1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the quarterly period ended June 30, 2001 ------------- OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to --------------- ---------- Commission file number 1-9516 AMERICAN REAL ESTATE PARTNERS, L.P. (Exact name of registrant as specified in its charter) Delaware 13-3398766 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 100 SOUTH BEDFORD ROAD, MT. KISCO, NY 10549 (Address of principal executive offices) (Zip Code) (Registrant's telephone number, including area code) (914) 242-7700 -------------- 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 ----- -----
2 INDEX PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS PAGE NO. Consolidated Balance Sheets - June 30, 2001 and December 31, 2000 .......................................... 1-2 Consolidated Statements of Earnings - Three Months Ended June 30, 2001 and 2000..................................... 3-4 Consolidated Statements of Earnings - Six Months Ended June 30, 2001 and 2000....................................... 5-6 Consolidated Statement of Changes In Partners' Equity and Comprehensive Income Six Months Ended June 30, 2001................................................ 7 Consolidated Statements of Cash Flows - Six Months Ended June 30, 2001 and 2000 ...................................... 8-9 Notes to Consolidated Financial Statements.................................... 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.................................................. 26 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS ............................................... 42 PART II. OTHER INFORMATION............................................................ 43
3 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS The financial information contained herein is unaudited; however, in the opinion of management, all adjustments necessary for a fair presentation of such financial information have been included. All such adjustments are of a normal recurring nature. CONSOLIDATED BALANCE SHEETS (UNAUDITED) (IN $000'S) JUNE 30, DECEMBER 31, 2001 2000 ---- ---- ASSETS Real estate leased to others: Accounted for under the financing method $ 185,484 $ 193,428 Accounted for under the operating method, net of accumulated depreciation 188,872 185,968 Hotel, casino and resort operating properties, net of accumulated depreciation: Stratosphere Corporation hotel and casino 179,969 152,335 Hotel and resort 39,536 32,918 Land and construction-in-progress 78,971 75,952 Investment in U.S. Government and Agency obligations 483,440 475,267 Cash and cash equivalents 127,263 147,705 Marketable equity and debt securities 45,061 54,736 Equity interest in GB Holdings, Inc. 40,284 38,359 Mortgages and notes receivable 36,034 19,946 Receivables and other assets 47,144 46,373 ---------- ---------- Total $1,452,058 $1,422,987 ========== ========== Continued..... 1
4 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 CONSOLIDATED BALANCE SHEETS - CONTINUED (UNAUDITED) (IN $000'S) JUNE 30, DECEMBER 31, 2001 2000 ---- ---- LIABILITIES Mortgages payable $ 175,995 $ 182,049 Due to affiliates 68,502 77,521 Accounts payable, accrued expenses and other liabilities 61,858 55,785 ----------- ----------- Total liabilities 306,355 315,355 ----------- ----------- Minority interest in Stratosphere Corporation hotel and casino 67,780 64,907 ----------- ----------- Commitments and Contingencies (Notes 2 and 3) PARTNERS' EQUITY Limited partners: Preferred units, $10 liquidation preference, 5% cumulative pay- in-kind redeemable; 9,400,000 authorized; 8,886,631 and 8,463,459 issued and outstanding as of June 30, 2001 and Dec. 31, 2000 89,977 87,808 Depositary units; 47,850,000 authorized; 47,235,484 outstanding 976,668 944,340 General partner 23,199 22,498 Treasury units at cost: 1,137,200 depositary units (11,921) (11,921) ----------- ----------- Total partners' equity 1,077,923 1,042,725 ----------- ----------- Total $ 1,452,058 $ 1,422,987 =========== =========== See notes to consolidated financial statements 2
5 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED) (IN $000'S EXCEPT PER UNIT DATA) THREE MONTHS ENDED JUNE 30, --------------------------- 2001 2000 ---- ---- Revenues: Hotel and casino operating income $ 33,508 $ 32,088 Land, house and condominium sales 10,163 22,227 Hotel and resort operating income 4,482 5,763 Interest income on financing leases 4,244 4,999 Interest income on treasury bills and other investments 7,876 8,962 Rental income 6,913 6,224 Equity in earnings of GB Holdings, Inc. 1,621 -- Dividend and other income 375 2,052 -------- -------- 69,182 82,315 -------- -------- Expenses: Hotel and casino operating expenses 30,777 28,798 Cost of land, house and condominium sales 7,984 16,539 Hotel and resort operating expenses 3,835 4,801 Interest expense 4,816 4,524 Depreciation and amortization 3,826 3,961 General and administrative expenses 1,691 2,123 Rental property expenses 1,284 1,273 -------- -------- 54,213 62,019 -------- -------- Earnings before property transactions and minority interest 14,969 20,296 Provision for loss on real estate -- (232) Gain on sales and disposition of real estate 1,362 1,109 Minority interest in net earnings of Stratosphere Corporation hotel and casino (116) (566) -------- -------- NET EARNINGS $ 16,215 $ 20,607 ======== ======== Continued........... 3
6 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 Continued........ CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED) (IN $000'S EXCEPT PER UNIT DATA) THREE MONTHS ENDED JUNE 30, -------------------------------- 2001 2000 ---- ----- Net earnings attributable to: (Note 9) Limited partners $ 15,892 $ 20,197 General partner 323 410 ----------- ----------- $ 16,215 $ 20,607 =========== =========== Net earnings per limited partnership unit: Basic earnings $ .32 $ .42 =========== =========== Weighted average limited partnership units outstanding 46,098,284 46,098,284 =========== =========== Diluted earnings $ .29 $ .36 =========== =========== Weighted average limited partnership units and equivalent partnership units outstanding 55,369,785 56,055,005 =========== =========== See notes to consolidated financial statements 4
7 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED) (IN $000'S EXCEPT PER UNIT DATA) SIX MONTHS ENDED JUNE 30, ----------------------------- 2001 2000 ---- ---- Revenues: Hotel and casino operating income $ 66,765 $ 66,092 Land, house and condominium sales 20,927 41,036 Hotel and resort operating income 7,214 9,527 Interest income on financing leases 8,655 10,271 Interest income on treasury bills and other investments 16,912 16,869 Rental income 13,053 11,481 Dividend and other income 1,888 2,406 Equity in earnings of GB Holdings, Inc. 675 -- --------- --------- 136,089 157,682 --------- --------- Expenses: Hotel and casino operating expenses 59,924 58,822 Cost of land, house and condominium sales 15,413 30,700 Hotel and resort operating expenses 6,671 9,261 Interest expense 10,123 8,457 Depreciation and amortization 7,902 7,598 General and administrative expenses 3,607 4,147 Rental property expenses 2,302 2,077 Bayswater acquisition costs -- 1,650 --------- --------- 105,942 122,712 --------- --------- Earnings before property and securities transactions and minority interest 30,147 34,970 Provision for loss on real estate -- (232) Gain on sale of marketable equity and debt securities 1,334 -- Gain on sales and disposition of real estate 1,362 2,106 Minority interest in net earnings of Stratosphere Corporation hotel and casino (797) (1,539) --------- --------- NET EARNINGS $ 32,046 $ 35,305 ========= ========= Continued........... 5
8 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 Continued........ CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED) (IN $000'S EXCEPT PER UNIT DATA) SIX MONTHS ENDED JUNE 30, -------------------------------- 2001 2000 ---- ----- Net earnings attributable to: (Note 9) Limited partners $ 31,408 $ 33,173 General partner 638 2,132 ----------- ----------- $ 32,046 $ 35,305 =========== =========== Net earnings per limited partnership unit: Basic earnings $ .63 $ .67 =========== =========== Weighted average limited partnership units outstanding 46,098,284 46,098,284 =========== =========== Diluted earnings $ .57 $ .59 =========== =========== Weighted average limited partnership units and equivalent partnership units outstanding 55,341,276 56,559,509 =========== =========== See notes to consolidated financial statements 6
