entered into an agreement which provided IORI and ARI with an option to purchase 1,858,900 shares of common stock of TCI from a third party. On October 19, 2000, IORI assigned all of its rights to purchase such shares to ARI. The total cost to purchase the TCI shares was $30.8 million. In October 2000, ARI paid $5.6 million of the option price. In April 2001, the remainder of the option price was paid, and ARI acquired the TCI shares.
During 2002, MRI sold two restaurants to a corporation owned in part by an officer of MRI. In conjunction with the sale of these restaurants, MRI guaranteed the bank debt incurred by the related party. The guaranty applies to all current debt, and to all future debt of the related party until such time as the guaranty is terminated by MRI. The amount of the debt outstanding that is subject to the guaranty is $1,250,000 at December 31, 2002.
Litigation. In August 2002, ARI obtained a favorable jury verdict in the legal action entitled American Realty Trust v. Matisse Partners, L.L.C. ("Matisse"). However, the judge set aside the jury verdict and imposed a judgment against ARI in excess of $6.0 million. The judgment is being appealed, and, in the opinion of ARI's management and legal counsel, there is a reasonable probability that the adverse judgment will be set aside and the jury verdict reinstated. Therefore, ARI has not recognized any expense nor established any reserve for this judgment. In November 2002, ARI posted a $6.0 million supercedeas bond. In April 2003, an additional judgment was issued against ARI for $1.2 million in legal fees. ARI will also appeal this judgment and will post an additional bond in this amount.
In addition to Matisse, ARI is involved in various lawsuits arising in the ordinary course of business. In the opinion of management the outcome of these lawsuits will not have a material impact on ARI's financial condition, results of operations or liquidity.
NOTE 24. GOODWILL AND OTHER INTANGIBLES--ADOPTION OF SFAS 142
In June 2001, the Financial Accounting Standards Board finalized Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS 141"), and No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 141 requires the use of the purchase method of accounting and prohibits the use of the pooling-of-interests method of accounting for business combinations initiated after June 30, 2001. SFAS 141 also requires that ARI recognize acquired intangible assets apart from goodwill if the acquired intangible assets meet certain criteria. SFAS 141 applies to all business combinations initiated after June 30, 2001. It also requires, upon adoption of SFAS 142, that ARI reclassify the carrying amounts of intangible assets and goodwill based on the criteria in SFAS 141.
SFAS 142 requires, among other things, that companies no longer amortize goodwill, but instead test goodwill for impairment at least annually. In addition, SFAS 142 requires that ARI identify reporting units in order to assess potential future impairment of goodwill, reassess the useful lives of other existing recognized
AMERICAN REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
intangible assets, and cease amortization of intangible assets with an indefinite useful life. SFAS 142 requires that an intangible asset with an indefinite useful life be tested for impairment in accordance with specified guidelines. SFAS 142 is required to be applied in fiscal years beginning after December 15, 2001 to all goodwill and other intangible assets recognized at that date, regardless of when those assets were initially recognized. SFAS 142 required ARI to complete a transitional goodwill impairment test six months from the date of adoption. ARI was also required to reassess the useful lives of other intangible assets within the first interim quarter after adoption of SFAS 142.
The adoption of SFAS 141 did not have a material impact on ARI's results of operations and financial position. ARI adopted SFAS 142 on January 1, 2002, and accordingly ceased amortizing costs in excess of net assets acquired. In connection with the adoption of SFAS 142, ARI completed the first step of the goodwill impairment test during the quarter ended June 30, 2002. Based on the results of this step, ARI believes that the fair value of its reporting unit that carries goodwill exceeds its carrying amount. Since the first step of the goodwill impairment test indicates that goodwill is not impaired, the second step of the goodwill impairment test is not necessary.
Transitional Disclosures. Net income (loss) and earnings per share, including the after-tax effect of amortization expense related to costs in excess of net assets acquired for 2002, 2001 and 2000 are as follows:
Acquisitions. On June 30, 2002, ARI acquired RAK from BCM, a related party, for $6.0 million. ARI recorded $1.9 million in goodwill as a result of this transaction. See NOTE 10. "RELATED PARTY TRANSACTIONS." ARI made no acquisitions resulting in goodwill during 2001.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 25. SUBSEQUENT EVENTS
In 2003, ARI sold the following property:
- -------- (1) Sold to TCI to satisfy debt. Gain deferred until sale to unrelated party.
In 2003, ARI financed/refinanced or obtained second mortgage financing on the following:
- -------- (1) Variable interest rate.
In March 2003, ARI sold three mortgage notes receivable, with a balance of $27.5 million, to a financial institution. The sales price was $26.4 million, representing a discount of 4% from the original balance, plus accrued but unpaid interest. ARI received $17.5 million in cash, after debt paydown of $11.9 million.
Notes receivable. In March 2003, ARI sold the Grand Hotel Sofia for $24.8 million, receiving $6.3 million in cash after paying closing costs and debt assumption and providing purchase money financing of $13.5 million. The loan is non-interest-bearing for 90 days, then bears interest at 9.0% per annum for the next 90 days and matures in September 2003. The purchaser has the right to extend the note at 9.0% per annum for an additional 90 days by providing notice of intent at least 15 days prior to maturity and paying a 1.5% extension fee on the unpaid principal balance. After the 90 day interest-free period, monthly interest payments are required.
Also in March 2003, ARI sold an 89.3 acre tract of its Katrina land parcel for $8.5 million, paying $410,000 after payment of closing costs and debt paydown and providing purchase money financing of $5.6 million. The note bears interest at 8.0% per annum and matures three years after the recording of the Deed of Trust. Interest begins accruing after improvements to the site have been completed by ARI. The future costs to ARI to complete
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
the improvements are estimated to be $2.5 million. A principal payment of $450,000 is due within ten days after a Tentative Parcel Map is recorded. Interest payments will be due on the first day of each calendar quarter, beginning with the first quarter following the completion of the site improvements.
On November 15, 2002, ARI commenced a tender offer for the IORI and TCI shares. The tender offer was completed on March 19, 2003. ARI paid $19.00 cash per IORI share and $17.50 cash per TCI share for the stock held by non-affiliated stockholders. Pursuant to the tender offer, ARI acquired 265,036 IORI shares and 1,213,226 TCI shares. The completion of the tender offer fulfills the obligations under the Olive Settlement, and the Olive Litigation has been dismissed with prejudice. After the tender offer, ARI owned 64.8% of the outstanding shares of TCI and 46.9% of the outstanding shares of IORI.
In February 1990, ARI sold the Bridgeview Plaza Shopping Center, located in LaCrosse, Wisconsin, providing purchase money financing of $5.0 million in the form of a wrap mortgage. In 1996, the first lienholder called a default under the ARI wrap note, and directed future payments be made directly to them. ARI began legal proceedings against the first lienholder. In December 1999, ARI sold the note to BCM at its carrying value of $489,000, retaining the right to receive any amounts collected by BCM in excess of the amount paid, plus accrued interest. In 2002, ARI prevailed in its litigation and ARI's lien on the property was restored. The borrower continued in default, and ARI foreclosed on the property in March 2003.
