UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
For the Year Ended December 31, 2003
Commission File Number 1-9240
Transcontinental Realty Investors, Inc.
(Exact Name of Registrant as Specified in Its Charter)
1800 Valley View Lane,
Suite 300, Dallas, Texas
(469) 522-4200
(Registrant’s Telephone Number, Including Area Code)
Securities Registered Pursuant to Section 12(b) of the Act:
Common Stock, $.01 par value
Securities Registered Pursuant to Section 12(g) of the Act:
NONE
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 at least the past 90 days. Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes ¨ No x
The aggregate market value of the shares of voting and non-voting common equity held by non-affiliates of the Registrant, computed by reference to the closing sales price of the Common Stock on the New York Stock Exchange as of June 30, 2003 (the last business day of the Registrant’s most recently completed second fiscal quarter) was $24,546,325 based upon a total of 1,669,818 shares held as of June 30, 2003 by persons believed to be non-affiliates of the Registrant. The basis of the calculation does not constitute a determination by the Registrant as defined in Rule 405 of the Securities Act of 1933, as amended, such calculation, if made as of a date within sixty days of this filing would yield a different value. As of March 19, 2004, there were 8,113,669 shares of common stock outstanding.
Documents Incorporated by Reference:
Consolidated Financial Statements of Income Opportunity Realty Investors, Inc.
Commission File No. 1-14784
Consolidated Financial Statements of American Realty Investors, Inc.
Commission File No. 001-15663
INDEX TO
ANNUAL REPORT ON FORM 10-K
Item 1.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
Item 15.
Signature Page
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PART I
Transcontinental Realty Investors, Inc. (“TCI”), a Nevada corporation, is the successor to a California business trust that was organized on September 6, 1983 and commenced operations on January 31, 1984. On November 30, 1999, TCI acquired all of the outstanding shares of beneficial interest of Continental Mortgage and Equity Trust (“CMET”), a real estate company, in a tax-free exchange of shares, issuing 1.181 shares of its Common Stock for each outstanding CMET share. Prior to January 1, 2000, TCI elected to be treated as a Real Estate Investment Trust (“REIT”) under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the “Code”). During the third quarter of 2000, due to a concentration of ownership TCI no longer met the requirement for tax treatment as a REIT. Under the Code, TCI cannot re-qualify for REIT tax status for at least five years.
TCI’s real estate at December 31, 2003, consisted of 120 properties held for investment, one partnership property and 13 properties held for sale. In 2003, TCI purchased 10 properties held for investment. TCI’s mortgage notes receivable portfolio at December 31, 2003, consisted of 12 mortgage loans. TCI’s real estate and mortgage notes receivable portfolios are more fully discussed in ITEM 2. “PROPERTIES.”
Effective March 31, 2003, TCI financial results have been consolidated in the American Realty Investors, Inc. (“ARI”) Form 10-K and related consolidated financial statements. As of December 31, 2003, ARI owned 80.0% of the outstanding TCI common shares.
On October 23, 2001, TCI, Income Opportunity Realty Investors, Inc. (“IORI”) and American Realty Investors, Inc. (“ARI”) jointly announced a preliminary agreement with the plaintiff’s legal counsel of the derivative action entitled Olive et al. v. National Income Realty Trust, et al. for complete settlement of all disputes in the lawsuit (the “Olive Litigation”). In February 2002, the court granted final approval of the proposed settlement (the “Olive Settlement”). Under the Olive Settlement, ARI agreed to either (i) acquire all of the outstanding shares of TCI and IORI not currently owned by ARI for a cash payment or shares of ARI preferred stock or (ii) make a tender offer for all of the outstanding shares of TCI and IORI not currently owned by ARI. On November 15, 2002, ARI commenced the tender offer for the TCI and IORI shares. The tender offer was completed on March 18, 2003. ARI paid $19.00 cash per IORI share and $17.50 cash per TCI share for the stock tendered by non-affiliated stockholders. Pursuant to the tender offers, ARI acquired 1,213,226 TCI shares and 265,036 IORI shares. The completion of the tender offers fulfilled the obligations under the Olive Settlement and the Olive Litigation, originally filed in February 1990, was dismissed with prejudice. TCI has the same board and the same advisor as ARI. Two of the directors of TCI are also directors of IORI.
