UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q/A
(Amendment No. 1)

(Mark One)
x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2006

OR

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number 1-31987

Affordable Residential Communities Inc.

(Exact name of Registrant as specified in its charter)

 

(303) 291-0222

(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer o Accelerated filer x Non-accelerated filer o

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o  No x

The number of shares of the Registrant’s common stock outstanding at May 5, 2006 was 41,298,339.

AFFORDABLE RESIDENTIAL COMMUNITIES INC.
FORM 10-Q/A
FOR THE QUARTER ENDED MARCH 31, 2006

Explanatory Note

On March 8, 2007, the Audit Committee of the Board of Directors of Affordable Residential Communities Inc. (the “Company”) determined that the Company should restate its unaudited consolidated financial statements as of and for the quarterly periods ended March 31, 2006, June 30, 2006 and September 30, 2006, to correct the allocation of income taxes (intra-period tax allocation) between continuing operations and discontinued operations for the first three quarters of 2006, as more fully described below. The Company does not expect any aggregate income tax expense or benefit for the year ended December 31, 2006.  The above corrections do not have an adverse impact on any covenants associated with the Company’s debt facilities.  As a result of the restatement, we are amending our originally filed Form 10-Q.

This amended report does not reflect events occurring after the filing of the original Form 10-Q except for the following: (1) amounts have been recast for discontinued communities; (2) in accordance with SFAS No. 128, Earnings per Share, our basic and diluted weighted average shares outstanding have been increased by a factor of approximately 1.06 to reflect the dilutive impact of our January 2007 rights offering in which ten million shares of our common stock were purchased by our stockholders at the below-market price of $8.00 per share; and (3) the items reflected in Note 14 – Subsequent Events.  This filing should be read in conjunction with the Company’s filings with the Securities and Exchange Commission subsequent to the filing of the initial reports.

Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (“SFAS 109”), requires that a company with a loss from continuing operations consider all items reported apart from continuing operations (for example extraordinary items, discontinued operations and other comprehensive income) in determining the tax benefit that results from a loss from continuing operations. In our case, because we had a loss from continuing operations and a gain from discontinued operations in each of the periods referenced above, in accordance with SFAS 109 and Emerging Issues Task Force Topic D32, Intra-period Tax Allocation of the Tax Effect of Pre-Tax Income from Continuing Operations, we should have considered the gain from discontinued operations in determining the amount of tax benefit to allocate to continuing operations.    However, we originally determined the allocation of income taxes (intra-period allocation) between continuing and discontinued operations using a “with and without” methodology. That is, we did not believe that a tax benefit resulted from the loss from continuing operations because we did not believe there was an incremental benefit from the loss generated from our continuing operations. Additionally, we believed that the gain from discontinued operations did not attract a tax consequence.

In accordance with FASB Interpretation No. 18, Accounting for Income Taxes in Interim Periods — An Interpretation of APB Opinion No. 28 , the tax benefit recognized in continuing operations is calculated using an effective rate methodology and therefore will be provided for over the course of the year. The tax expense recognized in discontinued operations is recognized on a discrete basis and therefore the entire amount of tax expense is recognized at the time the pretax gain on the discontinued operations is recognized.  This mismatch in the timing of the recognition of tax benefits and expense resulted in a restatement of the net loss for the quarter ended March 31, 2006.

We have also updated our evaluation of disclosure controls and procedures, as reflected in Item 4. Controls and Procedures.

 

Item		Description		Page
		PART I — FINANCIAL INFORMATION
1.		Consolidated Financial Statements
		Consolidated Balance Sheets as of March 31, 2006 (as restated) and December 31, 2005 (unaudited)		2
		Consolidated Statements of Operations for the Three Months ended March 31, 2006 (as restated) and 2005 (unaudited)		3
		Consolidated Statements of Cash Flows for the Three Months ended March 31, 2006 (as restated) and 2005 (unaudited)		4
		Notes to Consolidated Financial Statements (unaudited)		5
2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		24
3.		Quantitative and Qualitative Disclosures About Market Risk		35
4.		Controls and Procedures		36
		PART II — OTHER INFORMATION
6.		Exhibits		37

 

 

1

AFFORDABLE RESIDENTIAL COMMUNITIES INC.
CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 2006 AND DECEMBER 31, 2005
(in thousands, except share and per share data)
(unaudited)

		March 31, 2006			December 31, 2005
		(as restated)
Assets
Rental and other property, net		$	1,434,422		$	1,453,097
Assets held for sale		78,925			132,340
Cash and cash equivalents		31,312			27,926
Restricted cash		6,702			7,022
Tenant and other receivables, net		3,366			3,942
Notes receivable, net		33,622			33,418
Loan origination costs, net		15,405			16,164
Loan reserves		35,307			35,088
Lease intangibles and customer relationships, net		10,660			12,055
Prepaid expenses and other assets		9,122			7,429
Total assets		$	1,658,843		$	1,728,481
Liabilities and Stockholders’ Equity
Notes payable		$	1,106,258		$	1,146,331
Liabilities related to assets held for sale		37,886			56,827
Accounts payable and accrued expenses		25,471			32,653
Dividends payable		1,903			1,887
Tenant deposits and other liabilities		19,179			14,786
Total liabilities		1,190,697			1,252,484
Minority interest		29,178			31,902
Commitments and contingencies
Stockholders’ equity
Preferred stock, no par value, 5,750,000 shares authorized, 5,000,000 shares issued and outstanding at March 31, 2006 and December 31, 2005, respectively; liquidation preference of $25 per share plus accrued but unpaid dividends		119,108			119,108
Common stock, $.01 par value, 100,000,000 shares authorized, 41,288,948 and 40,971,423 shares issued and outstanding at March 31, 2006 and December 31, 2005, respectively		413			410
Additional paid-in capital		793,712			791,201
Accumulated other comprehensive income		—			583
Retained deficit		(474,265		)	(467,207		)
Total stockholders’ equity		438,968			444,095
Total liabilities and stockholders’ equity		$	1,658,843		$	1,728,481

 

The accompanying notes are an integral part of these consolidated financial statements.