SCHEDULE III
AMERICAN REALTY INVESTORS, INC.
REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 2002
SCHEDULE III (Continued)
AMERICAN REALTY INVESTORS, INC.
REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 2002
SCHEDULE III (Continued)
AMERICAN REALTY INVESTORS, INC.
REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 2002
SCHEDULE III (Continued)
AMERICAN REALTY INVESTORS, INC.
REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 2002
- -------- (1) The aggregate cost for federal income tax purposes is $505.7 million. (2) Write down of property to estimated net realizable value. (3) Cost basis assigned to portion of property sold. (4) Purchase accounting basis adjustment to Partnership properties. (5) Acquisition of ground lease. (6) Pledged as collateral on a loan primarily secured by another parcel of land. (7) Impairment loss.
SCHEDULE III (Continued)
AMERICAN REALTY INVESTORS, INC.
REAL ESTATE AND ACCUMULATED DEPRECIATION--(Continued)
SCHEDULE IV
AMERICAN REALTY INVESTORS, INC.
MORTGAGE LOANS ON REAL ESTATE December 31, 2002
SCHEDULE IV (Continued)
AMERICAN REALTY INVESTORS, INC.
MORTGAGE LOANS ON REAL ESTATE December 31, 2002
- -------- (1) The aggregate cost for federal income tax purposes is $85.1 million. (2) Interest rates and maturity dates shown are as stipulated in the loan documents at December 31, 2002. Where applicable, these rates have been adjusted at issuance to yield between 8% and 12%.
SCHEDULE IV (Continued)
AMERICAN REALTY INVESTORS, INC.
MORTGAGE LOANS ON REAL ESTATE
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
Directors
The affairs of American Realty Investors, Inc. ("ARI") are managed by a Board of Directors. The Directors are elected at the annual meeting of stockholders or are appointed by the incumbent Board and serve until the next annual meeting of stockholders or until a successor has been elected or appointed.
The Directors of ARI are listed below, together with their ages, terms of service, all positions and offices with ARI or its advisor, Basic Capital Management, Inc. ("BCM"), their principal occupations, business experience and directorships with other companies during the last five years or more. The designation "Affiliated" when used below with respect to a Director means that the Director is an officer, director or employee of BCM or an officer or employee of ARI. The designation "Independent", when used below with respect to a Director, means that the Director is neither an officer or employee of ARI nor a director, officer or employee of BCM, although ARI may have certain business or professional relationships with such Director, as discussed in ITEM 13. "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS--Certain Business Relationships."
TED P. STOKELY: Age 69, Director and Chairman of the Board (Independent) (since November 2002).
General Manager (since January 1995) of ECF Senior Housing Corporation, a nonprofit corporation; General Manager (since January 1993) of Housing Assistance Foundation, Inc., a nonprofit corporation; Part-time unpaid consultant (since January 1993) and paid consultant (April 1992 to December 1992) of Eldercare Housing Foundation ("Eldercare"), a nonprofit corporation; General Manager (since April 2002) of Unified Housing Foundation, Inc., a nonprofit corporation; Director (since April 1990) and Chairman of the Board (since January 1995) of Income Opportunity Realty Investors, Inc. ("IORI") and Transcontinental Realty Investors, Inc. ("TCI").
EARL D. CECIL: Age 73, Director (Independent) (since November 2001).
Financial and business consultant (since January 1994); Division Vice President (February 1987 to December 1993) of James Mitchell & Company, a financial services marketing organization; and Director (since March 2002) of IORI and TCI.
RICHARD W. HUMPHREY: Age 55, Director (Affiliated) (since November 2001).
Real estate broker (since January 2003) of Regis Realty I, LLC, (December 1999 to December 2002) of Regis Realty, Inc. and (June 1992 to November 1999) of Carmel Realty, Inc.; and President and Treasurer (since November 2000) of Unified Housing Foundation.
JOSEPH MIZRACHI: Age 57, Director (Independent) (since August 2000).
Registered Investment Advisor and Principal and President (since 1980) of PAZ Securities, Inc.; Chairman of the Board (since 1980) of Midwest Properties Management, Inc.; Director (since June 2001) of Tarrant Apparel Group; and Director of ART (June 2000 to August 2000).
Board Meetings and Committees
The Board of Directors held twenty meetings during 2002. For such year, Joseph Mizrachi was the only incumbent Director who attended fewer than 75% of the aggregate of (1) the total number of meetings held by
the Board during the period for which he or she had been a Director and (2) the total number of meetings held by all committees of the Board on which he or she served during the periods that he or she served.
The Board of Directors has an Audit Committee, the function of which is to review ARI's operating and accounting procedures. The members of the Audit Committee, all of whom are Independent Directors, are Messrs. Cecil, Mizrachi and Stokely. The Audit Committee met nine times during 2002.
The Board of Directors has a Stock Option Committee the function of which is to administer ARI's stock option plan. Mr. Cecil is the only member of the Stock Option Committee. The Stock Option Committee did not meet in 2002.
The Board of Directors does not have nominating or compensation committees.
Executive Officers
The following persons currently serve as executive officers of ARI: Mark W. Branigan, Executive Vice President--Residential; Louis J. Corna, Executive Vice President--Tax; and Ronald E. Kimbrough, Acting Principal Executive Officer, Executive Vice President and Chief Financial Officer. Their positions with ARI are not subject to a vote of stockholders. Their ages, terms of service, all positions and offices with ARI or BCM, other principal occupations, business experience and directorships with other companies during the last five years or more are set forth below.
MARK W. BRANIGAN: Age 48, Executive Vice President--Residential (since June 2001), Director (September 2000 to June 2001), and Executive Vice President and Chief Financial Officer (August 2000 to June 2001).
Executive Vice President--Residential (since June 2001), Executive Vice President and Chief Financial Officer (August 2000 to June 2001), Vice President--Director of Construction (August 1999 to August 2000) and Executive Vice President--Residential Management (January 1992 to October 1997) of BCM, TCI and IORI; Vice President--Director of Construction (August 1999 to August 2000) and Executive Vice President--Residential Asset Management (January 1992 to October 1997) of ART; and real estate consultant (November 1997 to July 1999).
LOUIS J. CORNA: Age 55, Executive Vice President--Tax (since October 2001), Executive Vice President and Chief Financial Officer (June 2001 to October 2001), and Senior Vice President--Tax (December 2000 to June 2001).