Business Plan and Investment Policy
TCI’s business is investing in real estate through direct equity ownership and partnerships and financing real estate and real estate related activities through investments in mortgage loans, including first, wraparound and junior mortgage loans. TCI’s real estate is located throughout the continental United States and one property is located in Poland. Information regarding TCI’s real estate and mortgage notes receivable portfolios is set forth in ITEM 2. “PROPERTIES”, and in Schedules III and IV to the Consolidated Financial Statements included at ITEM 8. “FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.” TCI has four operating segments, Apartments, Commercial Properties, Hotels and land ownership.
TCI’s business is not seasonal. Management has determined to continue to pursue a balanced investment policy, seeking both current income and capital appreciation. With respect to new real estate investments, management’s plan of operation is to consider all types of real estate with an emphasis on properties generating current cash flow. Management expects to invest in and improve these properties to maximize both their immediate and long-term value. Management has also considered the development of apartment properties in selected markets primarily in Texas. Management also expects to consider property sales opportunities for properties in stabilized real estate markets where TCI’s properties have reached their potential. Management also expects to be an opportunistic seller of properties in markets that have become overheated, i.e. an abundance of buyers. Management’s operating strategy with regard to TCI’s properties is to maximize each property’s operating income by aggressive property management through closely monitoring expenses while at the same time making property renovations and/or improvements where appropriate. While such expenditures increase the amount of revenue required to cover operating expenses, management believes that such expenditures are necessary to maintain or enhance the value of the properties.
Management does not expect that TCI will seek to fund or acquire new mortgage loans in 2004. However, TCI may originate mortgage loans in conjunction with providing purchase money financing of a property sale. Management intends to service and hold for investment the mortgage notes in TCI’s portfolio. However, TCI may borrow against its mortgage notes, using the proceeds from such borrowings for property acquisitions or for general working capital needs. Management also intends to pursue TCI’s rights vigorously with respect to mortgage notes that are in default. TCI’s Articles of Incorporation impose no limitations on its investment policy with respect to mortgage loans and does not prohibit it from investing more than a specified percentage of its assets in any one mortgage loan.
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Management of the Company
Although the Board of Directors is directly responsible for managing the affairs of TCI and for setting the policies which guide it, its day-to-day operations were performed by Basic Capital Management, Inc. (“BCM”), a contractual advisor under the supervision of the Board. Effective July 1, 2003, BCM was replaced as contractual advisor to TCI by Prime Asset Management, Inc., (“PAMI”) under the same terms as BCM’s advisory agreement. PAMI is owned by Realty Advisors (79%) and Syntek West, Inc. (21%), related parties. Syntek West, Inc. is owned by Gene Phillips. Effective August 18, 2003, PAMI changed its name to Prime Income Asset Management, Inc., (“PIAMI”). On October 1, 2003, Prime Income Asset Management, LLC (“Prime”), which is owned 100% by PIAMI, replaced PIAMI as the advisor to TCI. The duties of Prime include, among other things, locating, investigating, evaluating and recommending real estate and mortgage note investment and sales opportunities, as well as financing and refinancing sources. Prime also serves as a consultant in connection with TCI’s business plan and investment decisions made by the Board.
Prime is indirectly owned by a trust for the children of Gene E. Phillips, and Syntek West, Inc. (which is owned by Mr. Phillips), owns 21% of Prime. Mr. Phillips is not an officer or director of Prime, but serves as a representative of the trust, is involved in daily consultation with the officers of Prime and has significant influence over the conduct of Prime’s business, including the rendering of advisory services and the making of investment decisions for itself and for TCI. Prime is more fully described in ITEM 10. “DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT—The Advisor.”
BCM had provided advisory services to TCI from March 28, 1989 until June 30, 2003, when Prime replaced BCM as the contractual advisor to TCI. Prime also serves as advisor to ARI. The Directors of TCI are also directors of ARI. The officers of TCI also serve as officers of ARI, BCM and Prime. As of March 19, 2003 and after completion of the tender offer, TCI owned approximately 24.0% of IORI’s outstanding shares of common stock. ARI owned approximately 64.5% and Prime owned approximately 14.5% of the outstanding shares of TCI’s common stock.