2

AFFORDABLE RESIDENTIAL COMMUNITIES INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005
(in thousands, except per share data)
(unaudited)

		Three Months Ended March 31,
		2006			2005
		(as restated)
Revenue
Rental income		$	50,906		$	46,346
Sales of manufactured homes		2,672			7,464
Utility and other income		6,477			4,928
Net consumer finance interest income		179			—
Total revenue		60,234			58,738
Expenses
Property operations		16,422			18,242
Real estate taxes		5,136			3,967
Cost of manufactured homes sold		2,309			7,378
Retail home sales, finance and insurance		1,898			3,340
Property management		1,592			2,145
General and administrative		4,421			5,494
Depreciation and amortization		21,611			16,296
Loss on sale of airplane		541			—
Net consumer finance interest expense		—			446
Interest expense		19,581			15,689
Total expenses		73,511			72,997
Interest income		(423		)	(373		)
Loss from continuing operations before income tax benefit and allocation to minority interest		(12,854		)	(13,886		)
Income tax benefit from continuing operations		1,199			—
Loss from continuing operations before allocation to minority interest		(11,655		)	(13,886		)
Minority interest		236			544
Loss from continuing operations		(11,419		)	(13,342		)
Income from discontinued operations		1,692			781
Gain (loss) on sale of discontinued operations		10,296			(730		)
Income tax expense from discontinued operations		(4,795		)	—
Minority interest in discontinued operations		(253		)	(3		)
Net loss		(4,479		)	(13,294		)
Preferred stock dividend		(2,578		)	(2,578		)
Net loss attributable to common stockholders		$	(7,057	)	$	(15,872	)
Loss per share from continuing operations
		$	(0.32	)	$	(0.37	)
Diluted loss per share		$	(0.32	)	$	(0.37	)
Income per share from discontinued operations
Basic income per share		$	0.16		$	—
Diluted income per share		$	0.16		$	—
Loss per share attributable to common stockholders
Basic loss per share		$	(0.16	)	$	(0.37	)
Diluted loss per share		$	(0.16	)	$	(0.37	)
Weighted average share information
Basic shares outstanding		43,576			43,256

 

The accompanying notes are an integral part of these consolidated financial statements.

3

AFFORDABLE RESIDENTIAL COMMUNITIES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2006 and 2005
(in thousands)
(unaudited)

		Three Months Ended March 31,
		2006			2005
		(as restated)
Cash flow from operating activities
Net loss		$	(4,479	)	$	(13,294	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		21,611			16,296
Intra-period income taxes		3,596			—
Adjustments to fair value for interest rate caps		(312		)	219
Amortization of loan origination costs		1,434			1,693
Stock grant compensation expense		49			14
Partnership preferred unit distributions declared		276			393
Minority interest		(512		)	(937		)
Depreciation and minority interest included in income from discontinued operations		472			2,079
(Gain) loss on sale of discontinued operations		(10,296		)	730
Loss on sale of airplane		541			—
Gain on sale of manufactured homes		(363		)	(86		)
Changes in operating assets and liabilities		(8,078		)	(510		)
Net cash provided by operating activities		3,939			6,597
Cash flow from investing activities
Purchases of manufactured homes		(1,964		)	(11,681		)
Proceeds from community sales		60,804			37,378
Proceeds from manufactured home sales		2,561			7,240
Proceeds from sale of airplane		1,170			—
Community improvements and equipment purchases		(1,815		)	(26,359		)
Restricted cash		320			(9		)
Loan Reserves		(219		)	101
Net cash provided by investing activities		60,857			6,670
Cash flow from financing activities
Proceeds from issuance of debt		23,035			63,658
Repayment of debt		(80,918		)	(51,543		)
Payment of common dividends and OP unit distributions		—			(13,521		)
Payment of preferred dividends		(2,578		)	(2,578		)
Payment of partnership preferred distributions		(276		)	(393		)
Loan origination costs		(673		)	(1,349		)
Net cash used in financing activities		(61,410		)	(5,726		)
Net increase in cash and cash equivalents		3,386			7,541
Cash and cash equivalents, beginning of period		27,926			32,859
Cash and cash equivalents, end of period		$	31,312		$	40,400
Non-cash financing and investing transactions:
Notes receivable acquired from community sales		$	—		$	1,068
Notes receivable for manufactured home sales		$	95		$	—
Supplemental cash flow information:
Cash paid for interest		$	21,719		$	16,087

 

The accompanying notes are an integral part of these consolidated financial statements.

4

AFFORDABLE RESIDENTIAL COMMUNITIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

1.            Business, Basis of Presentation and Summary of Significant Accounting Policies

Business

Affordable Residential Communities Inc. is a Maryland corporation that is engaged in the acquisition, renovation, repositioning and operation of primarily all-age manufactured home communities, the retail sale and financing of manufactured homes, the rental of manufactured homes and other related businesses including acting as agent in the sale of homeowners’ insurance and related products, all exclusively to residents in our communities. We were organized in July 1998 and operate primarily through Affordable Residential Communities LP (the “Operating Partnership” or “OP”) and its subsidiaries, of which we are the sole general partner and owned 96.5% as of March 31, 2006.

As of March 31, 2006, we owned and operated 275 communities (net of 14 communities classified as discontinued operations, see Note 10) consisting of 57,246 homesites (net of 2,920 homesites classified as discontinued operations) in 23 states with occupancy of 83.6%. Our five largest markets are Dallas-Fort Worth, Texas, with 12.5% of our total homesites; Atlanta, Georgia, with 8.7% of our total homesites; Salt Lake City, Utah, with 6.6% of our total homesites; the Front Range of Colorado, with 5.7% of our total homesites; and Kansas City-Lawrence-Topeka, with 4.2% of our total homesites. We also conduct a retail home sales business.