Executive Vice President--Tax (since October 2001), Executive Vice President and Chief Financial Officer (June 2001 to October 2001) and Senior Vice President--Tax (December 2000 to June 2001) of BCM, TCI and IORI; Private Attorney (January 2000 to December 2000); Vice President--Taxes and Assistant Treasurer (March 1998 to January 2000) of IMC Global, Inc.; and Vice President--Taxes (July 1991 to February 1998) of Whitman Corporation.
RONALD E. KIMBROUGH: Age 50, Acting Principal Executive Officer (since February 2002) and Executive Vice President and Chief Financial Officer (since January 2002).
Acting Principal Executive Officer, Executive Vice President and Chief Financial Officer (since January 2002) of BCM, TCI and IORI; Controller (September 2000 to January 2002) of BCM; Director, Vice President and Treasurer (since February 2002) of First Equity Properties, Inc.; Vice President and Treasurer (January 1998 to September 2000) of Syntek West, Inc. and One Realco Corporation; and Consultant (1997).
Officers
Although not an executive officer, Robert A. Waldman currently serves as Senior Vice President, Secretary and General Counsel. His position with ARI is not subject to a vote of stockholders. His age, term of service,
all positions and offices with ARI or BCM, other principal occupations, business experience and directorships with other companies during the last five years or more is set forth below.
ROBERT A. WALDMAN: Age 50, Senior Vice President, Secretary and General Counsel (since August 2000).
Senior Vice President and General Counsel (since January 1995), Vice President (December 1990 to January 1995) and Secretary (December 1993 to February 1997 and since June 1999) of IORI and TCI; Senior Vice President and General Counsel (since November 1994), Vice President and Corporate Counsel (November 1989 to November 1994) and Secretary (since November 1989) of BCM; Senior Vice President and General Counsel (since January 1995), Vice President (January 1993 to January 1995) and Secretary (since December 1989) of ART; and Senior Vice President, Secretary and General Counsel (since January 1998) of NMC.
In addition to the foregoing officer, ARI has several vice presidents and assistant secretaries who are not listed herein.
Compliance with Section 16(a) of the Securities Exchange Act of 1934
Under the securities laws of the United States, ARI's Directors, executive officers, and any persons holding more than 10 percent of ARI's shares of Common Stock are required to report their ownership and any changes in that ownership to the Securities and Exchange Commission (the "Commission"). Specific due dates for these reports have been established and ARI is required to report any failure to file by these dates during 2002. All of these filing requirements were satisfied by ARI's Directors and executive officers and 10 percent holders. In making these statements, ARI has relied on the written representations of its incumbent Directors and executive officers and its 10 percent holders and copies of the reports that they have filed with the Commission.
The Advisor
Although the Board of Directors is directly responsible for managing the affairs of ARI and for setting the policies which guide it, the day-to-day operations of ARI are performed by BCM, a contractual advisor under the supervision of the Board. The duties of the advisor include, among other things, locating, investigating, evaluating and recommending real estate and mortgage loan investment and sales opportunities as well as financing and refinancing sources. BCM also serves as consultant in connection with ARI's business plan and investment policy decisions made by the Board.
BCM, an affiliate, serves as advisor to ARI. BCM is indirectly owned by a trust for the children of Gene E. Phillips. Mr. Phillips is not an officer or director of BCM, but serves as a representative of the trust, is involved in daily consultation with the officers of BCM and has significant influence over the conduct of BCM's business, including the rendering of advisory services and the making of investment decisions for itself and ARI. As of March 19, 2003, BCM owned 6,666,744 shares of ARI's Common Stock, approximately 58.6% of the shares then outstanding.
The Advisory Agreement provides for the advisor to receive monthly base compensation at the rate of 0.0625% per month (0.75% on an annualized basis) of Average Invested Assets.
In addition to base compensation, BCM, an affiliate of BCM, or a related party receives the following forms of additional compensation:
(1) an acquisition fee for locating, leasing or purchasing real estate for ARI in an amount equal to the lesser of (1) the amount of compensation customarily charged in similar arm's-length transactions or (2) up to 6% of the costs of acquisition, inclusive of commissions, if any, paid to non-affiliated brokers;
(2) a disposition fee for the sale of each equity investment in real estate in an amount equal to the lesser of (1) the amount of compensation customarily charged in similar arm's-length transactions or (2) 3% of the sales price of each property, exclusive of fees, if any, paid to non-affiliated brokers;
(3) a loan arrangement fee in an amount equal to 1% of the principal amount of any loan made to ARI arranged by BCM;
(4) an incentive fee equal to 10% of net income for the year in excess of a 10% return on stockholders' equity, and 10% of the excess of net capital gains over net capital losses, if any, realized from sales of assets;
(5) a mortgage placement fee, on mortgage loans originated or purchased, equal to 50%, measured on a cumulative basis, of the total amount of mortgage origination and placement fees on mortgage loans advanced by ARI for the fiscal year.
The Advisory Agreement further provides that BCM shall bear the cost of certain expenses of its employees, excluding fees paid to ARI's Directors; rent and other office expenses of both BCM and ARI (unless ARI maintains office space separate from that of BCM); costs not directly identifiable to ARI's assets, liabilities, operations, business or financial affairs; and miscellaneous administrative expenses relating to the performance by BCM of its duties under the Advisory Agreement.
If and to the extent that ARI shall request BCM, or any director, officer, partner or employee of BCM, to render services to ARI other than those required to be rendered by BCM under the Advisory Agreement, such additional services, if performed, will be compensated separately on terms agreed upon between such party and ARI from time to time.
The Advisory Agreement automatically renews from year to year unless terminated in accordance with its terms. ARI's management believes that the terms of the Advisory Agreement are at least as fair as could be obtained from unaffiliated third parties.
Situations may develop in which the interests of ARI are in conflict with those of one or more Directors or officers in their individual capacities or of BCM, or of their respective affiliates. In addition to services performed for ARI, as described above, BCM actively provides similar services as agent for, and advisor to, other real estate enterprises, including persons and entities involved in real estate development and financing, including IORI and TCI. The Advisory Agreement provides that BCM may also serve as advisor to other entities.
As advisor, BCM is a fiduciary of ARI's public investors. In determining to which entity a particular investment opportunity will be allocated, BCM will consider the respective investment objectives of each entity and the appropriateness of a particular investment in light of each such entity's existing mortgage note and real estate portfolios and business plan. To the extent any particular investment opportunity is appropriate to more than one such entity, such investment opportunity will be allocated to the entity that has had funds available for investment for the longest period of time, or, if appropriate, the investment may be shared among various entities. See ITEM 13. "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS--Certain Business Relationships."
The directors and principal officers of BCM are set forth below:
Mickey N. Phillips is the brother of Gene E. Phillips and Ryan T. Phillips is the son of Gene E. Phillips. Gene E. Phillips serves as a representative of the trust established for the benefit of his children which owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to its performance of advisory services for ARI.