Since February 1, 1990, affiliates of BCM and Prime have provided property management services to TCI. Currently, Triad Realty Services, Ltd. (“Triad”) provides such property management services. Triad subcontracts with other entities for the provision of property-level management services to TCI. The general partner of Triad is BCM. The limited partner of Triad is Highland Realty Services, Inc. (“Highland”) a related party. Until December 2002, Triad subcontracted the property-level management and leasing of 39 of TCI’s commercial properties to Regis Realty, Inc. (“Regis”), a related party, which was a company owned by GS Realty Services, Inc. Regis was entitled to receive property and construction management fees and leasing commissions in accordance with the terms of its property-level management agreement with Triad. Regis also was entitled to receive real estate brokerage commissions in accordance with the terms of a non-exclusive brokerage agreement. Since January 1, 2003, Regis Realty I, LLC (“Regis I”), has provided these services. Regis I is owned by Highland. Regis Hotel Corporation, a related party, managed TCI’s five hotels, until December 2002. Since January 1, 2003, Regis Hotel I, LLC, has managed TCI’s five hotels. The sole member of Regis I and Regis Hotel I, LLC is Highland. See ITEM 10. “DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT—The Advisor.”
TCI has no employees. Employees of Prime render services to TCI.
Competition
The real estate business is highly competitive and TCI competes with numerous entities engaged in real estate activities (including certain entities described in ITEM 13. “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS—Related Party Transactions”), some of which have greater financial resources than those of TCI. Management believes that success against such competition is dependent upon the geographic location of the property, the performance of property-level managers in areas such as marketing, collections and control of operating expenses, the amount of new construction in the area and the maintenance and appearance of the property. Additional competitive factors with respect to commercial properties are the ease of access to the property, the adequacy of related facilities, such as parking, and sensitivity to market conditions in setting rent levels. With respect to apartments, competition is also based upon the design and mix of units and the ability to provide a community atmosphere for the tenants. Management believes that beyond general economic circumstances and trends, the rate at which properties are renovated or the rate new properties are developed in the vicinity of each of TCI’s properties also are competitive factors.
To the extent that TCI seeks to sell any of its properties, the sales prices for such properties may be affected by competition from other real estate entities and financial institutions also attempting to sell their properties located in areas in which TCI’s properties are located, as well as by aggressive buyers attempting to penetrate or dominate a particular market.
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As described above and in ITEM 13. “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS—Related Party Transactions,” the officers and Directors of TCI also serve as officers or directors of certain other entities, also advised by Prime, and which have business objectives similar to those of TCI. TCI’s Directors, officers and advisor owe fiduciary duties to such other entities as well as to TCI under applicable law. In determining to which entity a particular investment opportunity will be allocated, the officers, Directors and advisor consider the respective investment objectives of each such entity and the appropriateness of a particular investment in light of each such entity’s existing real estate portfolio. To the extent that any particular investment opportunity is appropriate to more than one of the entities, the investment opportunity will be allocated to the entity which has had funds available for investment for the longest period of time or, if appropriate, the investment may be shared among all or some of the entities.
In addition, as also described in ITEM 13. “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS—Certain Business Relationships,” TCI also competes with other entities which are affiliates of Prime and which have investment objectives similar to TCI’s and that may compete with it in purchasing, selling, leasing and financing of real estate and real estate related investments. In resolving any potential conflicts of interest which may arise, Prime has informed management that it intends to continue to exercise its best judgment as to what is fair and reasonable under the circumstances in accordance with applicable law.
Certain Factors Associated with Real Estate and Related Investments
TCI is subject to all the risks incident to ownership and financing of real estate and interests therein, many of which relate to the general illiquidity of real estate investments. These risks include, but are not limited to, changes in general or local economic conditions, changes in interest rates and the availability of permanent mortgage financing which may render the purchase, sale or refinancing of a property difficult or unattractive and which may make debt service burdensome, changes in real estate and zoning laws, increases in real estate taxes, federal or local economic or rent controls, floods, earthquakes, hurricanes and other acts of God and other factors beyond the control of management and Prime. The illiquidity of real estate investments may also impair the ability of management to respond promptly to changing circumstances. Management believes that such risks are partially mitigated by the diversification by geographic region and property type of TCI’s real estate and mortgage notes receivable portfolios. However, to the extent new property investments or mortgage lending is concentrated in any particular region or property type, the advantages of diversification may be mitigated.