9 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 CONSOLIDATED STATEMENT OF CHANGES IN PARTNERS' EQUITY AND COMPREHENSIVE INCOME SIX MONTHS ENDED JUNE 30, 2001 (UNAUDITED) (IN $000'S ) Limited Partners' Equity General -------------------------- Total Partner's Depositary Preferred Held in Partners' Equity Units Units Treasury Equity ------ ----- ----- -------- ------ Balance Dec. 31, 2000 $ 22,498 $ 944,340 $87,808 $(11,921) $ 1,042,725 Comprehensive income: Net earnings 638 31,408 -- -- 32,046 Sale of debt securities available for sale 78 3,818 -- -- 3,896 Unrealized losses on securities available for sale (15) (729) -- -- (744) -------- --------- ------- -------- ----------- Comprehensive income 701 34,497 -- -- 35,198 Pay-in-kind distribution -- (2,169) 2,169 -- -- -------- --------- ------- -------- ----------- Balance June 30, 2001 $ 23,199 $ 976,668 $89,977 $(11,921) $ 1,077,923 ======== ========= ======= ======== =========== Accumulated other comprehensive loss at June 30, 2001 was $4,396. See notes to consolidated financial statements 7
10 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN $000'S) SIX MONTHS ENDED JUNE 30, ------------------------- 2001 2000 ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings $ 32,046 $ 35,305 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 7,902 7,598 Gain on sale of marketable equity and debt securities (1,334) -- Gain on sales and disposition of real estate (1,362) (2,106) Minority interest in net earnings of Stratosphere Corporation hotel and casino 797 1,539 Provision for loss on real estate -- 232 Equity in earnings of GB Holdings Inc. (675) -- Changes in: (Increase) decrease in land and construction-in-progress (1,852) 9,816 Increase in receivables and other assets (2,613) (179) Increase (decrease) in accounts payable, accrued expenses and other liabilities 8,641 (1,967) -------- -------- Net cash provided by operating activities 41,550 50,238 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: (Increase) decrease in mortgages and notes receivable (16,088) 5,974 Net proceeds from the sale and disposition of real estate 2,061 10,337 Principal payments received on leases accounted for under the financing method 3,463 3,848 Acquisition of Bayswater's net assets -- (84,350) Acquisition of rental real estate -- (27,308) Additions to rental real estate (424) (2,028) Additions to hotel casino and resort operating properties (41,630) (5,325) Increase (decrease) in investment in U.S. Government and Agency obligations (8,173) 18,655 Decrease in minority interest in Stratosphere Corp. hotel and casino -- (1,970) Proceeds from the deposition of marketable equity and debt securities 13,891 -- (Decrease) increase in due to affiliate (9,038) 41,266 Other -- 455 -------- -------- Net cash used in investing activities (55,938) (40,446) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Partners' equity: Distributions to General Partner -- (4,100) Debt: Decrease in mortgages payable (182) (632) Periodic principal payments (3,409) (4,715) Balloon payments (2,463) (3,221) -------- -------- Net cash used in financing activities (6,054) (12,668) -------- -------- Continued.............. 8
11 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)) (IN $000'S) SIX MONTHS ENDED JUNE 30, ----------------------------- 2001 2000 ---- ---- NET DECREASE IN CASH AND CASH EQUIVALENTS (20,442) (2,876) CASH AND CASH EQUIVALENTS, beginning of period 147,705 142,697 --------- --------- CASH AND CASH EQUIVALENTS, end of period $ 127,263 $ 139,821 ========= ========= SUPPLEMENTAL INFORMATION: Cash payments for interest-net of amount capitalized $ 7,188 $ 7,023 ========= ========= SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING ACTIVITIES: Reclassifications: From financing lease $ (4,481) $ (6,730) To operating lease 4,481 6,730 From hotel and resort operating properties (1,167) -- To land and construction-in-progress 1,167 -- From mortgages and notes receivable -- (62,338) To marketable equity and debt securities -- 62,338 --------- --------- $ -- $ -- ========= ========= Net unrealized losses on securities available for sale $ (744) $ (556) ========= ========= Increase in equity and debt securities $ 2,500 $ -- ========= ========= See notes to consolidated financial statements 9
12 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. GENERAL The accompanying consolidated financial statements and related footnotes should be read in conjunction with the consolidated financial statements and related footnotes contained in the Company's annual report on Form 10-K for the year ended December 31, 2000. The consolidated financial statements include the accounts of the Company and its wholly-owned and majority owned subsidiaries. All material intercompany accounts and transactions have been eliminated in consolidation. The results of operations for the three and six months ended June 30, 2001 are not necessarily indicative of the results to be expected for the full year. The Company has adopted Statement of Financial Accounting Standards No. 133-Accounting for Derivative Instruments and Hedging Activities ("Statement 133") as of January 1, 2001. The adoption of Statement 133 has not had any impact in the Company's financial statements. In July 2001, the Financial Accounting Standards Board (FASB) issued FASB Statements Nos. 141 and 142 (FAS 141 and FAS 142): "Business Combinations" and "Goodwill and Other Intangible Assets." FAS 141 replaces APB 16 and eliminates pooling-of-interests accounting prospectively. It also provides guidance on purchase accounting related to the recognition of intangible assets and accounting for negative goodwill. FAS 142 changes the accounting for goodwill from an amortization method to an impairment-only approach. Under FAS 142, goodwill will be tested annually and whenever events or circumstances occur indicating that goodwill might be impaired. FAS 141 and FAS 142 are effective for all business combinations completed after June 30, 2001. Upon adoption of FAS 142, amortization of goodwill recorded for business combinations consummated prior to July 1, 2001 will cease, and intangible assets acquired prior to July 1, 2001 that do not meet the criteria for recognition under FAS 141 will be reclassified to goodwill. Companies are required to adopt FAS 142 for fiscal years beginning after December 15, 2001, but early adoption is permitted. The Company is evaluating the impact of the adoption of these standards but does not expect them to have any material effect on the Company's financial statements. 10
13 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 2. CONFLICTS OF INTEREST AND TRANSACTIONS WITH RELATED PARTIES a. The Company entered into a license agreement with an affiliate of the General Partner for a portion of office space at an annual rental of approximately $135,000, plus its share of certain additional rent. Such agreement was approved by the Audit Committee of the Board of Directors of the General Partner (the "Audit Committee"). For the three and six months ended June 30, 2001 the Company paid rent of approximately $35,000 and $70,000 respectively, in accordance with the agreement. b. Stratosphere Corp. ("Stratosphere") billed affiliates of the General Partner approximately $344,000 and $449,000 for administrative services performed by Stratosphere personnel during the three and six months ended June 30, 2001, respectively. Stratosphere also received hotel revenue of approximately $200,000 and $300,000 during the three and six months ended June 30, 2001, respectively, in connection with a tour and travel agreement entered into with an affiliate of the General Partner. c. As of August 10, 2001 affiliates of Carl C. Icahn ("Icahn"), the Chairman of the Board of the General Partner, own 7,689,016 Preferred Units and 39,409,836 Depositary Units. 11