Our common stock is traded on the New York Stock Exchange under the symbol “ARC”. Our Series A Cumulative Redeemable Preferred Stock is traded on the New York Stock Exchange under the symbol “ARC-PA”. We have no public trading history prior to February 12, 2004.

Basis of Presentation

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America and in conformity with the rules and regulations of the Securities and Exchange Commission requires us to make estimates and assumptions that affect the reported amount of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amount of revenues and expenses during the reporting period. Actual results may differ from previously estimated amounts.

The interim consolidated financial statements presented herein reflect all adjustments that are necessary to fairly present the financial position, results of operations and cash flows of the Company, and all such adjustments are of a normal and recurring nature. The results of operations for the interim period ended March 31, 2006 are not necessarily indicative of the results that may be expected for the year ended December 31, 2006. These financial statements should be read in conjunction with the financial statements included in our Current Report on Form 8-K for the year ended December 31, 2005 filed on October 5, 2006.

The accompanying consolidated financial statements include all of our accounts, which include the results of operations of the manufactured home communities acquired only for the periods subsequent to the date of acquisition.  We have eliminated all significant inter-company balances and transactions.

We have reclassified certain prior period amounts to conform to the current year presentation.

5

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Summary of Significant Accounting Policies

Rental and Other Property

We carry rental property at cost, less accumulated depreciation. We capitalize significant renovations and improvements that extend the useful life of assets and depreciate them over their estimated remaining useful lives. We expense maintenance and repairs as incurred.  Depreciation is computed primarily using the straight-line method over the estimated useful lives of the assets. The estimated useful lives of the various classes of rental property assets are as follows:

 

We evaluate the recoverability of our investment in rental property whenever events or changes in circumstances indicate that the recoverability of the net book value of the asset is questionable. Our assessment of the recoverability of rental property includes, but is not limited to, recent operating results and expected net operating cash flows from future operations. In the event that facts and circumstances indicate that the carrying amount of rental property may be impaired, we perform an evaluation of recoverability in which we compare the estimated future undiscounted cash flows associated with the asset to the asset’s carrying amount to determine if an impairment adjustment is required. If this review indicates that the asset’s carrying amount will not be fully recoverable, we will reduce the carrying value of the asset to its estimated fair value. We recorded no impairment charges during the three months ended March 31, 2006 and 2005.

Restricted Stock Grants

During 2004 we granted 95,000 shares of restricted common stock that vest over five years. In June 2004, 42,500 of these restricted shares were forfeited and in October 2004, an additional 37,500 shares of restricted stock were forfeited pursuant to the terms of their issuance, leaving 15,000 restricted shares outstanding. During both of the three month periods ended March 31, 2006 and 2005, 3,000 shares vested leaving 9,000 shares unvested at March 31, 2006.  We have recorded the unvested portion of the remaining 9,000 outstanding restricted shares as of March 31, 2006 as unearned compensation and are amortizing the balance ratably over the vesting period.  We recorded $14,000 in compensation expense related to these restricted shares during both of the three month periods ended March 31, 2006 and 2005.  In accordance with SFAS No. 123(R) (see Recent Statements of Financial Accounting Standards below), effective January 1, 2006, unearned compensation will continue to be amortized over the vesting period but is now included as part of additional paid-in capital on the consolidated balance sheets.  We expect that there will be no forfeitures of the unvested restricted stock outstanding at March 31, 2006.

We consider the number of vested shares issued under our 2003 equity incentive plan as common stock outstanding and include them in the denominator of our calculation of basic earnings per share. We also consider the total number of unvested restricted shares granted under our 2003 equity incentive plan in the denominator of our calculation of diluted earnings per share if they are dilutive. We return shares forfeited to the 2003 equity incentive plan as shares eligible for future grant and adjust any compensation expense previously recorded on such shares in the period the forfeiture occurs.

Interest and Internal Cost Capitalization

We capitalize our interest costs (using our average cost of borrowings) and internal costs (using actual time spent and related costs) on development of long-lived assets from the date we begin substantive activities through the date we place such assets into service in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 34, Capitalization of Interest and SFAS No. 67, Accounting for Costs and Initial Rental Operations of Real Estate Projects, respectively. The long-lived assets on which we capitalize interest include general construction activities in our communities, manufactured homes and, in the case of the communities

6

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acquired, the cost of the vacant homesites we acquired on which we are making improvements and placing a manufactured home for rent or sale.

Income Taxes

Deferred tax assets and liabilities are recorded for the estimated future tax effects of the temporary difference between the tax basis of assets and liabilities reported in the accompanying consolidated balance sheets.  Deferred tax assets are reduced by a valuation allowance to the extent that their benefits are not expected to be realized.  At March 31, 2006 a valuation allowance of $76.1 million was recorded to reduce deferred tax assets to the amount expected to be recoverable.

We allocate income taxes between continuing and discontinued operations in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (“SFAS No. 109”), particularly paragraph 140.  We recognize interim income tax benefits in continuing operations on the effective rate method and income tax expense in discontinued operations without such pro-ration in accordance with Accounting Principles Bulletin 28, Interim Financial Reporting (“APB 28”) and FASB Interpretations 18, Accounting for Income Taxes in Interim Periods — An interpretation of APB Opinion No. 28 (“FIN 18”).

Accumulated Other Comprehensive Income and Comprehensive Loss

Amounts recorded in accumulated other comprehensive income as of December 31, 2005 represent unrecognized gains on our interest rate swap, which qualified as a cash flow hedge and was marked to market over the life of the instrument.  Including these unrecognized gains or losses, our comprehensive loss for the three months ended March 31, 2006 was $7.6 million compared with a comprehensive loss of $15.6 million for the three months ended March 31, 2005.  Our interest rate swap agreement expired in February 2006 and was not renewed.

Recent Statements of Financial Accounting Standards

On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123(R)”), which is a revision of SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”).  SFAS No. 123(R) became effective on January 1, 2006 and we have adopted the standard using the modified prospective method.  Since our only share based payments are nominal restricted stock issuance and shares issued to members of the board of directors as compensation, the implementation of SFAS No. 123(R) did not have a material impact on our financial position as of March 31, 2006 or our operations or cash flows for the three months ended March 31, 2006.