TCI’s principal offices are located at 1800 Valley View Lane, Suite 300, Dallas, Texas 75234 and are, in the opinion of management, suitable and adequate for TCI’s present operations.
Details of TCI’s real estate and mortgage notes receivable portfolios at December 31, 2003, are set forth in Schedules III and IV to the Consolidated Financial Statements included at ITEM 8. “FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.” The discussions set forth below under the headings “Real Estate” and “Mortgage Loans” provide certain summary information concerning TCI’s real estate and mortgage notes receivable portfolios.
TCI’s real estate portfolio consists of properties held for investment, properties held for sale, which were primarily obtained through foreclosure of the collateral securing mortgage notes receivable, and investments in partnerships. The discussion set forth below under the heading “Real Estate” provides certain summary information concerning TCI’s real estate and further summary information with respect to its properties held for investment, properties held for sale and its investment in partnerships.
At December 31, 2003, none of TCI’s properties, mortgage notes receivable or investment in partnerships exceeded 10% of total assets. At December 31, 2003, 81% of TCI’s assets consisted of properties held for investment, 7% consisted of properties held for sale, 4% consisted of mortgage notes and interest receivable and 2% consisted of investments in partnerships. The remaining 6% of TCI’s assets were invested in cash, cash equivalents and other assets. The percentage of TCI’s assets invested in any one category is subject to change and no assurance can be given that the composition of TCI’s assets in the future will approximate the percentages listed above.
TCI’s real estate is geographically diverse. At December 31, 2003, TCI held investments in apartments and commercial properties in each of the geographic regions of the continental United States, although its apartments and commercial properties were concentrated in the Southeast and Southwest regions, as shown more specifically in the table under “Real Estate” below. At December 31, 2003, TCI held mortgage notes receivable secured by apartments and commercial properties in the Southwest and Southeast regions of the continental United States, as shown more specifically in the table under “Mortgage Loans” below.
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Geographic Regions
Excluded from the above are 35 parcels of unimproved land and one hotel in Wroclaw, Poland, as described below.
Real Estate
At December 31, 2003, approximately 88% of TCI’s assets were invested in real estate. TCI invests primarily in real estate located throughout the continental United States, either on a leveraged or nonleveraged basis. TCI’s real estate portfolio consists of properties held for investment, investments in partnerships and properties held for sale (which were primarily obtained through foreclosure of the collateral securing mortgage notes receivable).
Types of Real Estate Investments. TCI’s real estate consists of commercial properties (office buildings, industrial warehouses and shopping centers), hotels and apartments having established income-producing capabilities. In selecting real estate for investment, the location, age and type of property, gross rents, lease terms, financial and business standing of tenants, operating expenses, fixed charges, land values and physical condition are among the factors considered. TCI may acquire properties subject to or assume existing debt and may mortgage, pledge or otherwise obtain financing for its properties. The Board of Directors may alter the types of and criteria for selecting new real estate investments and for obtaining financing without a vote of stockholders.
TCI’s real estate portfolio consists of 134 owned properties. Of the 134 properties, 12 apartments were sold to partnerships controlled by Metra Capital, LLC (“Metra”). See NOTE 7. “NOTES AND INTEREST PAYABLE.” Because the Metra sales transaction was accounted for as a finance transaction, TCI continues to account for the 12 properties as owned properties.
TCI typically invests in developed real estate. However, TCI has recently invested in unimproved land and apartment development and construction. To the extent that TCI continues to invest in development and construction projects, it will be subject to business risks, such as cost overruns and construction delays, associated with such higher risk projects.
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At December 31, 2003, TCI had the following properties under construction:
Property
Location
Bluffs at Vista Ridge
Breakwater Bay
Capitol Hill
DeSoto Ranch
Echo Valley
Heather Creek
Kingsland Ranch
Verandas at City View
Vistas at Pinnacle Park
In 2002, TCI completed the 252 unit Limestone Ranch in Lewisville, Texas, the 284 unit Falcon Lakes Apartments in Arlington, Texas, the 190 unit Tivoli Apartments in Dallas, Texas, the 80 unit Waters Edge IV Apartments in Gulfport, Mississippi and the 161 room Hotel Akademia in Wroclaw, Poland. In 2003, TCI completed 186 unit Blue Lake Villas in Waxahachie, Texas, the 284 unit Falcon Lakes in Arlington, Texas, the 180 unit River Oaks Apartments in Wiley, Texas, the 384 unit Sendero Ridge Apartments in San Antonio, Texas, the 256 unit Spyglass Apartments in Mansfield, Texas and the 188 unit Windsong Apartments in Fort Worth, Texas.