14 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 3. COMMITMENTS AND CONTINGENCIES a. On November 18, 1998, Ruth Ellen Miller filed a class Action Complaint bearing the caption Ruth Ellen Miller, on behalf of herself and all others similarly situated v. American Real Estate Partners, L.P., High Coast Limited Partnership, American Property Investors, Inc., Carl C. Icahn, Alfred Kingsley, Mark H. Rachesky, William A. Leidesdorf, Jack G. Wasserman and John P. Saldarelli in the Delaware Chancery Court in New Castle County (Civil Action No. 16788NC). On September 21, 2000, Ruth Ellen Miller, Charles and Lydia Hoffman, and Joy Lazarus, claiming as plaintiffs on behalf of themselves and all others similarly situated, filed an amended complaint (the "Complaint") and a motion for class certification. Plaintiffs allege that all defendants, in breach of their fiduciary duties to the Company, have caused the Company to engage in self-dealing or self-interested transactions which inure to the benefit of defendants. Plaintiff's claims are alleged to arise out of two transactions: the February 1995 Rights Offering effectuated pursuant to a purportedly false and misleading prospectus; and Icahn's alleged use of his voting control to change the business purpose of the Company by amending the Partnership Agreement to permit the Company to make "non-real estate related investments," including investments in entities owned or controlled by Icahn. The Complaint seeks to have plaintiffs appointed as class representative and that the putative class be certified. The Complaint also seeks an unspecified amount in damages and injunctive relief: (i) dissolving the Partnership; (ii) enjoining API from continuing to act as general partner of the Partnership; (iii) enjoining the Partnership from engaging in any transaction in which Icahn has either a direct or indirect interest; (iv) ordering API to exercise its fiduciary obligations; and (v) compelling the Partnership to make periodic distributions on the Depositary Units. Further, plaintiffs seek damages resulting from the alleged breach of the Partnership Agreement for an unquantified amount. The Complaint also seeks costs and attorneys' fees. Defendants moved to dismiss the amended complaint. The Company joined in the motions to the extent that the allegations are deemed applicable to it. Management believes plaintiffs' claims are without merit and intends to vigorously defend against them. b. In January 2001, Stratosphere Gaming Corp. ("Stratosphere Gaming"), a wholly-owned subsidiary of Stratosphere, was named in an action styled Disabled Rights Action Committee v. Stratosphere Gaming Corp., Case No. A430070, in the Eighth Judicial District Court of the State of Nevada. The complaint alleges a number of violations of the Americans with Disabilities Act ("ADA"), including inadequate room selection, door widths and other similar items. Simultaneously with the complaint, plaintiffs filed a Motion for Preliminary Injunction, seeking to have construction halted on the new tower until the property fully complies with the ADA. Stratosphere Gaming removed the action to the United States District Court in Nevada and it is now styled as Disabled Rights Action Committee v. Stratosphere Gaming Corp., Case No. CV-S-01-0162-RSH (PAL). Stratosphere Gaming has moved to dismiss one of the counts of plaintiffs' complaint. Stratosphere Gaming also opposed plaintiffs' Motion for Preliminary Injunction.In March, 2001, the Court held a hearing on the plaintiffs' Motion for Preliminary Injunction and denied the motion, focusing upon what the Court believed to be the plaintiffs' lack of irreparable injury. At present, discovery has commenced and the parties are awaiting the Court's ruling on the Motion to Dismiss. In May, 2001, Stratosphere was named in an action brought by Harrah's Entertainment, Inc. alleging infringement of a purported patent covering a business method allegedly developed by Harrah's. The use of an allegedly similar business method by Stratosphere in its advertising and promotions is said by plaintiff to infringe upon its patent rights. 12
15 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 Stratosphere's management intends to vigorously defend itself against the above actions which are in the early stages of the litigation process. However, the Company does not believe that they will have a material effect on the results of operations or financial position of the Company. c. In addition, in the ordinary course of business, the Company, its subsidiaries and other companies in which the Company has invested are parties to various legal actions. In management's opinion, the ultimate outcome of such legal actions will not have a material effect on the results of operations or the financial position of the Company. d. In October, 2000, Grand Union Company, a tenant leasing four properties owned by the Company filed for Chapter 11 Bankruptcy protection. The annual rental for these four properties is approximately $395,000. In 2001, the tenant exercised its right to affirm the leases which were simultaneously assigned to unaffiliated third parties. At June 30, 2001, the carrying value of these four properties was approximately $2,739,000. e. In December 2000, Bradlees, a tenant leasing two properties owned by the Company, filed a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code. The annual rentals for these two properties is approximately $550,000. In 2001, the tenant exercised its right to affirm the leases which were simultaneously assigned to unaffiliated third parties. At June 30, 2001, the carrying value of these two properties was approximately $2,381,000. f. In April 2001, WR Grace, a tenant in a property owned by the Company, filed a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code. The annual rental for the property is approximately $988,000. The tenant has not yet exercised its right to affirm or reject the lease. At June 30, 2001, the carrying value of the property was approximately $5,279,000. 13
16 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 4. HOTEL, CASINO AND RESORT OPERATING PROPERTIES a. Stratosphere Hotel and Casino The Company owns approximately 51% of Stratosphere and consolidates Stratosphere in its financial statements. In September 2000, Stratosphere's Board of Directors approved a going private transaction proposed by the Company and an affiliate of Icahn. The Company, subject to certain conditions, will pay approximately $44.3 million for the outstanding shares of Stratosphere not currently owned. This transaction is expected to be completed in the fourth quarter of 2001. Stratosphere owns and operates the Stratosphere Tower Casino & Hotel, a resort complex located in Las Vegas, Nevada. Stratosphere will invest up to $100 million for construction of an additional 1,000 rooms to the hotel, related amenities and purchase of the leasehold interest to the shopping center located on its premises. The improvements were substantially completed in July 2001. As of June 30, 2001, Stratosphere has expended approximately $78.2 million for additions to hotel and casino operating property. Stratosphere's operations for the three and six months ended June 30, 2001 and 2000 have been included in "Hotel and casino operating income and expenses" in the Consolidated Statements of Earnings. Hotel and casino 14
17 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 operating expenses include all expenses except for approximately $2,229,000 and $4,652,000 of depreciation and amortization for the three and six months ended June 30, 2001, respectively, and $2,124,000 and $4,214,000 of depreciation and amortization for the three and six months ended June 30, 2000, respectively. Such amounts have been included in "Depreciation and amortization expense" in the Consolidated Statements of Earnings. b. Hotel and Resort Operating Properties Hotel and resort operations for the three and six months ended June 30, 2001 and 2000 have been included in "Hotel and resort operating income and expenses" in the Consolidated Statements of Earnings. Hotel and resort operating expenses include all expenses except for approximately $325,000 and $648,000 of depreciation and amortization for the three and six months ended June 30, 2001 respectively, and $369,000 and $673,000 of depreciation and amortization for the three and six months ended June 30, 2000, respectively. Such amounts have been included in "Depreciation and amortization expense" in the Consolidated Statements of Earnings. Hotel, casino and resort operations are highly seasonal in nature and are not necessarily indicative of results expected for the full year. 15