7

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2.              Restatement

On March 8, 2007, the Audit Committee of the Board of Directors of Affordable Residential Communities Inc. (the “Company”) determined that the Company should restate its unaudited consolidated financial statements as of and for the quarterly periods ended March 31, 2006, June 30, 2006 and September 30, 2006, to correct the allocation of income taxes (intra-period tax allocation) between continuing operations and discontinued operations for the first three quarters of 2006, as more fully described below. The Company does not expect any aggregate income tax expense or benefit for the year ended December 31, 2006.  The above corrections do not have an adverse impact on any covenants associated with the Company’s debt facilities.

Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (“SFAS 109”), requires that a company with a loss from continuing operations consider all items reported apart from continuing operations (for example extraordinary items, discontinued operations and other comprehensive income) in determining the tax benefit that results from a loss from continuing operations. In our case, because we had a loss from continuing operations and a gain from discontinued operations in each of the periods referenced above, in accordance with SFAS 109 and Emerging Issues Task Force Topic D32, Intra-period Tax Allocation of the Tax Effect of Pre-Tax Income from Continuing Operations, we should have considered the gain from discontinued operations in determining the amount of tax benefit to allocate to continuing operations. However, we originally determined the allocation of income taxes (intra-period allocation) between continuing and discontinued operations using a “with and without” methodology. That is, we did not believe that a tax benefit resulted from the loss from continuing operations because we did not believe there was an incremental benefit from the loss generated from our continuing operations. Additionally, we believed that the gain from discontinued operations did not attract a tax consequence.

In accordance with FASB Interpretation No. 18, Accounting for Income Taxes in Interim Periods — An Interpretation of APB Opinion No. 28 , the tax benefit recognized in continuing operations is calculated using an effective rate methodology and therefore will be provided for over the course of the year. The tax expense recognized in discontinued operations is recognized on a discrete basis and therefore the entire amount of tax expense is recognized at the time the pretax gain on the discontinued operations is recognized.  This mismatch in the timing of the recognition of tax benefits and expense resulted in a restatement of the net loss for the quarter ended March 31, 2006.

8

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The impact of the restatement on our consolidated balance sheet and consolidated statement of operations is outlined in the table below (dollars in thousands).  This restatement did not have an impact on our cash flows from operating, investing or financing activities or periods prior to 2006.  The previously reported amounts have been recast for discontinued communities.  However, the associated amounts were not separately reflected as they were considered immaterial of the presentation.  Intra-period taxes are included in tenant deposits and other liabilities.  In accordance with SFAS No. 128, Earnings per Share, our basic and diluted weighted average shares outstanding have been increased by a factor of approximately 1.06 to reflect the dilutive impact of our January 2007 rights offering in which ten million shares of our common stock were purchased by our stockholders at the below-market price of $8.00 per share.

		As of March 31, 2006
		Previously Reported			As Restated
Consolidated Balance Sheet
Tenant deposits and other liabilities		$	15,954		$	19,179
Total liabilities		$	1,187,472		$	1,190,697
Minority interest		$	29,293		$	29,178
Retained deficit		$	(471,154	)	$	(474,265	)
Total stockholders’ equity		$	442,079		$	438,968
Total liabilities and stockholders’ equity		$	1,658,843		$	1,658,843
		Three Months Ended March 31, 2006
		Previously Reported			As Restated
Consolidated Statement of Operations
Loss from continuing operations before income tax benefit and allocation to minority interest		$	(12,854	)	$	(12,854)
Income tax benefit from continuing operations		—			1,199
Loss before allocation to minority interest		(12,854		)	(11,655		)
Minority interest		278			236
Loss from continuing operations		(12,576		)	(11,419		)
Income from discontinued operations		1,692			1,692
Gain on sale of discontinued operations		10,296			10,296
Income tax expense from discontinued operations		(371		)	(4,795		)
Minority interest in discontinued operations		(410		)	(253		)
Net loss		(1,369		)	(4,479		)
Preferred stock dividend		(2,578		)	(2,578		)
Net loss attributable to common stockholders		$	(3,947	)	$	(7,057	)
Loss per share from continuing operations
Basic loss per share		$	(0.35	)	$	(0.32	)
Diluted loss per share		$	(0.35	)	$	(0.32	)
Income per share from discontinued operations
Basic income per share		$	0.26		$	0.16
Diluted income per share		$	0.26		$	0.16
Loss per share attributable to common stockholders
Basic loss per share		$	(0.09	)	$	(0.16	)
Diluted loss per share		$	(0.09	)	$	(0.16	)
Weighted average common shares outstanding		43,576			43,576

 

9

 

3.            Common Stock, Preferred Stock and Minority Interest Related Transactions

On March 2, 2006, the board of directors declared a quarterly cash dividend of $0.515625 per share for its Series A Cumulative Redeemable Preferred Stock, and $0.39 per unit on the Series C Preferred Operating Partnership Units of Affordable Residential Communities LP. The dividends are payable on April 28, 2006 to shareholders of record on April 14, 2006. The Board reviews the payment of dividends on a quarterly basis.

At March 31, 2006, minority interest consisted of 1,517,060 OP Units that were issued to various limited partners and 705,688 preferred partnership units (“PPUs”) issued on June 30, 2004 as part of the D.A.M. portfolio acquisition. Each OP Unit outstanding is paired with 1.9268 shares of our special voting stock (each a “Paired Equity Unit”) that allows each holder to vote an OP Unit on matters as if it were a common share of our stock. Each OP Unit is redeemable for cash, or at our election, one share of our common stock.  During the first quarter of 2006, we redeemed approximately 313,900 OP Units for an equal number of shares of our common stock valued at $3.0 million.