In the opinion of management, the properties owned by TCI are adequately covered by insurance.
The following table sets forth the percentages, by property type and geographic region, of TCI’s real estate (other than four hotels in the Pacific and Midwest regions, one hotel in Poland and 35 parcels of unimproved land, as described below) at December 31, 2003.
Region
Commercial
Properties
Pacific
Midwest
Southwest
Southeast
Mountain
The foregoing table is based solely on the number of apartment units and amount of commercial square footage and does not reflect the value of TCI’s investment in each region. TCI owns 35 parcels of unimproved land, two parcels for a total of 22.16 acres in the Southeast region and 33 parcels for a total of 1,025.38 acres in the Southwest region. See Schedule III to the Consolidated Financial Statements included at ITEM 8. “FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” for a detailed description of TCI’s real estate portfolio.
During 2003, the activity in TCI’s owned real estate portfolio was:
Owned properties at January 1, 2003
Properties purchased
Properties added from consolidation of partnerships
Properties sold
Owned properties at December 31, 2003
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Properties Held for Investment. Set forth below are TCI’s properties held for investment and the monthly rental rate for apartments, the average annual rental rate for commercial properties and the average daily room rate and room revenue divided by total available rooms for hotels and occupancy at December 31, 2003, 2002 and 2001, for apartments and commercial properties and average occupancy during 2003, 2002 and 2001 for hotels:
Rent Per
Square Foot
Units/Square Footage
Apartments
4400
Apple Lane
Arbor Point
Ashton Way
Autumn Chase
Bay Walk
Bluelake Villas
By the Sea
Cliffs of Eldorado
Courtyard
Coventry
El Chapparal
Fairway View Estates
Fairways
Falcon Lakes
Fountain Lake
Fountains of Waterford
Harper’s Ferry
Hunters Glen
In the Pines
Island Bay
Limestone Canyon
Limestone Ranch
Marina Landing
Mountain Plaza
Oak Park IV
Paramount Terrace
Plantation
Quail Oaks
River Oaks
Sendero Ridge
Somerset
Southgate
Spy Glass
Sunchase
Terrace Hills
Tivoli
Timbers
Waters Edge IV
Westwood
Willow Creek
Willo-Wick Gardens
Windsong
Woodview
Office Buildings
1010 Common
225 Baronne
4135 Beltline Road
9033 Wilshire
Ambulatory Surgery Center
Amoco
Atrium
Bay Plaza
Bay Plaza II
Brandeis
Centura
Corporate Pointe
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Office Buildings (continued)
Durham Center
Eton Square
Forum
Institute Place
Lexington Center
Mimado
One Steeplechase
Parkway North
Venture Center
Westgrove Air Plaza
Industrial Warehouses
5360 Tulane
5700 Tulane
Addison Hanger
Addison Hanger II
Encon
Space Center
Texstar
Shopping Centers
Bridgeview Plaza
Cullman
Dunes Plaza
K-Mart
Promenade
Sadler Square
Other
Signature Athletic Club
Total Room Revenues
Divided By
Total Available Rooms
Rooms
Hotels
Willows
City Suites
Majestic Inn
The Majestic
Akademia
Acres
Land
1013 Common
2301 Valley Branch
Alamo Springs
Dominion
Fiesta
Fruitland
Folsom
Hollywood Casino
Lakeshore Villas
Lamar/Parmer
Las Colinas
Lemmon Carlisle
Limestone Canyon II
Manhatten
Marine Creek
Mason Park
Maumelle
Mira Lago
Nashville
Pac Trust
Pulaski
Rasor
Round Mountain
Seminary West
Sheffield Village
West End
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Occupancy presented here and throughout this ITEM 2. is without reference to whether leases in effect are at, below or above market rates.