Property Management and Real Estate Brokerage
Affiliates of BCM provided property management services to ARI. Currently, Triad Realty Services, Ltd. ("Triad"), an affiliate, and Carmel Realty, Inc. ("Carmel") provide property management services to ARI's properties for a fee of 5% or less of the monthly gross rents collected on the residential properties under its management and 3% or less of the monthly gross rents collected on the commercial properties under its management. Triad and Carmel subcontract with other entities for the provision of the property-level management services at various rates. The general partner of Triad is BCM. The limited partner of Triad is Highland Realty Services, Inc. ("Highland"), a related party. Until December 2002, Triad subcontracted the property-level management and leasing of 12 of ARI's commercial properties (shopping centers, office buildings and a merchandise mart) and eight of its hotels to Regis Realty, Inc. ("Regis"), a related party, which was a company owned by GS Realty Services, Inc. Regis was entitled to receive property and construction management fees and leasing commissions in accordance with the terms of its property-level management agreement with Triad. Since January 1, 2003, Regis Realty I, LLC ("Regis I"), has provided these services. Regis I is owned by Highland. Regis Hotel Corporation, a related party, managed eight of ARI's hotels, until December 2002. Since January 1, 2003, Regis Hotel I, LLC, has managed eight of ARI's hotels. The sole member of Regis I and Regis Hotel I, LLC is Highland. Carmel is a company owned by First Equity Properties, Inc., which is a company affiliated with BCM.
Regis I, a related party, provides real estate brokerage services to ARI and receives brokerage commissions in accordance with the Advisory Agreement.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
ARI has no employees, payroll or benefit plans and pays no compensation to its executive officers. The Directors and executive officers of ARI who are also officers or employees of BCM are compensated by BCM. Such affiliated Directors and executive officers perform a variety of services for BCM and the amount of their compensation is determined solely by BCM. BCM does not allocate the cash compensation of its officers among the various entities for which it serves as advisor. See ITEM 10. "DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT--The Advisor" for a more detailed discussion of compensation payable to BCM by ARI.
The only direct remuneration paid by ARI is to those Directors who are not officers or employees of BCM or its affiliated companies. Until December 31, 2000, each Independent Director was compensated at the rate of $20,000 per year, plus $300 per Audit Committee meeting attended and the Chairman of the Audit Committee received an annual fee of $500. Effective January 1, 2001, the annual fee was increased from $20,000 to $45,000. In addition, each Independent Director receives an additional fee of $1,000 per day for any special services rendered outside of their ordinary duties as Director, plus reimbursement of expenses. During 2002, $162,000 was paid to Independent Directors in total Directors' fees for all services including the annual fee for service during the period January 1, 2002 through December 31, 2002, and 2002 special service fees as follows: Earl D. Cecil, $57,000; Collene C. Currie, $53,000; Joseph Mizrachi, $47,000; and Ted P. Stokely, $5,000.
In January 1999, stockholders approved the Director's Stock Option Plan (the "Director's Plan") which provides for options to purchase up to 40,000 shares of Common Stock. Options granted pursuant to the Director's Plan are immediately exercisable and expire on the earlier of the first anniversary of the date on which a Director ceases to be a Director or ten years from the date of grant. Each Independent Director was granted an option to purchase 1,000 shares at an exercise price of $17.71 per share on January 11, 1999, the date stockholders approved the plan. On January 1, 2000, 2001 and 2002, each Independent Director was granted an
option to purchase 1,000 shares at an exercise price of $18.53, $13.625 and $9.87 per share, respectively. Each Independent Director will be awarded an option to purchase an additional 1,000 shares on January 1 of each year. At December 31, 2002, 1,000 options were exercisable at $18.53 per share, 2,000 options were exercisable at $13.625 per share and 3,000 options were exercisable at $9.87 per share.
In January 1998, stockholders approved the 1997 Stock Option Plan (the "Option Plan") which provides for options to purchase up to 300,000 shares of Common Stock. At December 31, 2002, there were 99,750 options outstanding under the Option Plan. No options were granted under the Option Plan in 2002.
Performance Graph
The following graph compares the cumulative total stockholder return on ARI's shares (ART's shares prior to August 2000) of Common Stock with the Dow Jones Equity Market Index ("DJ Equity Index") and the Dow Jones Real Estate Investment Index ("DJ Real Estate Index"). The comparison assumes that $100 was invested on December 31, 1997 in shares of Common Stock and in each of the indices and further assumes the reinvestment of all dividends. Past performance is not necessarily an indicator of future performance.
[CHART] ARI DJ Equity Index DJ Real Estate Index 1997 100.00 100.00 100.00 1998 116.48 124.90 78.88 1999 121.26 153.28 74.69 2000 97.22 139.07 95.24 2001 70.40 122.50 106.49 2002 57.70 95.45 110.35
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Security Ownership of Certain Beneficial Owners. The following table sets forth the ownership of ARI's Common Stock both beneficially and of record, both individually and in the aggregate, for those persons or entities known by ARI to be the owner of more than 5% of the shares of ARI's Common Stock as of the close of business on March 19, 2003.
- -------- (1) Percentages are based upon 11,375,127 shares outstanding as of March 19, 2003. (2) Includes 6,666,744 shares owned by BCM over which each of the directors of BCM, Ryan T. Phillips and Mickey Ned Phillips, may be deemed to be beneficial owners by virtue of their positions as directors of BCM. The directors of BCM disclaim beneficial ownership of such shares. (3) Includes 1,437,209 shares owned by One Realco Corporation and 234,450 shares owned by New Starr Corp., which is a company owned by One Realco Corporation. Each of the directors of One Realco Corporation, Ronald F. Akin and F. Terry Shumate, may be deemed to be the beneficial owners by virtue of their positions as directors of One Realco Corporation. Messrs. Akin and Shumate disclaim beneficial ownership of such shares. (4) Each of the directors of TCI, Henry A. Butler, Earl D. Cecil, Ted P. Stokely and Martin L. White, may be deemed to be the beneficial owners by virtue of their positions as Directors of TCI. The directors of TCI disclaim such beneficial ownership. (5) Includes 27,602 shares owned by the Gene E. Phillips' Children's Trust. Ryan T. Phillips is a beneficiary of such trust.
Security Ownership of Management. The following table sets forth the ownership of shares of ARI's Common Stock, both beneficially and of record, both individually in the aggregate, for the Directors and executive officers of ARI, as of the close of business on March 19, 2003.