18 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 5. MARKETABLE EQUITY AND DEBT SECURITIES a. In March 2000, in accordance with a prior agreement, the Company transferred its First Mortgage Notes ("Notes") in the Sands Hotel and Casino ("Sands") and the Claridge Hotel and Casino ("Claridge") to an affiliate of the General Partner in order to facilitate the bankruptcy reorganizations of the two Atlantic City casinos. The Company was paid its cost for such notes. However, the affiliate of the General Partner is obligated to sell back to the Company and the Company is obligated to repurchase its interest in the Sands and/or Claridge, as the case may be, at the same price increased by Icahn advances, decreased by distributions and/or interest payments received (together with a commercially reasonable interest factor) when the appropriate licenses are obtained by the Company. The Company's liability to repurchase its interests is reflected as "Due to affiliates" in the Consolidated Balance Sheets. In February 2001, the Icahn affiliates sold their entire Claridge portfolio ($37.1 million face amount of Claridge Notes) for the following additional interests in the Sands: (i) 779,861 common shares of GB Holdings Inc. ("GB Holdings"), (ii) $15.96 million face amount of GB Property First Mortgage Notes ("GB Notes") and (iii) $21.56 million in cash. The Company recognized a gain of approximately $1.3 million as a result of this sale in the six months ended June 30, 2001. As a result, affiliates of the General Partner are, in effect, holding on behalf of the Company approximately (i) 3.6 million common shares of GB Holdings and (ii) $26.9 million face amount of GB Notes, to which the Company will become entitled and obligated to purchase when it is fully licensed. The Company no longer has any interest in the Claridge. 16
19 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 For accounting purposes, the Company reflects its interest in the new Sands notes as held to maturity and has recorded its corresponding liability to repurchase such interests from the affiliate of the General Partner. At June 30, 2001 this investment is carried at cost of $21.3 million in the Consolidated Balance Sheets. The Company reflects its pro rata equity interest in the Sands as "Equity interest in GB Holdings, Inc." in the Consolidated Balance Sheets (see note 6). 6. EQUITY INTEREST IN GB HOLDINGS, INC. The Company reflects its pro rata equity interest (approximately 36%) in the Sands under this caption in the Consolidated Balance Sheets. The Company's corresponding obligation to repurchase its interest is included in "Due to affiliates" in the Consolidated Balance Sheets. The Company accounts for its investment under the equity method. 7. BAYSWATER In March 2000, the Company acquired from affiliates of the General Partner the assets of Bayswater Realty & Capital Corp. and the ownership interests of its affiliated entities ("Bayswater") for approximately $84.35 million. 17
20 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 In accordance with generally accepted accounting principles, assets and liabilities transferred between entities under common control are accounted for at historical costs similar to a pooling of interests, and the financial statements of the previously separate companies for periods prior to the acquisition are restated on a combined basis. 8. PREFERRED UNITS Pursuant to the terms of the Preferred Units, on February 23, 2001, the Company declared its scheduled annual preferred unit distribution payable in additional Preferred Units at the rate of 5% of the liquidation preference of $10. The distribution was payable March 31, 2001 to holders of record as of March 15, 2001. A total of 423,172 additional Preferred Units were issued. As of June 30, 2001, 8,886,631 Preferred Units are issued and outstanding. 9. EARNINGS PER SHARE Basic earnings per share are based on earnings after the preferred pay-in-kind distribution to Preferred Unitholders. 18
21 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 Diluted earnings per share uses net earnings attributable to limited partner interests as the numerator with the denominator based on the weighted average number of units and equivalent units outstanding. The Preferred Units are considered to be unit equivalents. For the three and six months ended June 30, 2001 and 2000, basic and diluted earnings per weighted average limited partnership unit are detailed as follows: Three Months Ended Six Months Ended ------------------ ---------------- 6/30/01 6/30/00 6/30/01 6/30/00 ------- ------- ------- ------- Basic: Earnings before property and securities transactions $ .29 $ .41 $ .57 $ .63 Net gain from property and securities transactions .03 .01 .06 .04 ----- ----- ----- ----- Net earnings $ .32 $ .42 $ .63 $ .67 ===== ===== ===== ===== Diluted: Earnings before property and securities transactions $ .27 $ .35 $ .52 $ .55 Net gain from property and securities transactions .02 .01 .05 .04 ----- ----- ----- ----- Net earnings $ .29 $ .36 $ .57 $ .59 ===== ===== ===== ===== 19
22 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 For accounting purposes Bayswater's earnings prior to the date of acquisition (March 23, 2000) were allocated to the General Partner and therefore excluded from the computation of basic and diluted earnings per limited partnership unit. 10. COMPREHENSIVE INCOME The Company follows SFAS No. 130 "Reporting Comprehensive Income" which establishes standards for the reporting and display of comprehensive income and its components. The components of comprehensive income include net income and certain amounts previously reported directly in equity. Comprehensive income for the three and six months ended June 30, 2001 and 2000 is as follows (in $000's): 20
23 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 Three Months Ended Six Months Ended ------------------ ---------------- 2001 2000 2001 2000 -------- -------- -------- -------- Net income $ 16,215 $ 20,607 $ 32,046 $ 35,305 Sale of debt securities available for sale -- -- 3,896 -- Unrealized losses on securities available for sale (1,459) (743) (744) (1,299) -------- -------- -------- -------- Comprehensive income $ 14,756 $ 19,864 $ 35,198 $ 34,006 ======== ======== ======== ======== 11. SEGMENT REPORTING The Company is engaged in five operating segments consisting of: (i) rental real estate, (ii) hotel and resort operating properties, (iii) hotel and casino operating properties, (iv) land sales, house and condominium development, and (v) investment in securities including investment in other limited partnerships and marketable equity securities. The Company's reportable segments offer different services and require different operating strategies and management expertise. There have been no material changes in segment assets since December 31, 2000. 21
24 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 The Company assesses and measures segment operating results based on segment earnings from operations as disclosed below. Segment earnings from operations are not necessarily indicative of cash available to fund cash requirements nor synonymous with cash flow from operations. The revenues and net earnings for each of the reportable segments are summarized as follows for the three and six months ended June 30, 2001 and 2000 (in $000's). Three Months Ended ------------------ 6/30/01 6/30/00 ------- ------- Revenues: Rental real estate $11,157 $11,223 Land, house and condominium sales 10,163 22,227 Hotel & resort operating properties 4,482 5,763 Hotel & casino operating properties 33,508 32,088 Other investments 2,830 2,915 ------- ------- Sub-total 62,140 74,216 Reconciling items - primarily interest income on short-term investments and other income 7,042 8,099 ------- ------- Total revenues $69,182 $82,315 ======= ======= 22
25 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 Three Months Ended ------------------ 6/30/01 6/30/00 ------- ------- Net earnings: Segment earnings (losses): Rental real estate $ 9,873 $ 9,950 Land, house and condominium development 2,179 5,688 Hotel and resort operating properties 647 962 Hotel and casino operating properties 2,731 3,290 Other investments 2,830 2,915 ------- ------- Total segment earnings 18,260 22,805 Other expenses net (2,045) (2,198) General partner's share (323) (410) ------- ------- Net earnings-limited partner unitholders $15,892 $20,197 ======= ======= 23
26 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 Six Months Ended ---------------- 6/30/01 6/30/00 --------- --------- Revenues: Rental real estate $ 21,708 $ 21,752 Land, house and condominium sales 20,927 41,036 Hotel & resort operating properties 7,214 9,527 Hotel & casino operating properties 66,765 66,092 Other investments 3,941 3,978 --------- --------- Sub-total 120,555 142,385 Reconciling items - primarily interest income on short-term investments and other income 15,534 15,297 --------- --------- Total revenues $ 136,089 $ 157,682 ========= ========= 24