In 2003, TCI purchased the following properties:
Units/Sq. Ft./Acres
Breakwater Bay(1)
Capitol Hill(1)
Heather Creek(1)
Kingsland Ranch(1)
Shopping Center
Bridgeview Plaza(2)
Cullman(2)
In 2003, TCI sold the following properties:
Lincoln Court
Quail Creek
Stone Oak
Summerfield
Treehouse(5)
Willow Wick
Office Building
Bonita Plaza
Remington Tower
Industrial Warehouse
Kelly (301 Hilltop)
Kelly (108th Street)
McLeod
Tricon
Oak Tree Village
Parkway Centre(7)
Eagle Crest(9)
Palm Desert
Sendero Ranch
Solco-Valley Ranch
State Highway 121/Watters Road(11)
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In 2003, TCI financed/refinanced the following property:
Tree House
Countryside Retail Center
Harmon
Ogden Industrial
Bridgeview
Properties Held for Sale. Set forth below are TCI’s properties held for sale.
Sandstone
McKinney 36
Red Cross
Sandison
Solco—Allen
Stacy Road
State Highway 121
Watters Road
Whisenant
Kelly Warehouses
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Partnership Properties. TCI accounts for partnership properties using the equity method. Set forth below are the properties owned by partnerships, the average annual rental rate for commercial properties, and occupancy rates at December 31, 2003, 2002 and 2001:
Square
Footage
Prospect Park #29
TCI is a 30% general partner in Sacramento Nine (“SAC 9”), which owns the Prospect Park #29 Office Building.
TCI recorded asset impairments of $4.7 million in 2003 and $2.6 million for 2002, representing the write down of certain operating properties to current estimated fair value. The assets for 2003 include the following properties:
Sq. Feet/
Brandeis was returned to the lien holder via a Deed in Lieu of Foreclosure on February 27, 2004 and the outstanding debt and accrued interest was used as the fair value. The gross impairment for Brandeis was $4.9 million but was reduced by $452,000 for the minority interest portion. Red Cross land was sold on January 30, 2004 and the actual sales price less selling costs was used as the fair value.
The assets for 2002 include the following properties:
Units/
Fairway View
The Red Cross land was under contract to sell in 2002 and the sales price was used as fair value. The fair value determined for four apartments above were agreed upon purchase prices as part of the refinancing transaction with Metra Capital, LLC. The costs to sell were actual fees paid to refinance the properties. TCI refinanced the Plantation Apartments in May 2003, incurring a new note for $2.3 million and discharging debt of $1.9 million. See NOTE 7. “NOTES AND INTEREST PAYABLE.”
Mortgage Loans
In addition to investments in real estate, a portion of TCI’s assets are invested in mortgage notes receivable, principally secured by real estate. TCI may originate mortgage loans in conjunction with providing purchase money financing of property sales. Management intends to service and hold for investment the mortgage notes in TCI’s portfolio. TCI’s mortgage notes receivable consist of first, wraparound and junior mortgage loans.
Types of Mortgage Activity. TCI has originated its own mortgage loans, as well as acquired existing mortgage notes either directly from builders, developers or property owners, or through mortgage banking firms, commercial banks or other qualified brokers. BCM, in its capacity as a mortgage servicer, services TCI’s mortgage notes. TCI’s investment policy is described in ITEM 1. “BUSINESS—Business Plan and Investment Policy.”
Types of Properties Securing Mortgage Notes. The properties securing TCI’s mortgage notes receivable portfolio at December 31, 2003, consisted of two apartments, five office buildings, unimproved land, a partnership interest, an assignment of claims from litigation and two unsecured loans. The Board of Directors may alter the types of properties securing or collateralizing mortgage loans in which TCI invests without a vote of stockholders. TCI’s Articles of Incorporation impose certain restrictions on transactions with related parties, as discussed in ITEM 13. “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.”
At December 31, 2003, TCI’s mortgage notes receivable portfolio included seven mortgage loans with an aggregate principal balance of $23.6 million secured by income-producing real estate located in the Southeast and Southwest regions of the continental
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United States, one mortgage loan with an aggregate principal balance of $2.4 million secured by unimproved land in the Southwest region of the continental United States, one loan with a principal balance of $300,000 secured by a partnership interest, one loan with a principal balance of $4.3 million secured by an assignment of litigation proceeds and two unsecured loans with a principal balance of $64,000. At December 31, 2003, 3.6% of TCI’s assets were invested in notes and interest receivable.