- -------- * Less than 1%. (1) Percentage is based upon 11,375,127 shares outstanding as of March 19, 2003. (2) Each of Messrs. Cecil, Humphrey, Mizrachi and Stokely have options to purchase shares of Common Stock of ARI which are exercisable within 60 days of March 19, 2003. (3) Includes 746,972 shares owned by TCI over which Messrs. Cecil and Stokely may be deemed to be the beneficial owners by virtue of their positions as members of the Board of Directors of TCI. Messrs. Cecil and Stokely disclaim beneficial ownership of such shares. (4) Includes 746,972 shares owned by TCI over which the executive officers of ARI may be deemed to be the beneficial owners by virtue of their positions as executive officers of TCI. The executive officers of ARI disclaim beneficial ownership of such shares. (5) Includes 6,666,744 shares owned by BCM over which the executive officers of ARI may be deemed to be the beneficial owners by virtue of their positions as executive officers of BCM. The executive officers of ARI disclaim beneficial ownership of such shares. Also includes 7,600 shares which may be acquired by the Directors of ARI pursuant to stock option plans.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Policies with Respect to Certain Activities
Article ELEVENTH of ARI's Articles of Incorporation provides that ARI shall not, directly or indirectly, contract or engage in any transaction with (1) any director, officer or employee of ARI, (2) any director, officer or employee of the advisor, (3) the advisor or (4) any affiliate or associate (as such terms are defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended) of any of the aforementioned persons, unless (a) the material facts as to the relationship among or financial interest of the relevant individuals or persons and as to the contract or transaction are disclosed to or are known by ARI's Board of Directors or the appropriate committee thereof and (b) ARI's Board of Directors or committee thereof determines that such contract or transaction is fair to ARI and simultaneously authorizes or ratifies such contract or transaction by the affirmative vote of a majority of independent directors of ARI entitled to vote thereon.
Article ELEVENTH defines an "Independent Director" as one who is neither an officer or employee of ARI, nor a director, officer or employee of ARI's advisor.
ARI's policy is to have such contracts or transactions approved or ratified by a majority of the disinterested Directors with full knowledge of the character of such transactions, as being fair and reasonable to the stockholders at the time of such approval or ratification under the circumstances then prevailing. Such Directors also consider the fairness of such transactions to ARI. Management believes that, to date, such transactions have represented the best investments available at the time and that they were at least as advantageous to ARI as other investments that could have been obtained.
ARI expects to enter into future transactions with entities the officers, directors or stockholders of which are also officers, Directors or stockholders of ARI, if such transactions would be beneficial to the operations of ARI
and consistent with ARI's then-current investment objectives and policies, subject to approval by a majority of disinterested Directors as discussed above.
ARI does not prohibit its officers, Directors, stockholders or related parties from engaging in business activities of the types conducted by ARI.
Certain Business Relationships
BCM, ARI's advisor, is a company for which Messrs. Branigan, Corna and Kimbrough serve as executive officers. BCM is a company owned by a trust for the benefit of the children of Gene E. Phillips.
The executive officers of ARI, also serve as executive officers of IORI and TCI, and owe fiduciary duties to each of those entities as well as to BCM under applicable law. IORI and TCI have the same relationship with BCM as does ARI.
ARI contracts with affiliates of BCM for property management services. Currently, Triad, an affiliate, and Carmel provide such property management services. The general partner of Triad is BCM. The limited partner of Triad is Highland, a related party. Triad subcontracts the property-level management of 12 of ARI's commercial properties (office buildings, shopping centers and a merchandise mart) and eight of its hotels to Regis I, a related party, which is a company also owned by Highland. Regis I also provides real estate brokerage services to ARI and receives brokerage commissions in accordance with the Advisory Agreement. Carmel is a company owned by First Equity Properties, Inc., which is a company affiliated with BCM. ARI owns an equity interest in each of IORI and TCI. See ITEM 2. "PROPERTIES--Investments in Real Estate Companies and Real Estate Partnerships."
At December 31, 2002, ARI owned approximately 49.8% of TCI's outstanding common stock and approximately 28.5% of IORI's outstanding common stock.
Related Party Transactions
Historically, ARI, TCI, IORI and BCM have each engaged in and may continue to engage in business transactions, including real estate partnerships, with related parties. Management believes that all of the related party transactions represented the best investments available at the time and were at least as advantageous to ARI as could have been obtained from unrelated parties.
Operating Relationships
In October 1997, ARI entered into leases with BCM and an affiliate of BCM for space at the One Hickory Centre Office Building, construction of which was completed in December 1998. The BCM leases, effective upon ARI obtaining permanent financing of the building, were for 75,852 sq. ft. (approximately 75% of the building), had terms of ten and fifteen years and provided for annual base rent of $19.25 per sq. ft. for the first year. In January 2001, both leases were terminated, and ARI entered into a new lease with BCM, effective October 1, 2000. The new lease is for 59,463 sq. ft. (approximately 62% of the building), has a term of three years, and provides for annual base rent of $1.3 million or $21.50 per sq.ft. Effective March 1, 2002, the lease was amended to 57,879 sq. ft. (approximately 59% of the building), with an annual base rent of $1.2 million, or $21.50 per sq. ft. In April 2002, ARI sold the subsidiary which owns the building to TCI.
In 2002, ARI paid BCM, its affiliates and a related party $5.9 million in advisory fees, $689,000 in mortgage brokerage and equity refinancing fees, $13,000 in property acquisition fees, $5.3 million in real estate brokerage commissions, $1.9 million in construction supervision fees and $4.3 million in property and construction management fees and leasing commissions, net of property management fees paid to subcontractors, other than affiliates of BCM. In addition, as provided in the Advisory Agreement, BCM received cost reimbursements of $2.5 million.
Partnership Transactions
BCM has entered into put agreements with certain holders of the Class A limited partner units of Ocean Beach Partners, L.P. The Class A units are convertible into Series D Cumulative Preferred Stock of ARI. The put price of the Series D Preferred Stock is $20.00 per share plus accrued but unpaid dividends.
BCM entered into put agreements with the holders of the Class A limited partner units of Valley Ranch, L.P. Such Class A units were convertible into Series B Cumulative Convertible Preferred Stock of ARI which was further convertible into Common Stock of ARI. The put price for the Class A units was $1.00 per unit and the put price for either the Series B Preferred Stock or ARI's Common Stock was 80% of the average daily closing price of ARI's Common Stock for the prior 20 trading days. In March 1999, ARI reached agreement with the Class A unitholders of Valley Ranch, L.P. to acquire their eight million Class A units for $1.00 per unit. In 1999, three million units were purchased. Additionally, one million units were purchased in January 2000 and two million units were purchased in May 2001. ARI purchased the remaining two million units in 2002.
BCM has entered into put agreements with the holders of the Class A units of ART Palm, L.P. Such Class A units are convertible into Series C Cumulative Convertible Preferred Stock of ARI. The put price for the Class A units is $1.00 per unit and the put price for either the Series C Preferred Stock or ARI's Common Stock is 90% of the average daily closing price of ARI's Common Stock for the prior 20 trading days. The put agreement calls for ARI to repurchase the outstanding Class A units as follows: June 30, 2003, 1,625,000 units; December 31, 2005, 1,625,000 units; and December 31, 2006, 8,563,750 units.