27 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 Six Months Ended ---------------- 6/30/01 6/30/00 --------- --------- Net earnings: Segment earnings (losses): Rental real estate $ 19,406 $ 19,675 Land, house and condominium development 5,514 10,336 Hotel and resort operating properties 543 266 Hotel and casino operating properties 6,841 7,270 Other investments 3,941 3,978 --------- --------- Total segment earnings 36,245 41,525 Other expenses net (4,199) (6,220) General partner's share (638) (2,132) --------- --------- Net earnings-limited partner unitholders $ 31,408 $ 33,173 ========= ========= 25
28 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Statements included in Management's Discussion and Analysis of Financial Condition and Results of Operations which are not historical in nature, are intended to be, and are hereby identified as, "forward looking statements" for purposes of the safe harbor provided by Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended by Public Law 104-67. Forward-looking statements regarding management's present plans or expectations involve risks and uncertainties and changing economic or competitive conditions, as well as the negotiation of agreements with third parties, which could cause actual results to differ from present plans or expectations, and such differences could be material. Readers should consider that such statements speak only as to the date hereof. GENERAL The Company believes that it will benefit from the diversification of its portfolio of assets. To further its investment objectives, the Company may consider the acquisition or seek effective control of land development companies and other real estate operating companies which may have a significant inventory of quality assets under development. In selecting future real estate investments, the Company intends to focus on assets that it 26
29 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 believes are undervalued in the real estate market, which investments may require substantial liquidity to maintain a competitive advantage. The Company believes that there are still opportunities available to acquire investments that are undervalued. These may include commercial properties, residential and commercial development projects, land, assets in the gaming industry, non-performing loans, the securities of entities which own, manage or develop significant real estate assets, including limited partnership units and securities issued by real estate investment trusts and the acquisition of debt or equity securities of companies which may be undergoing restructuring and under-performing properties that may require active asset management and significant capital improvements. The Company has made investments in the gaming industry, and may consider additional gaming industry investments and investments related to the entertainment industry. Such investments may include additional casino properties and those in the entertainment field, such as movie theater interests and the financing and investment in the movie production and distribution industry. Such investments may include acquisitions from, or in joint venture or co-management with, Icahn, the General Partner or their affiliates, provided that the terms thereof are fair and reasonable to the Company. The Company notes that while there are still opportunities available to acquire investments that are undervalued, acquisition opportunities in the real estate market for value-added investors have become more competitive to source and the increased competition may have some impact on the spreads and the ability to find quality assets that provide returns that are sought. These investments may not be readily financeable and may not generate immediate positive cash flow for the Company. As such, they require the Company to maintain a strong capital base in order to react quickly to these market opportunities as well as to allow the Company the financial strength to develop or reposition these assets. While 27
30 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 this may impact cash flow in the near term and there can be no assurance that any asset acquired by the Company will increase in value or generate positive cash flow, the Company intends to focus on assets that it believes may provide opportunities for long-term growth and further its objective to diversify its portfolio. Historically, substantially all of the Company's real estate assets have been net leased to single corporate tenants under long-term leases. With certain exceptions, these tenants are required to pay all expenses relating to the leased property and therefore the Company is not typically responsible for payment of expenses, such as maintenance, utilities, taxes and insurance associated with such properties. By the end of the year 2003, net leases representing approximately 11% of the Company's net annual rentals from its portfolio will be due for renewal, and by the end of the year 2005, net leases representing approximately 31% of the Company's net annual rentals will be due for renewal. Since most of the Company's properties are net-leased to single, corporate tenants, it may be difficult and time-consuming to re-lease or sell those properties that existing tenants decline to re-let or purchase and the Company may be required to incur expenditures to renovate such properties for new tenants. In addition, the Company may become responsible for the payment of certain operating expenses, including maintenance, utilities, taxes, insurance and environmental compliance costs associated with such properties, which are presently the responsibility of the tenant. As a result, the Company could experience an adverse impact on net cash flow in the future from such properties. 28
31 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 An amendment to the Partnership Agreement (the "Amendment" ) became effective in August, 1996 which permits the Company to invest in securities issued by companies that are not necessarily engaged as one of their primary activities in the ownership, development or management of real estate while remaining in the real estate business and continuing to pursue suitable investments for the Company in the real estate market. In September 1997, the Company completed its Rights Offering (the "1997 Offering") to holders of its Depositary Units to increase its assets available for investment, take advantage of investment opportunities and further diversify its portfolio of assets. Net proceeds of approximately $267 million were raised for investment purposes. Expenses relating to environmental clean-up have not had a material effect on the earnings, capital expenditures, or competitive position of the Company. Management believes that substantially all such costs would be the responsibility of the tenants pursuant to lease terms. While most tenants have assumed responsibility for the environmental conditions existing on their leased property, there can be no assurance that the Company will not be deemed to be a responsible party or that the tenant will bear the costs of remediation. Also, as the Company acquires more operating properties, its exposure to environmental clean-up costs may increase. The Company completed Phase I Environmental Site Assessments on most of its properties by third-party consultants. Based on the results of these Phase I Environmental Site Assessments, the environmental consultant has recommended that certain sites may have environmental conditions that should be further reviewed. 29
32 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 The Company has notified each of the responsible tenants to attempt to ensure that they cause any required investigation and/or remediation to be performed and most tenants continue to take appropriate action. However, if the tenants fail to perform responsibilities under their leases referred to above, based solely upon the consultant's estimates resulting from its Phase I Environmental Site Assessments referred to above, it is presently estimated that the Company's exposure could amount to $2-3 million. However, as no Phase II Environmental Site Assessments have been conducted by the consultants, there can be no accurate estimation of the need for or extent of any required remediation, or the costs thereof. In addition, the Company has notified all tenants of the Resource Conservation and Recovery Act's ("RCRA") December 22, 1998 requirements for regulated underground storage tanks. The Company may, at its own cost, have to cause compliance with RCRA's requirements in connection with vacated properties, bankrupt tenants and new acquisitions. Phase I Environmental Site Assessments will also be performed in connection with new acquisitions and property refinancings. The Company is in the process of updating its Phase I Site Assessments for certain of its environmentally sensitive properties including properties with open RCRA requirements. Approximately forty-one updates are expected to be completed in 2001 with another thirty-seven scheduled for the year 2002. 30