The PPUs outstanding as of March 31, 2006 consist of 705,688 Series “C” units.  The Series “C” PPUs carry a liquidation preference of $25 per unit and earn cash distributions at the rate of 6.25% per annum, payable quarterly.  The Series “C” PPUs can be redeemed at the option of the Operating Partnership for cash after the fifth anniversary of their issuance.  Series “C” PPU holders can request redemption of their units after the two and a half year anniversary of issuance, at which time the Operating Partnership must redeem the PPUs or repurchase them with common stock, cash and/or a note payable, at the Operating Partnership’s option.  As of March 31, 2006, we had accrued $183,773 of the Series “C” PPU preferred distribution, representing the portion of the preferred distribution earned by Series “C” preferred unitholders through that date.

 We have recorded an equity transfer adjustment between additional paid-in capital and the minority interest in our consolidated balance sheet as of March 31, 2006 to account for changes in the respective ownership in the underlying equity of the Operating Partnership.

The following summarizes the activity of the minority interest in the Operating Partnership (in thousands):

 

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4.            Rental and Other Property, Net

The following summarizes rental and other property (in thousands):

 

We have capitalized interest and internal costs of $0.2 million in the cost of land and building improvements and manufactured home purchases for the three months ended March 31, 2005.  No interest and internal costs were capitalized for the three months ended March 31, 2006.

5.     Notes Payable

The following table sets forth certain information regarding our notes payable (in thousands):

		March 31, 2006			December 31, 2005
Senior fixed rate mortgage due 2009, 5.05% per annum		$	89,155		$	89,512
Senior fixed rate mortgage due 2012, 7.35% per annum		281,523			286,433
Senior fixed rate mortgage due 2014, 5.53% per annum		195,550			196,270
Senior variable rate mortgage due 2007, one-month LIBOR plus 3.00% per annum (7.83% at March 31, 2006)		118,523			126,297
Various individual fixed rate mortgages due 2006 through 2031, averaging 7.23% per annum at March 31, 2006		135,977			150,104
Revolving credit mortgage facility due 2006, one-month LIBOR plus 2.75% per annum (7.58% at March 31, 2006)		58,764			58,764
Floorplan line of credit due 2007, ranging from prime plus 0.75% to prime plus 4.00% per annum (8.50% at March 31, 2006)		6,945			14,188
Trust preferred securities due 2035, three-month LIBOR plus 3.25% per annum (8.25% at March 31, 2006)		25,780			25,780
Consumer finance facility due 2008, one-month LIBOR plus 3.00% per annum (7.83% at March 31, 2006)		18,188			18,607
Lease receivable facility due 2008, one-month LIBOR plus 4.25% per annum (8.95% at March 31, 2006)		75,500			77,500
Senior exchangeable notes due 2025, 7.50% per annum		96,600			96,600
D.A.M. PPU notes payable due 2006, 7.00% per annum		2,499			4,999
Other loans		1,254			1,277
		$	1,106,258		$	1,146,331

 

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Senior Fixed Rate Mortgage Due 2009

The Senior Fixed Rate Mortgage due 2009 is an obligation of certain real property subsidiaries of the Operating Partnership and is collateralized by 26 manufactured home communities owned by these subsidiaries. The Senior Fixed Rate Mortgage due 2009 bears interest at a fixed rate of 5.05%, is being amortized based on a 30-year amortization schedule and matures on March 1, 2009. Pursuant to the terms of the mortgage agreement, we have established reserves relating to the mortgaged properties for real estate taxes, insurance, capital spending and property operating expenditures. The Senior Fixed Rate Mortgage due 2009 contains customary defeasance-based prepayment penalties for repayments made prior to maturity.

Senior Fixed Rate Mortgage Due 2012

The Senior Fixed Rate Mortgage due 2012 is an obligation of certain of our special purpose real property subsidiaries and is collateralized by 99 manufactured home communities. The Senior Fixed Rate Mortgage due 2012 bears interest at a fixed rate of 7.35% per annum, is amortized based on a 30-year schedule and matures on May 1, 2012. Pursuant to the terms of the mortgage agreement, we have established reserves relating to the mortgaged properties for real estate taxes, insurance, capital spending and property operating expenditures. The Senior Fixed Rate Mortgage due 2012 contains customary defeasance-based prepayment penalties for repayments made prior to maturity.

Senior Fixed Rate Mortgage Due 2014

The Senior Fixed Rate Mortgage due 2014 is an obligation of certain real property subsidiaries of the Operating Partnership and is collateralized by 43 manufactured home communities owned by these subsidiaries. The Senior Fixed Rate Mortgage due 2014 bears interest at a fixed rate of 5.53% per annum, is amortized based on a 30-year schedule and matures on March 1, 2014. Pursuant to the terms of the mortgage agreement, we have established reserves relating to the mortgaged properties for real estate taxes, insurance, capital spending and property operating expenditures. The Senior Fixed Rate Mortgage due 2014 contains customary defeasance-based prepayment penalties for repayments made prior to maturity.

Senior Variable Rate Mortgage Due 2007

The Senior Variable Rate Mortgage due 2007 is an obligation of certain real property subsidiaries of the Operating Partnership and is collateralized by 32 manufactured home communities owned by these subsidiaries. The Senior Variable Rate Mortgage due 2007 bears interest at a variable rate based on a spread of 3.00% over the one-month LIBOR rate (7.83% at March 31, 2006).  On February 10, 2006, we extended the due date to February 11, 2007.  At our option and subject to certain conditions, we may extend the Senior Variable Rate Mortgage due 2007 for two additional 12-month periods. In connection with the second and third extensions, we would be required to pay extension fees of 0.25% and 0.375% of the outstanding principal balance, respectively.  We will incur an exit fee equal to 0.50% of the loan amount payable upon any repayment of the principal amount of the loan. The exit fee will be subject to reduction by an amount equal to 0.50% of the principal amount of any first mortgage loans provided by the lenders to refinance the Senior Variable Rate Mortgage due 2007. Pursuant to the terms of the mortgage agreement, we have established reserves relating to the mortgaged properties for real estate taxes, insurance, capital spending and property operating expenditures.