Advances and Loans
From time-to-time, ARI and its affiliates have made advances to each other, which have not had specific repayment terms, do not bear interest, are unsecured and have been reflected in ARI's financial statements as other assets or other liabilities. At December 31, 2002, after accounting for affiliate purchases and sales, amounts still owed by ARI were $26.6 million, $6.6 million, $3.5 million and $2.7 million to BCM, TCI, IORI and Regis, respectively.
In October 1999, ARI funded a $4.7 million loan to Realty Advisors, Inc., an affiliate. The loan, to provide funds for acquisitions or working capital needs, was secured by all of the outstanding shares of common stock of American Reserve Life Insurance Company. The loan bore interest at 10.25% per annum, and matured in November 2001. In January 2000, $100,000 was collected. In November 2001, the maturity date was extended to November 2004. The collateral was changed to a subordinate pledge of 850,000 shares of ARI Common Stock owned by BCM. The shares are also pledged to a lender on ARI's behalf. The interest rate was changed to 2% over the prime rate, currently 6.25% per annum, and the accrued but unpaid interest of $984,000 was added to the principal. The new principal balance is $5.6 million. All principal and accrued interest are due at maturity.
In March 2000, a loan with a current principal balance of $2.6 million to Lordstown, L.P., matured. The loan, to provide funds to purchase for resale various parcels of land, is secured by a second lien on land in Ohio and Florida, by 100% of the general and limited partner interest in Partners Capital, Ltd., the limited partner of Lordstown, L.P., and a profits interest in subsequent land sales. At December 2002, the loan, and $1.1 million of accrued interest, remained unpaid. A corporation controlled by Richard D. Morgan is the general partner of Lordstown, L.P. Mr. Morgan served as a director of ARI until October 2001.
In December 2000, an unsecured loan with a current principal balance of $1.9 million to Warwick of Summit, Inc. ("Warwick") matured. The loan was made to provide funds to purchase, renovate and expand a shopping center property in Warwick, Rhode Island. All principal and interest were due at maturity. At December 2002, the loan, and $188,000 of accrued interest, remained unpaid. Richard D. Morgan, a Warwick shareholder, served as a director of ARI until October 2001.
In December 2000, a loan with a current principal balance of $1.6 million to Bordeaux Investments Two, L.L.C. ("Bordeaux"), matured. The loan, to provide funds to purchase and renovate a shopping center in
Oklahoma City, Oklahoma, is secured by (1) a 100% interest in Bordeaux, which owns a shopping center in Oklahoma City, Oklahoma; (2) 100% of the stock of Bordeaux Investments One, Inc., which owns 6.5 acres of undeveloped land in Oklahoma City, Oklahoma; and (3) the personal guarantees of the Bordeaux members. At December 2002, the loan, and $710,000 of accrued interest, remained unpaid. Richard D. Morgan, a Bordeaux member, served as a director of ARI until October 2001.
In March 2001, ARI funded $13.6 million of a $15.0 million unsecured line of credit to One Realco Corporation ("One Realco"), which owns approximately 14.7% of the outstanding shares of ARI's Common Stock. One Realco periodically borrows money to meet its cash obligations. The line of credit bears interest at 12.0% per annum. All principal and interest were due at maturity in February 2002. The line of credit is guaranteed by BCM. In June 2001, $394,000 in principal and $416,000 in interest was collected. In December 2001, $21,000 in principal and $804,000 in interest was collected. In February 2002, the line of credit was increased to $18.0 million, accrued but unpaid interest of $217,000 was added to the principal and the maturity date was extended to February 2004. In March 2002, ARI funded an additional $1.8 million, increasing the outstanding principal balance to $15.5 million. In October 2002, $856,900 in interest was collected, by the return of 85,690 shares of ARI Series A Preferred Stock. All principal and interest are due at maturity. Ronald E. Kimbrough, Acting Principal Executive Officer, Executive Vice President and Chief Financial Officer of ARI, is a 10% shareholder of One Realco. During 2001 and 2002, Mr. Kimbrough did not participate in day-to-day operations or management of One Realco.
In June 2002, ARI converted $4.5 million of its receivable from BCM to a recourse note receivable. This transaction was to provide ARI with additional security over that provided by an unsecured receivable. The note bears interest at 10.0% per annum, matures in March 2004 and requires quarterly payments of principal and accrued interest, beginning in December 2002.
Property Transactions
In May 2001, ARI exchanged with TCI two parcels of land, a 10.5 acre tract of Vista Ridge land and an 8.88 acre tract of Hollywood Casino land, for the 168 unit Glenwood Apartments. The business purpose of the transaction was for TCI to construct apartments on the Vista Ridge land and office buildings on the Hollywood Casino land. ARI received net cash of $3.2 million on the subsequent sale of the apartments. See NOTE 2. "REAL ESTATE."
In December 2001, TCI purchased 100% of the outstanding common shares of National Melrose, Inc. ("NM"), a wholly-owned subsidiary of ARI, for $2.0 million. The purchase price was determined based upon the market value of the property exchanged, using a market rate multiple of net operating income. NM owns the Executive Court Office Building. ARI has guaranteed that the asset will produce at least a 12% annual return on the purchase price for a period of three years from the purchase date. If the asset fails to produce the annual return, ARI will pay TCI any shortfall. In addition, if the asset fails to produce the 12% return for a calendar year, TCI may require ARI to repurchase the shares of NM for the purchase price. The business purpose of the transaction was for TCI to make an equity investment in NM, anticipating a profitable return, and for ARI to receive cash for its equity investment. Management has classified this related party transaction as a note payable to TCI.
In January 2002, IORI purchased 100% of the outstanding common shares of Rosedale Corporation ("Rosedale"), a wholly-owned subsidiary of ARI, for $5.1 million. The purchase price was determined based upon the market value of the property exchanged, using a market rate multiple of net operating income. Rosedale owned the Rosedale Towers Office Building. ARI guaranteed that the asset would produce at least a 12% annual return on the purchase price for a period of three years from the purchase date. If the asset failed to produce the 12% return, ARI would pay IORI any shortfall. In addition, if the asset failed to produce the 12% return for a calendar year, IORI could require ARI to repurchase the shares of Rosedale for the purchase price. The business purpose of the transaction was for IORI to make an equity investment in Rosedale, anticipating a profitable
return, and for ARI to receive cash for its equity investment. Management classified this related party transaction as a note payable to IORI. IORI sold the Rosedale Towers Office Building to an unrelated buyer in December 2002. ARI owes $2.1 million to IORI for remaining principal and 12% return.