33 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 RESULTS OF OPERATIONS THREE MONTHS ENDED JUNE 30, 2001 COMPARED TO THREE MONTHS ENDED JUNE 30, 2000 Gross revenues decreased by $13,133,000, or 16%, during the three months ended June 30, 2001 as compared to the same period in 2000. This decrease reflects decreases of $12,064,000 in land, house and condominium sales, $1,677,000 in dividend and other income, $1,281,000 in hotel and resort operating income, $1,086,000 in interest income on treasury bills and other investments and $755,000 in financing lease income partially offset by increases of $1,621,000 in equity in earnings of GB Holdings, Inc., $1,420,000 in hotel and casino operating income and $689,000 in rental income. The decrease in land, house and condominium sales is primarily due to a decline in inventory of completed units available for sale. The decrease in dividend and other income is primarily due to a decrease in distributions from limited partnership investments. The decrease in hotel and resort operating income is primarily attributable to New Seabury resort operations which were negatively impacted by the construction of a new club house and golf course improvements. The decrease in interest income on treasury bills and other investments is primarily attributable to a decrease in interest rates on short-term investments. The decrease in financing lease income is the result of lease expirations and normal financing lease amortization. The increase in hotel and casino operating income is primarily attributable to an increase in gaming revenues. The equity in earnings of GB Holdings, Inc. is the result of accounting for the Company's 31
34 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 interest under the equity method effective October 1, 2000. The increase in rental income is primarily attributable to operating lease rentals. Expenses decreased by $7,806,000, or 12.6%, during the three months ended June 30, 2001 as compared to the same period in 2000. This decrease reflects decreases of $8,555,000 in the cost of land, house and condominium sales, $966,000 in hotel and resort operating expenses, $432,000 in general and administrative expenses and $135,000 in depreciation and amortization partially offset by increases of $1,979,000 in hotel and casino operating expenses, $292,000 in interest expense and $11,000 in rental property expenses. The decrease in cost of land, house and condominium sales is due to decreased sales as explained above. The decrease in hotel and resort operating expenses is primarily attributable to the New Seabury resort operations as explained above. The increase in hotel and casino operating expenses is primarily attributable to increased costs associated with increased revenues. As a result of the completion of Stratosphere's additional 1,000 rooms and related amenities, management anticipates increased hotel and casino operating revenues and expenses in the second half of 2001. Due to this expansion, management also expects the occupancy percentage and average daily rate ("ADR") to decline during this period while marketing and advertising expenses are expected to increase. Earnings before property and securities transactions and minority interest decreased during the three months ended June 30, 2001 by $5,327,000 as compared to the same period in 2000. Gain on property transactions increased by $253,000 during the three months ended June 30, 2001 as compared to the same period in 2000 due to the size and number of transactions. 32
35 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 During the three months ended June 30, 2000, the Company recorded a provision for loss on real estate of $232,000. No such provision was required in 2001. Minority interest in the net earnings of Stratosphere Corporation decreased by $450,000 during the three months ended June 30, 2001 as compared to the same period in 2000 due to a decrease in Stratosphere's net hotel and casino operating income. Net earnings for the three months ended June 30, 2001 decreased by $4,392,000 as compared to the three months ended June 30, 2000 primarily due to decreased interest income ($1.1 million) and decreased earnings from land, house and condominium operations ($3.5 million). Interest income declined due to lower short-term rates which trend is expected to continue. Earnings from land, house and condominium operations decreased due to a decline in inventory of completed units available for sale. Based on existing contracts, sales are expected to increase in the second half of 2001. However, the decrease in land inventory in approved sub-divisions is expected to negatively impact 2002 earnings from this business segment unless mitigated by the purchase of land, development and sale of units in approved sub-divisions. Diluted earnings per weighted average limited partnership unit outstanding before property and securities transactions were $.27 in the three months ended June 30, 2001 compared to $.35 in the comparable period of 2000, and net gain from property transactions was $.02 in the three months ended June 30, 2001 compared to $.01 in the comparable period of 2000. Diluted net earnings per weighted average limited partnership unit 33
36 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 outstanding totalled $.29 in the three months ended June 30, 2001 compared to $.36 in the comparable period of 2000. RESULTS OF OPERATIONS SIX MONTHS ENDED JUNE 30, 2001 COMPARED TO SIX MONTHS ENDED JUNE 30, 2000 Gross revenues decreased by $21,593,000, or 13.7%, during the six months ended June 30, 2001 as compared to the same period in 2000. This decrease reflects decreases of $20,109,000 in land, house and condominium sales, $2,313,000 in hotel and resort operating income, $1,616,000 in financing lease income and $518,000 in dividend and other income partially offset by increases of $1,572,000 in rental income, $675,000 in equity in earnings of GB Holdings, Inc., $673,000 in hotel and casino operating income and $43,000 in interest income on treasury bills and other investments. The decrease in land, house and condominium sales is primarily due to a decline in inventory of completed units available for sale. The decrease in hotel and resort operating income is primarily attributable to a decline in New Seabury resort operations, including membership initiation fees, which were negatively impacted by the construction of a new clubhouse and golf course improvements. The decrease in financing lease income is the result of lease expirations and normal financing lease amortization. The decrease in dividend and other income is primarily due to decreased distributions from limited partnership investments partially offset by a lease termination fee received in the six months ended June 30, 2001. The increase in rental income is primarily attributable to newly acquired properties. The equity in earnings of GB Holdings, Inc. is the 34
37 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 result of accounting for the Company's interest under the equity method effective October 1, 2000. The increase in hotel and casino operating income is primarily attributable to increased gaming revenues. Expenses decreased by $16,770,000, or 13.7%, during the six months ended June 30, 2001 as compared to the same period in 2000. This decrease reflects decreases of $15,287,000 in the cost of land, house and condominium sales, $2,590,000 in hotel and resort operating expenses, $1,650,000 in Bayswater acquisition costs and $540,000 in general and administrative expenses partially offset by increases of $1,666,000 in interest expense, $1,102,000 in hotel and casino operating expenses, $304,000 in depreciation and amortization and $225,000 in rental property expenses. The decrease in cost of land, house and condominium sales is due to decreased sales as explained above. The decrease in hotel and resort operating expenses is primarily attributable to New Seabury resort operations as explained above. The increase in interest expense is primarily attributable to increased interest due affiliates in connection with repurchase obligations. The increase in hotel and casino operating expenses is primarily attributable to increased costs associated with increased revenues. As a result of the completion of Stratosphere's additional 1,000 rooms and related amenities, management anticipates increased hotel and casino operating revenues and expenses in the second half of 2001. Due to this expansion, management also expects the occupancy percentage and ADR to decline during this period while marketing and advertising expenses are expected to increase. Earnings before property and securities transactions and minority interest decreased during the six months ended June 30, 2001 by $4,823,000 as compared to the same period in 2000. Gain on property transactions decreased by $744,000 during the six months ended June 30, 2001 as compared to the same period in 2000 due to the number and size of transactions. 35