Various Individual Fixed Rate Mortgages

We have assumed various individual fixed rate mortgages in connection with the acquisition of various properties that were encumbered at the time of acquisition as follows:

a)              Mortgages assumed as part of individual property purchases. These notes total approximately $40.0 million at March 31, 2006, mature from 2006 ($5.2 million in 2006) through 2028 and have an average effective interest rate of 7.46%. These mortgages are secured by 13 specific manufactured home communities.

b)             Mortgages assumed in conjunction with the Hometown acquisition. These notes total approximately $68.2 million, mature from 2008 through 2031 and carry an average effective interest rate of 7.12%. These mortgages are secured by 12 specific manufactured home communities and subject to early pre-payment penalties, the terms of which vary from mortgage to mortgage.

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c)              Notes assumed in conjunction with the D.A.M. portfolio purchase. These notes total approximately $27.8 million, mature in 2008 and carry an average effective annual interest rate of 7.18%. These mortgages are secured by 24 specific manufactured home communities.

Revolving Credit Mortgage Facility

Our Revolving Credit Mortgage Facility provides for borrowings of up to $85.0 million. This facility is an obligation of a subsidiary of the Operating Partnership and is secured by 28 communities. Advances under the Revolving Credit Mortgage Facility are limited by borrowing base requirements related to the value and cash flow of the communities securing the loan ($62.4 million as of March 31, 2006). The Revolving Credit Mortgage Facility bears interest at the one month LIBOR plus 2.75% (7.58% at March 31, 2006) and matures in September 2006. We incurred a commitment fee of 0.5% at the closing of the facility and will pay origination fees of 0.5% with each advance. The facility contains no significant financial covenants.

Floorplan Lines of Credit

Our floorplan line of credit provides for borrowings of up to $35.0 million, secured by manufactured homes in inventory. Under the lines of credit, the lender will advance 75% of the cost of manufactured homes. Repayments of borrowed amounts are due upon sale or lease of the related manufactured home. Advances under the lines of credit bear interest ranging from the prime rate plus 0.75% to the prime rate plus 4.00% (averaging 8.50% at March 31, 2006), based on the length of time each advance has been outstanding. Monthly curtailment payments are required for unsold homes beginning 360 days following the purchase of the home. The required curtailment payment will be between 3.00% and 5.00% of the home’s original invoice amount depending on the type of home and the number of months since the home’s purchase. The lines of credit require us to maintain a minimum tangible net worth, a maximum debt to tangible net worth ratio of 3 to 1, and minimum cash and cash equivalents of $15.0 million, all as defined in the agreement.  The minimum tangible net worth required is $425.0 million through December 31, 2006, and $385.0 million from January 1, 2007 through September 13, 2007, the due date of the line.  We are in compliance with all financial covenants of the line of credit as of March 31, 2006. The line of credit is subject to an annual commitment fee of $250,000, an unused line fee of .25% per annum and a termination fee of 1.00% to 3.00%, based on the termination date.

Trust Preferred Securities Due 2035

On March 15, 2005, the Company issued $25.8 million in unsecured trust preferred securities. The $25.8 million trust preferred securities bear interest at three-month LIBOR plus 3.25% (8.25% at March 31, 2006).  Interest on the securities is paid on the 30th of March, June, September and December of each year.  The Company may redeem these securities on or after March 30, 2010 in whole or in part at principal amount plus accrued interest.  The securities are mandatorily redeemable on March 15, 2035 if not redeemed sooner.

Consumer Finance Facility

The Consumer Finance Facility has a total commitment of $125.0 million and a term of four years.  This facility is an obligation of a subsidiary of our Operating Partnership, and borrowings under this facility are secured by manufactured housing conditional sales contracts. Borrowings under the facility are limited by specified borrowing base requirements related to the value of the collateral securing the facility ($19.7 million as of March 31, 2006). The facility bears interest at a variable rate based upon a spread of 3.00% over the one-month LIBOR (7.83% at March 31, 2006).  During the quarter, we paid a commitment fee of 1.00% on the original committed amount and 0.75% of the amended committed amount and will pay additional annual commitment fees payable on each anniversary of the closing. Advances under the facility are subject to a number of conditions, including certain underwriting and credit screening guidelines and the conditions that the home must be located in one of our communities, the loan term may not exceed 12 years for a single-section home or 15 years for a multi-section home and the loan amount shall not exceed 90% of the value of the home securing the conditional sales contract.

The line of credit requires the Operating Partnership to maintain a minimum tangible net worth, a maximum debt to tangible net worth ratio of 3 to 1, and minimum cash and cash equivalents of $15.0 million, all as defined in the agreement.  The minimum tangible net worth required is $425.0 million through December 31, 2006, $385.0 million

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from January 1, 2007 through December 31, 2007, and $355.0 million from January 1, 2008 through September 30, 2008.  We were in compliance as of March 31, 2006 with all financial covenants under the line of credit.

The availability of advances under the Consumer Finance Facility is subject to certain conditions that are beyond our control. Conditions that could result in our inability to draw on these facilities include a downgrade in the credit rating of the lender and the absence of certain markets for financing debt obligations secured by securities or mortgage loans. Funding under this facility may also be denied if the lender determines that the value of the assets serving as collateral would be insufficient to maintain the required 75% loan-to-value ratio upon giving effect to a request for funding. The lender can also at any time require that we prepay amounts funded or provide additional collateral if, in its judgment, this is necessary to maintain the 75% loan-to-value ratio.

Lease Receivables Facility

The Company has a $150.0 million secured revolving credit facility (the “Lease Receivables Facility”) which we use to finance the purchase of manufactured homes and for general corporate purposes.  Pursuant to the agreement, borrowings are limited to approximately 65% of the net book value of the eligible manufactured housing units owned by two of our indirect wholly owned subsidiaries, ARC Housing LLC and ARC HousingTX LP (collectively, “Housing”) and located in ARC’s communities, subject to certain other applicable borrowing base requirements.  The facility bears interest at a variable rate based on a spread of 4.25% over the one-month LIBOR (8.95% at March 31, 2006).  The facility matures September 30, 2008.