In January 2002, TCI purchased 100% of the common shares of ART Two Hickory Corporation ("Two Hickory"), a wholly-owned subsidiary of ARI, for $4.4 million. The purchase price was determined based upon the market value of the property exchanged, using a market rate multiple of net operating income. Two Hickory owns the Two Hickory Centre Office Building. ARI has guaranteed that the asset will produce at least a 12% annual return on the purchase price for a period of three years from the purchase date. If the asset fails to produce the 12% return, ARI will pay TCI any shortfall. In addition, if the asset fails to produce the 12% return for a calendar year, TCI may require ARI to repurchase the shares of Two Hickory for the purchase price. The business purpose of the transaction was for TCI to make an equity investment in Two Hickory, anticipating a profitable return, and for ARI to receive cash for its equity investment. Management has classified this related party transaction as a note payable to TCI.
In March 2002, ARI received $520,000 and exchanged with TCI a 24.5 acre tract of Rasor land, a 16.89 acre tract of Lakeshore Villas Apartments land and the 45,623 sq. ft. Oaktree Village Shopping Center for the 80,278 sq. ft. Plaza on Bachman Creek Shopping Center. The exchange value prices for the shopping centers were determined using a market rate multiple of net operating income, and the values of the land parcels were determined using appraised rates. The business purpose of the transaction was for TCI to construct apartments on the Rasor and Lakeshore Villas land. To give ample value for the property TCI exchanged, the Oaktree Village Shopping Center was added to the transaction. ARI received $4.4 million on the subsequent financing of the shopping center. Failure to notify and receive approval from the lender for this transaction may constitute an event of default under the terms of the debt assumed by TCI.
In April 2002, TCI purchased all of the general and limited partnership interest in Garden Confederate Point, L.P. ("Confederate Point") from ARI for $1.9 million. The purchase price was determined based on the market value of the property exchanged using a market rate multiple of net operating income. Confederate Point owns the Confederate Point Apartments. ARI has guaranteed that the asset will produce at least a 12% annual return on the purchase price for a period of three years from the purchase date. If the asset fails to produce the 12% return for a calendar year, TCI may require ARI to repurchase the interests in Confederate Point for the purchase price. The business purpose of this transaction was for TCI to make an equity investment in Confederate Point anticipating a profitable return and to reduce ARI's payable to BCM. Management has classified this related party transaction as a note payable to TCI. Failure to notify and receive approval from the lender for this transaction may constitute an event of default under the terms of the debt assumed by TCI.
In April 2002, TCI purchased all of the general and limited partnership interests in Garden Foxwood, L.P. ("Foxwood") from ARI for $1.1 million. The purchase price was determined based on the market values of the property exchanged, using a market rate multiple of net operating income. Foxwood owns the Foxwood Apartments. ARI has guaranteed that the asset will produce at least a 12% annual return on the purchase price for a period of three years from the purchase date. If the asset fails to produce the 12% return, ARI will pay TCI any shortfall. In addition, if the asset fails to produce the 12% return for a calendar year, TCI may require ARI to repurchase the interests in Foxwood for the purchase price. The business purpose for the transaction was for TCI to make an equity investment in Foxwood anticipating a profitable return and to reduce ARI's payable to BCM. Management has classified this related party transaction as a note payable to TCI. Failure to notify and receive approval from the lender for this transaction may constitute an event of default under the terms of the debt assumed by TCI.
In April 2002, TCI purchased all of the general and limited partnership interests in Garden Woodsong, L.P. ("Woodsong") from ARI for $2.5 million. The purchase price was determined based on the market values of the property exchanged, using a market rate multiple of net operating income. Woodsong owns the Woodsong Apartments. ARI has guaranteed that the asset will produce at least a 12% annual return on the purchase price for
a period of three years from the purchase date. If the asset fails to produce the 12% return, ARI will pay TCI any shortfall. In addition, if the asset fails to produce the 12% return for a calendar year, TCI may require ARI to repurchase the interests in Woodsong for the purchase price. The business purpose for the transaction was for TCI to make an equity investment in Woodsong anticipating a profitable return and to reduce ARI's payable to BCM. Management has classified this related party transaction as a note payable to TCI. In July 2002, the Woodsong Apartments was sold for $9.1 million. TCI received $2.6 million from the proceeds of $2.8 million as payment of principal and accrued but unpaid interest on the loan.
In April 2002, TCI purchased 100% of the common shares of ARI One Hickory Corporation ("One Hickory"), a wholly-owned subsidiary of ARI, for $4.5 million. The purchase price was determined based on the market values of the property exchanged, using a market rate multiple of net operating income. One Hickory owns the One Hickory Centre Office Building. ARI has guaranteed that the asset will produce at least a 12% annual return on the purchase price for a period of three years from the purchase date. If the asset fails to produce the 12% return, ARI will pay TCI any shortfall. In addition, if the asset fails to produce the 12% return for a calendar year, TCI may require ARI to repurchase the interests in One Hickory for the purchase price. The business purpose for the transaction was for TCI to make an equity investment in One Hickory anticipating a profitable return and to reduce ARI's payable to BCM. Management has classified this related party transaction as a note payable to TCI. Failure to notify and receive approval from the lender for this transaction may constitute an event of default under the terms of the debt assumed by TCI.
In June 2002, TCI purchased Centura Tower, Ltd. partnership, which owns the Centura Tower Office Building, from ARI for $50.0 million. See NOTE 2. "REAL ESTATE." The purchase price for the Centura Tower was determined based on appraised value and replacement cost. The business purpose of the transaction was for TCI to acquire a Class A office building with significant upside potential anticipating a profitable return and for ARI to satisfy debt.
In June 2002, TCI purchased five parcels of unimproved land from ARI for $30.0 million: the Hollywood Casino, Marine Creek, Mason Goodrich, Nashville and Monterrey land parcels. See NOTE 2. "REAL ESTATE." The purchase price of the Hollywood Casino land was determined based on an appraised value. The business purpose of the transaction was for TCI to consolidate its holdings within the Mercer Crossing development. The purchase price for the Marine Creek, Mason Goodrich, Nashville and Monterrey land parcels was determined based on appraised rates. The business purpose of the transaction was for TCI to develop apartments on these four tracts of land and for ARI to satisfy debt. Failure to notify and receive approval from the lender for this transaction may constitute an event of default under the terms of the debt assumed by TCI.
In June 2002, ARI purchased all the general and limited partnership interests in Chalet North, L.P. ("Chalet North") from BCM for $3.0 million. Chalet North owns the Pinecrest Apartments. The purchase price was determined based on the market value of the property exchanged, using a market rate multiple of net operating income. ARI assumed debt of $1.4 million. ARI's receivable from BCM was reduced by $1.6 million, and no cash was paid by ARI. The business purpose of the transaction was to reduce the affiliate payable owed by BCM to ARI.
In June 2002, ARI purchased the Tiberon Trails Apartments from BCM for $12.3 million. The purchase price was determined based on the market value of the property exchanged, using a market rate multiple of net operating income. ARI assumed debt of $6.4 million. ARI's receivable from BCM was reduced by $5.9 million, and no cash was paid by ARI. The business purpose of the transaction was to reduce the affiliate payable owed by BCM to ARI.