38 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 During the six months ended June 30, 2000, the Company recorded a provision for loss on real estate of $232,000. No such provision was required in 2001. Gain on sale of marketable equity and debt securities was $1,334,000 in the six months ended June 30, 2001. There was no such transaction in 2000. Minority interest in the net earnings of Stratosphere Corporation decreased by $742,000 during the six months ended June 30, 2001 as compared to the same period in 2000 due to a decrease in Stratosphere's net hotel and casino operating income. Net earnings for the six months ended June 30, 2001 decreased by $3,259,000 as compared to the six months ended June 30, 2000 primarily due to decreased earnings from land, house and condominium operations ($4.8 million) and increased interest expense ($1.7 million) partially offset by decreased Bayswater acquisition costs ($1.7 million) and increased gain on sale of marketable equity and debt securities ($1.3 million). Earnings from land, house and condominium operations decreased due to a decline in inventory of completed units available for sale. Based on existing contracts, sales are expected to increase in the second half of 2001. However, the decrease in land inventory in approved sub-divisions is expected to negatively impact 2002 earnings from this business segment unless mitigated by the purchase of land, development and sale of units in approved sub-divisions. 36
39 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 Diluted earnings per weighted average limited partnership unit outstanding before property and securities transactions were $.52 in the six months ended June 30, 2001 compared to $.55 in the comparable period of 2000, and net gain from property and securities transactions was $.05 in the six months ended June 30, 2001 compared to $.04 in the comparable period of 2000. Diluted net earnings per weighted average limited partnership unit outstanding totalled $.57 in the six months ended June 30, 2001 compared to $.59 in the comparable period of 2000. For accounting purposes Bayswater's earnings prior to the date of acquisition (March 23, 2000) were allocated to the General Partner and therefore excluded from the computation of basic and diluted earnings per limited partnership unit. CAPITAL RESOURCES AND LIQUIDITY Generally, the cash needs of the Company for day-to-day operations have been satisfied from cash flow generated from current operations. Cash flow from day-to-day operations represents net cash provided by operating activities (excluding working capital changes, non-recurring other income and the cash flow from the operations of Bayswater and Stratosphere retained for their operations) plus principal payments received on financing leases as well as principal receipts on certain mortgages receivable reduced by periodic principal payments on mortgage debt. 37
40 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 In 2001, ten leases covering ten properties and representing approximately $1.0 million in annual rentals are schedule to expire. Seven leases, originally representing approximately $667,000 in annual rental income, have been renewed at tenants' option for approximately $434,000 annual rentals. Such renewals are generally for a term of five years. The renewal status of two properties, with an approximate annual rental income of $300,000, is currently pending. One property representing approximately $33,000 in annual rentals was sold. The Board of Directors of the General Partner announced that no distributions on its Depositary Units are expected to be made in 2001. The Company believes that it should continue to hold and invest rather than distribute cash. In making its announcement, the Company noted it plans to continue to apply available operating cash flow toward its operations, repayment of maturing indebtedness, tenant requirements and other capital expenditures and creation of cash reserves for contingencies including environmental matters and scheduled lease expirations. During the six months ended June 30, 2001, the Company generated approximately $26.1 million in cash flow from day-to-day operations which excludes approximately $7.2 million in cash flow from the operations of Bayswater and Stratosphere which are being retained for their operations and excludes approximately $3.2 million in interest earned on the 1997 Offering proceeds which is being retained for future acquisitions. 38
41 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 In 2001, the Company had approximately $1.77 million of maturing debt obligations which was repaid in the first quarter of 2001. In addition, the Company repaid a mortgage of approximately $706,000 in connection with a lease termination in the six months ended June 30, 2001. Capital expenditures for real estate, excluding hotel and casino operating property, were approximately $8.8 million during the six months ended June 30, 2001. During the six months ended June 30, 2001, net cash flow after payment of maturing debt obligations and capital expenditures was approximately $14.8 million which was added to the Company's operating cash reserves. This excludes cash flow from Bayswater and Stratosphere which is being retained for their operations. The Company's operating cash reserves are approximately $156.3 million at June 30, 2001 (not including the cash from capital transactions or from the 1997 Offering which is being retained for investment), which are being retained to meet maturing debt obligations, capital expenditures and certain contingencies. The Company has the right and obligation to repurchase its interest in the Sands when licensed by the N.J. Casino Control Commission. At June 30, 2001, the Company's obligation to affiliates of the General Partner for interests held in the Sands on its behalf was approximately $68.5 million. In September 2000, Stratosphere's Board of Directors approved a going private transaction proposed by the 39
42 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 Company and an affiliate of Icahn. The Company, subject to certain conditions, will pay approximately $44.3 million for the outstanding shares of Stratosphere not currently owned. This transaction is expected to be completed in the fourth quarter of 2001. In addition, Stratosphere will invest up to $100 million for expansion of its hotel and casino facility, related amenities and the purchase of the leasehold interest in the shopping center located on the premises. This expansion was substantially completed in July 2001. As of June 30, 2001, Stratosphere has expended approximately $78.2 million for additions to hotel and casino operating property. The parent company has funded $68.5 million of this expansion and the balance has been funded from Stratosphere's working capital. The Company anticipates that golf course and clubhouse improvements in New Seabury, Massachusetts will require the expenditure by the Company of an aggregate of approximately $10 million in the year 2001, of which $8.0 million was expended in the six months ended June 30, 2001. These improvements are expected to be completed in the third quarter of 2001. Pursuant to the 1997 Offering, which closed in September 1997, the Company raised approximately $267 million to increase its available liquidity so that it will be in a better position to take advantage of investment opportunities and to further diversity its portfolio. The Company's cash and cash equivalents and investment in U.S. Government and Agency obligations decreased by $12.3 million during the six months ended June 30, 2001, primarily due to additions to hotel and casino property ($33.8 million), mezzanine loan advances ($9.3 million) and participation loan ($6.8 million) partially 40