The line of credit requires the Operating Partnership to maintain a minimum tangible net worth, a maximum debt to tangible net worth ratio of 3 to 1, and minimum cash and cash equivalents of $15.0 million, all as defined in the agreement.  The minimum tangible net worth required is $425.0 million through December 31, 2006, $385.0 million from January 1, 2007 through December 31, 2007, and $355.0 million from January 1, 2008 through September 30, 2008.  We were in compliance as of March 31, 2006 with all financial covenants under the amended line of credit.  Borrowings under the Lease Receivables Facility are secured by an assignment of all lease receivables and rents, an assignment of the underlying manufactured homes and a pledge by ARCHC LLC and ARC Housing GP LLC of 100% of the outstanding equity in Housing.  Interest is payable monthly.

Senior Exchangeable Notes Due 2025

In August 2005, our Operating Partnership issued $96.6 million aggregate principal amount of 7.50% senior exchangeable notes due 2025 to qualified institutional buyers in a private transaction.  The notes are senior unsecured obligations of the OP and are exchangeable, at the option of the holders, into shares of ARC common stock at an initial exchange rate of 69.8812 shares per $1,000 principal amount of the notes (equal to an initial exchange price of approximately $14.31 per share), subject to adjustment and, in the event of specified corporate transactions involving ARC or the OP, an additional make-whole premium. Upon exchange, the OP shall have the option to deliver, in lieu of shares of ARC common stock, cash or a combination of cash and shares of ARC common stock.

Prior to August 20, 2010, the notes are not redeemable at the option of the OP. After August 20, 2010, the OP may redeem all or a portion of the notes at a redemption price equal to the principal amount plus accrued and unpaid interest, if any, on the notes, if the closing price of ARC common stock has exceeded 130% of the exchange price for at least 20 trading days in any consecutive 30-trading day period.

Holders of the notes may require the OP to repurchase all or a portion of the notes at a purchase price equal to the principal amount plus accrued and unpaid interest, if any, on the notes on each of August 15, 2010, August 15, 2015, and August 15, 2020, or after the occurrence of certain corporate transactions involving ARC or the OP.

In connection with the sale and issuance of the notes and pursuant to a registration rights agreement, ARC filed a registration statement with the SEC with respect to the notes.  In the event that the registration statement was not declared effective by the SEC within 180 days of the closing of the sale of the notes, which occurred on August 9, 2005, the holders of the notes are entitled to receive liquidated damages.  The 180-day period expired on February 5, 2006 prior to the registration statement being declared effective.

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As a result of this registration effectiveness default, the holders of the notes are entitled to liquidated damages to be paid for each day following the default until the registration statement is declared effective in an amount equal to 0.25% of the principal amount of the notes on an annual basis for the first 90 days following the default.  The rate increases to 0.50% (the maximum annual rate) of the principal amount on and after the 91st day following the default.  Liquidated damages incurred through March 31, 2006 are approximately $35,700 and are reflected in the consolidated statement of operations as interest expense. The registration statement became effective prior to the end of the 90-day period.

We have determined that, subsequent to the initial declaration of effectiveness of the registration statement, it is extremely unlikely that any events will occur that could trigger the payment of any additional liquidated damages.  Accordingly, the registration rights agreement was valued a nominal value at inception.

D.A.M. PPU Notes Payable Due 2006

According to the terms of our Series “B” PPUs, in July 2005 the Series “B” PPU holders requested redemption of their units, and the Operating Partnership elected to repurchase them for approximately $2.5 million in cash and notes payable totaling approximately $5.0 million.  A principal payment of approximately $2.5 million plus interest accrued at 7.00% was made on January 18, 2006 and the final payment of approximately $2.5 million plus interest accrued at 7.00% is due on July 18, 2006.

 

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6.              Loss per share

In accordance with SFAS No. 128, Earnings per Share, our basic and diluted weighted average shares outstanding have been increased by a factor of approximately 1.06 to reflect the impact of our January 2007 rights offering in which ten million shares of our common stock were purchased by our stockholders at the below-market price of $8.00 per share.  The following reflects the calculation of income (loss) per share on a basic and diluted basis (in thousands, except per share information):

 

(a)          From March 31, 2005 through March 31, 2006, we redeemed a weighted average of 787,000 operating partnership units.

(b)         In July 2005 we redeemed all of the Series B preferred partnership units (see our Form 8-K for the year ended December 31, 2005 filed on October 5, 2006).

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7.              Property Operations Expense

During the three months ended March 31, 2006 and 2005, we incurred property operations expense as follows (in thousands):

 

8.              Retail Home Sales, Finance, Insurance and Other Operating Expense

During the three months ended March 31, 2006 and 2005, we incurred retail home sales, finance, insurance and other operating expense as follows (in thousands):

 

9.              General and Administrative Expense

During the three months ended March 31, 2006 and 2005, we incurred general and administrative expense as follows (in thousands):

 

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10.          Discontinued Operations

As of December 31, 2005, the Company held 41 communities as discontinued operations and as of March 31, 2006 had closed sales for 27 of these communities comprising $34.2 million of cash proceeds net of related debt, defeasance and other closing costs of $34.3 million.  Subsequent to March 31, 2006, we closed an additional 13 communities for $51.2 million of cash proceeds net of related debt, defeasance and other closing costs of $40.7 million.    The remaining sales transaction is expected to close in 2007.  There can be no assurance, however, that the Company will close the remaining community sale, or, if it closes, that it will close on the terms set forth in its contract.