In June 2002, ARI purchased the Alta Mesa Shopping Center from BCM for $3.8 million. The purchase price was determined based on the market value of the property exchanged, using a market rate multiple of net operating income. ARI assumed debt of $1.8 million. ARI's receivable from BCM was reduced by $2.0 million, and no cash was paid by ARI. The business purpose of the transaction was to reduce the affiliate payable owed by BCM to ARI.
On June 30, 2002, ARI obtained 74.31% interest in RAK from BCM for $6.0 million. The business purpose of the transaction was to reduce the affiliate payable owed by BCM to ARI. ARI's receivable from BCM was reduced by $6.0 million, and no cash was paid by ARI. At the date of acquisition, RAK's assets consisted of $2.3 million in cash, $3.0 million in deposits and marketable securities, and $225,000 in other assets. RAK's net equity was $5.5 million. ARI recorded $1.9 million in goodwill as a result of this transaction.
In December 2002, ARI sold the Lakeshore Villas Apartments to Housing for Seniors of Humble, LLC ("Humble"), a related party, for $22.0 million, paying $764,000 after payment of closing costs and debt paydown and providing purchase money financing of $8.4 million. One loan has a principal amount of $2.0 million. The loan is unsecured, and is guaranteed by Unified Housing Foundation, Inc. ("Unified"), a related party. The second loan has a principal amount of $6.4 million, and is secured by a pledge by Unified of 100% of the Member Interest in Humble. Both loans bear interest at 11.5% per annum, mature in December 2009 and require quarterly payments beginning in March 2003. Richard W. Humphrey, a director of ARI, is the President of Humble and the President and Treasurer of Unified. Ted P. Stokely, Chairman of the Board and a director of ARI, is the General Manager of Unified.
In December 2002, TCI purchased the NLP/CH, Ltd. partnership, which owns the Centura Holdings, Clark and Woolley land parcels, from ARI for $13.3 million. See NOTE 2. "REAL ESTATE." The purchase price was determined based on an appraised rate. The business purpose of the transaction was for TCI to construct apartments on the land and for ARI to satisfy debt.
In March 2003, TCI purchased the Bridgeview Plaza and Cullman shopping centers from ARI for $8.7 million and $2.0 million, respectively, to satisfy debt. The purchase price was determined using a market rate multiple of net operating income.
PART IV
ITEM 14.
ITEM 14. CONTROLS AND PROCEDURES
(a) Within the 90 days prior to the date of this report, ARI carried out an evaluation, under the supervision and with the participation of ARI's management, including ARI's Acting Principal Executive Officer and Principal Accounting Officer, of the effectiveness of the design and operation of ARI's disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon the evaluation, ARI's Acting Principal Executive Officer and Principal Accounting Officer concluded that ARI's disclosure controls and procedures are effective in timely alerting him to material information relating to ARI (including its consolidated subsidiaries) required to be included in ARI's periodic SEC filings.
(b) There have been no significant changes in ARI's internal controls or in other factors that could significantly affect ARI's internal controls subsequent to the date ARI carried out this evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Report:
1. Consolidated Financial Statements
Report of Independent Certified Public Accountants
Consolidated Balance Sheets--December 31, 2002 and 2001
Consolidated Statements of Operations--Years Ended December 31, 2002, 2001 and 2000
Consolidated Statements of Stockholders' Equity--Years Ended December 31, 2002, 2001 and 2000
Consolidated Statements of Cash Flows--Years Ended December 31, 2002, 2001 and 2000
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
Schedule III--Real Estate and Accumulated Depreciation
Schedule IV--Mortgage Loans on Real Estate
All other schedules are omitted because they are not applicable or because the required information is shown in the financial statements or the notes thereto.
3. Incorporated Financial Statements
Consolidated Financial Statements of Income Opportunity Realty Investors, Inc. (Incorporated by reference to Item 8 of Income Opportunity Realty Investors, Inc.'s Annual Report on Form 10-K for the year ended December 31, 2002).
Consolidated Financial Statements of Transcontinental Realty Investors, Inc. (Incorporated by reference to Item 8 of Transcontinental Realty Investors, Inc.'s Annual Report on Form 10-K for the year ended December 31, 2002).
4. Exhibits
The following documents are filed as Exhibits to this Report:
(b) Reports on Form 8-K:
A Current Report on Form 8-K, dated November 11, 2002, was filed with respect to Item 5. "Other Events," which reports the resignation of a Director.
A Current Report on Form 8-K/A, dated August 30, 2002, was filed with respect to Item 2. "Acquisition and Disposition of Assets," and Item 7. "Financial Statements and Exhibits," which reports the disposition of 10 apartments and two commercial properties and 14 land parcels.
A Current Report on Form 8-K, dated March 18, 2003, was filed with respect to Item 5. "Other Events," which reports the completion of a cash tender offer to purchase any and all the issued and outstanding common stock of IORI and TCI.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.
Signature Title Date --------- ----- ----
/s/ TED P. STOKELY Chairman of the Board and April 14, 2003 - ----------------------------- Director Ted P. Stokely
/s/ EARL D. CECIL Director April 14, 2003 - ----------------------------- Earl D. Cecil
/s/ RICHARD W. HUMPHREY Director April 14, 2003 - ----------------------------- Richard W. Humphrey
/s/ JOSEPH MIZRACHI Director April 14, 2003 - ----------------------------- Joseph Mizrachi
/s/ RONALD E. KIMBROUGH Executive Vice President and April 14, 2003 - ----------------------------- Chief Financial Officer Ronald E. Kimbrough (Principal Financial and Accounting Officer and Acting Principal Executive Officer)
CERTIFICATION
I, Ronald E. Kimbrough, Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer and Acting Principal Executive Officer) of American Realty Investors, Inc. ("ARI"), certify that:
1. I have reviewed this annual report on Form 10-K of ARI;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. I am responsible for establishing and maintaining internal controls and procedures and have:
a. designed such internal controls to insure that material information relating to ARI and its consolidated subsidiaries is made known to me by others within those entities, particularly for the periods presented in this quarterly report;
b. evaluated the effectiveness of ARI's internal controls as of a date within 90 days prior to the filing date of this annual report; and
c. presented in this annual report my conclusions about the effectiveness of the disclosure controls and procedures based on a date within 90 days prior to the filing date of this annual report;
5. I have disclosed to ARI's auditors and Audit Committee of the Board of Directors (or persons fulfilling the equivalent function):
a. all significant deficiencies in the design or operation of internal controls which could adversely affect ARI's ability to record, process, summarize, and report financial data and have identified for ARI's auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or other employees who have a significant role in ARI's internal controls; and
6. I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of my most recent evaluation, including corrective actions with regard to significant deficiencies and material weaknesses.
ANNUAL REPORT ON FORM 10-K
EXHIBIT INDEX
For the Year Ended December 31, 2002