43 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 offset by net cash flow from operations ($14.8 million), net cash flow from Bayswater and Stratosphere operations ($7.2 million), working capital changes ($4.2 million), interest earned on the 1997 Rights Offering ($3.2 million), equity and debt securities ($3.1 million) and miscellaneous other items ($5.1 million). The United States Securities and Exchange Commission requires that registrants include information about primary market risk exposures relating to financial instruments. Through its operating and investment activities, the Company is exposed to market, credit and related risks, including those described elsewhere herein. As the Company may invest in debt or equity securities of companies undergoing restructuring or undervalued by the market, these securities are subject to inherent risks due to price fluctuations, and risks relating to the issuer and its industry, and the market for these securities may be less liquid and more volatile than that of higher rated or more widely followed securities. Other related risks include liquidity risks, which arise in the course of the Company's general funding activities and the management of its balance sheet. This includes both risks relating to the raising of funding with appropriate maturity and interest rate characteristics and the risk of being unable to liquidate an asset in a timely manner at an acceptable price. Real estate investments by their nature are often difficult or time-consuming to liquidate. Also, buyers of minority interests may be difficult to secure, while transfers of large block positions may be subject to legal, contractual or market restrictions. Other operating risks for the Company include lease terminations, whether scheduled terminations or due to tenant defaults or bankruptcies, development risks, and 41
44 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 environmental and capital expenditure matters, as described elsewhere herein. Whenever practical, the Company employs internal strategies to mitigate exposure to these and other risks. The Company, on a case by case basis with respect to new investments, performs internal analyses of risk identification, assessment and control. The Company reviews credit exposures, and seeks to mitigate counter party credit exposure through various techniques, including obtaining and maintaining collateral, and assessing the creditworthiness of counterparties and issuers. Where appropriate, an analysis is made of political, economic and financial conditions, including those of foreign countries. Operating risk is managed through the use of experienced personnel. The Company seeks to achieve adequate returns commensurate with the risk it assumes. The Company utilizes qualitative as well as quantitative information in managing risk. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS Response to this item is included in Item 2. "Management's Discussion and Analysis of Financial Condition and Results of Operations" above. 42
45 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 PART II. Other information ITEM 1. LEGAL PROCEEDINGS Unitholder Litigation - --------------------- a. On November 18, 1998, Ruth Ellen Miller filed a class Action Complaint bearing the caption Ruth Ellen Miller, on behalf of herself and all others similarly situated v. American Real Estate Partners, L.P., High Coast Limited Partnership, American Property Investors, Inc., Carl C. Icahn, Alfred Kingsley, Mark H. Rachesky, William A. Leidesdorf, Jack G. Wasserman and John P. Saldarelli in the Delaware Chancery Court in New Castle County (Civil Action No. 16788NC). On September 21, 2000, Ruth Ellen Miller, Charles and Lydia Hoffman, and Joy Lazarus, claiming as plaintiffs on behalf of themselves and all others similarly situated, filed an amended complaint (the "Complaint") and a motion for class certification. Plaintiffs allege that all defendants, in breach of their fiduciary duties to the Company, have caused the Company to engage in self-dealing or self-interested transactions which inure to the benefit of defendants. Plaintiff's claims are alleged to arise out of two transactions: the February 1995 Rights Offering effectuated pursuant to a purportedly false and misleading prospectus; and Icahn's alleged use of his voting control to change the business purpose of the Company by amending the Partnership Agreement to permit the Company to make "non-real estate related investments," including investments in entities owned or controlled by Icahn. The Complaint seeks to have plaintiffs appointed as class representative and that the putative class be certified. The Complaint also seeks an unspecified amount in damages and injunctive relief: (i) dissolving the Partnership; (ii) enjoining API from continuing to act as general partner of the Partnership; (iii) enjoining the Partnership from engaging in any transaction in which Icahn has either a direct or indirect interest; (iv) ordering API to exercise its fiduciary obligations; and (v) compelling the Partnership to make periodic distributions on the Depositary Units. Further, plaintiffs seek damages resulting from the alleged breach of the Partnership Agreement for an unquantified amount. The Complaint also seeks costs and attorneys' fees. Management believes plaintiffs' claims are without merit and intends to vigorously defend against them. Defendants moved to dismiss the amended complaint. The Company joined in the motions to the extent that the allegations are deemed applicable to it. Stratosphere Litigation - ----------------------- In January 2001, Stratosphere Gaming Corp. ("Stratosphere Gaming"), a wholly-owned subsidiary of Stratosphere, was named in an action styled Disabled Rights Action Committee v. Stratosphere Gaming Corp., Case No. A430070, in the Eighth Judicial District Court of the State of Nevada. The complaint alleges a number of violations of the Americans with Disabilities Act ("ADA"), including inadequate room selection, door widths and other similar items. Simultaneously with the complaint, plaintiffs filed a Motion for Preliminary Injunction, seeking to have construction halted on the new tower until the property fully complies with the ADA. Stratosphere Gaming removed the action to the United States District Court in Nevada and it is now styled as Disabled Rights Action Committee v. Stratosphere Gaming Corp., Case No. CV-S-01-0162-RSH (PAL). Stratosphere Gaming has moved to dismiss one of the counts of plaintiffs' complaint. Stratosphere Gaming also opposed plaintiffs' Motion for Preliminary Injunction. In March, 2001, the Court held a hearing on the plaintiffs' Motion for Preliminary Injunction and denied the motion, focusing upon what the Court believed to be the plaintiffs' lack of irreparable injury. At present, discovery has commenced and the parties are awaiting the Court's ruling on the Motion to Dismiss. In May, 2001, Stratosphere was named in an action brought by Harrah's Entertainment, Inc. alleging infringement of a purported patent covering a business method allegedly developed by Harrah's. The use of an allegedly similar business method by Stratosphere in its advertising and promotions is said by plaintiff to infringe upon its patent rights. 43
46 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 Stratosphere's management intends to vigorously defend itself against the above actions which are in the early stages of the litigation process. However, the Company does not believe that they will have a material effect on the results of operations or financial position of the Company. In addition, in the ordinary course of business, the Company, its subsidiaries and other companies in which the Company has invested are parties to various legal actions. In management's opinion, the ultimate outcome of such legal actions will not have a material effect on the results of operations or the financial position of the Company. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits - none (b) (1) Form 8-K was filed on April 2, 2001 announcing 2000 fourth quarter and full year financial results and that no distributions are expected to be made during 2001. 44
47 AMERICAN REAL ESTATE PARTNERS, L.P.-FORM 10-Q-JUNE 30, 2001 SIGNATURES Pursuant to the requirements 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. AMERICAN REAL ESTATE PARTNERS, L.P. By: American Property Investors, Inc. General Partner /s/ John P. Saldarelli ---------------------- John P. Saldarelli Treasurer Chief Financial Officer and Principal Accounting Officer Date: August 14, 2001 45