In accordance with the provisions of Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-lived Assets,” each of the communities designated as held for sale and not sold have been classified as discontinued operations as of March 31, 2006 and December 31, 2005. We have included $78.9 million and $132.3 million of net assets related to these communities as assets held for sale in the accompanying consolidated balance sheets as of March 31, 2006 and December 31, 2005, respectively, and $37.9 million and $56.8 million, respectively, of mortgage notes payable and other obligations related to these communities as liabilities related to assets held for sale. In addition, we have recast the operations of each of these communities as discontinued operations in the accompanying statements of operations for the three months ended March 31, 2006 and 2005 and recorded a gain of $10.3 million and loss of $0.7 million, respectively, related to the sale of the discontinued operations for the quarters ended March 31, 2006 and 2005 in connection with these sales.

The following table summarizes combined balance sheet and income statement information for the discontinued operations noted above (in thousands):

 

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11.          Commitments and Contingencies

In the normal course of business, from time to time we are involved in legal actions relating to the ownership and operations of our properties. In our opinion, the liabilities, if any, which may ultimately result from such legal actions, will not have a material adverse effect on our financial position, results of operations or cash flows.  In the normal course of business, from time to time we incur environmental obligations relating to the ownership and operation of our properties. In our opinion, the liabilities, if any, which may ultimately result from such environmental obligations, will not have a material adverse effect on our financial position, results of operations or cash flows.

12.          Segment Information

We operate in three business segments—real estate, retail home sales, and finance and insurance. A summary of our business segment information is shown below (in thousands):

(a)          Net segment income represents total revenues less expenses for property operations, real estate taxes, cost of manufactured homes sold and retail home sales, finance, insurance and other operations.  Net segment income is a measure of the performance of the properties before the effects of the following expenses:  property management, general and administrative, depreciation, amortization, interest expense and the effect of discontinued operations.

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13.          Income Taxes

The Company has determined that certain sales of properties that will close during the year ending December 31, 2006 will result in gains for Federal income tax purposes. In certain circumstances, gains on sales of properties by companies taxed as a REIT may result in a Federal income tax liability equal to the amount of the gain for Federal income tax purposes (a 100% tax rate). As a result, on March 30, 2006, the Company elected not to be taxed as a REIT for the year ending December 31, 2006.

At March 31, 2006, the Company has net operating loss carry-forwards for Federal income tax purposes, subject to certain limitations, of approximately $354 million and $339 million for regular income tax and alternative minimum tax, respectively. These net operating loss carry-forwards expire in 2018 through 2025.  Losses from continuing operations during the quarter only partially offset the regular taxable earnings from discontinued operations for the quarter ending March 31, 2006 due to the allocation of intra-period taxes as discussed below. The net operating loss carry-forwards for alternative minimum Federal income taxes generally are limited to offsetting 90% of the alternative minimum taxable earnings for a given period. Therefore, alternative minimum tax was incurred in the first quarter of 2006 by the Company as a result of this change in tax status.

Based on our estimated composite Federal and state tax rate of 40%, we recorded as of March 31, 2006, a deferred tax asset of approximately $150.6 million less a valuation allowance reserve of approximately $75.5 million and deferred tax liabilities of approximately $75.2 million.  We could experience circumstances in the future that result in a non-cash income tax benefit based on the timing of recognition of the tax benefit of our operating losses carried forward from prior years.  Under current IRS rules, we can elect to return to REIT status after five years.  There can be no assurances that the tax laws and regulations will not change or that we will change our REIT election status in five years.

The Company does not expect to have aggregate income tax benefits or expense for the year ended December 31, 2006.  We allocate income taxes between continuing and discontinued operations in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (“SFAS No. 109”), particularly paragraph 140.  We recognize income tax benefits in continuing operations on the effective rate method and income tax expense in discontinued operations without such pro-ration in accordance with Accounting Principles Bulletin 28, Interim Financial Reporting (“APB 28”) and FASB Interpretations 18, Accounting for Income Taxes in Interim Periods — An interpretation of APB Opinion No. 28 (“FIN 18”)

The significant components of the provision for income taxes are as follows (in thousands):

 

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The provision for income taxes differs from the amount that would be computed by applying the statutory Federal income tax rate of 35% to income before income taxes as a result of the following (in thousands):

 

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of the assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.  The tax effects of significant temporary differences that give rise to the net deferred tax assets and liabilities are as follows (in thousands):

 

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14.          Subsequent Events

Redemption of Series “C” PPUs

In January 2007, all 705,688 units of our Series “C” PPUs were redeemed according to their terms for 1,628,410 shares of ARC common stock.

Acquisition of NLASCO, Inc.

On January 31, 2007, we acquired all of the stock of NLASCO, Inc. (“NLASCO”), a privately held property and casualty insurance holding company, and its subsidiaries.  In exchange for the stock, NLASCO’s shareholders, consisting of C. Clifton Robinson and affiliates, received $105.75 million in cash and 1,218,880 shares of ARC common stock for a total consideration of $117.5 million.  In addition, Flexpoint Fund, L.P., a fund managed by Flexpoint Partners, LLC of Chicago, Illinois, invested $20 million to purchase 2,154,763 shares of common stock of the Company at the leading ten-day average market price of our common stock on the date the agreement was signed, subject to certain anti-dilution provisions.  The acquisition closed on January 31, 2007.

In order to raise $80 million to provide a source of funding for a portion of the acquisition of NLASCO, we conducted a rights offering to our stockholders.  In the rights offering, all holders of ARC common stock as of the record date of December 19, 2006 received one non-transferable right to purchase approximately 0.242 shares of common stock of the Company for each share held.  The price at which the additional shares were purchased was $8.00 per share.  The rights offering expired on January 23, 2007, and the company issued approximately 7.8 million shares of common stock to existing shareholders on that date.  In addition, Gerald J. Ford and certain affiliates controlled by him purchased approximately 1.8 million shares that they would have been entitled to in the rights offering in a separate private placement transaction.  Gerald J. Ford, one of the Company’s directors and the beneficial owner of approximately 17.6% of ARC’s common stock as of the record date, and certain of his affiliates also backstopped the rights offering and purchased another approximately 400,000 shares that were not purchased in the rights offering by the stockholders of record on the record date, at the rights offering price per share of $8.00.

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