The following table sets forth the percentages (based on the mortgage note principal balance) by property type and geographic region, of the income producing properties that serve as collateral for TCI’s mortgage notes receivable at December 31, 2003. See Schedule IV to the Consolidated Financial Statements included at ITEM 8. “FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” for further details of TCI’s mortgage notes receivable portfolio.
A summary of the activity in TCI’s mortgage notes receivable portfolio during 2003 is as follows:
Mortgage notes receivable at January 1, 2003
Loans paid off
Loans funded
Mortgage notes receivable at December 31, 2003
During 2003, $4.5 million was collected in full payment of five mortgage notes and $141,000 in principal payments were received on other mortgage notes. At December 31, 2003, 1% of TCI’s assets were invested in mortgage notes secured by non-income producing real estate, comprised of a second lien mortgage note secured by 33 acres of unimproved land in Travis County, Texas and a loan secured by a partnership interest.
First Mortgage Loans. TCI invests in first mortgage notes with short, medium or long-term maturities. First mortgage loans generally provide for level periodic payments of principal and interest sufficient to substantially repay the loan prior to maturity, but may involve interest-only payments or moderate amortization of principal and a “balloon” principal payment at maturity. With respect to first mortgage loans, the borrower is required to provide a mortgagee’s title policy or an acceptable legal title opinion as to the validity and the priority of the mortgage lien over all other obligations, except liens arising from unpaid property taxes and other exceptions normally allowed by first mortgage lenders in the relevant area. TCI may grant participations in first mortgage loans that it originates to other lenders.
In July 2001, TCI funded a $1.7 million mortgage loan secured by a first lien on 44.6 acres of unimproved land in Fort Worth, Texas, and a 100% interest in a partnership. The note receivable bears interest at 16.0% per annum, requires monthly interest only payments and matured in June 2002. In September 2002, TCI received $1.3 million on the note. With this payment, TCI agreed to release the lien on the 44.6 acres substituting a second lien on 21.61 acres of unimproved land in Tarrant County, Texas, from the borrower to secure the remaining $689,000 in debt. TCI has extended the maturity to November 2002. In May 2003, the loan was paid off, including accrued but unpaid interest.
In December 2003, TCI purchased a note receivable secured by a second lien on 33 acres of raw land in Travis County, Texas at par value from ARI for $2.4 million as a paydown on an affiliate loan balance. This note bears interest at 10%, requires interest only payments in November 2007 and matures in October 2008.
Junior Mortgage Loans. TCI may invest in junior mortgage loans, secured by mortgages that are subordinate to one or more prior liens either on the fee or a leasehold interest in real estate. Recourse on such loans ordinarily includes the real estate on which the loan is made, other collateral and personal guarantees by the borrower. The Board of Directors restricts investment in junior mortgage loans, excluding wraparound mortgage loans, to not more than 10% of TCI’s assets. At December 31, 2003, 3% of TCI’s assets were invested in junior and wraparound mortgage loans.
The following discussion briefly describes the junior mortgage loans that TCI originated as well as events that affected previously funded junior mortgage loans during 2003.
In March 2001, TCI funded a $3.5 million mortgage loan secured by a second lien on a retail center in Montgomery County, Texas. In June 2001, an additional $1.5 million was funded. The note receivable bore interest at 16.0% per annum, required monthly interest only payments of $67,000 and matured in September 2001. In October 2001, TCI extended the loan until February 2002, receiving $100,000 as an extension fee. In December 2001, TCI received a $1.5 million principal payment. In February 2002, TCI
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sold a $2.0 million senior participation interest in the loan to IORI, a related party. TCI and IORI received 43% and 57%, respectively, of the remaining principal and interest payments. Also in February 2002, TCI extended the loan until April 2002, receiving $23,000 as an extension fee. In April 2002, the loan was extended until July 2002. In July 2002, the loan was extended until September 2002. In August 2002, the loan was paid off, including accrued but unpaid interest.
In June 2001, in conjunction with the sale of 275 unit McCallum Glen Apartments in Dallas, Texas, TCI funded a $1.5 million mortgage loan secured by a second lien on the apartments. The note receivable bore interest at 10% per annum, required monthly interest only payments and matured in June 2003. In May 2002, the loan was paid off. TCI agreed to a 5% discount on the note and recognized a loss of $75,000 from the note. TCI also recognized a previously deferred gain on $1.5 million on the sale of the property.
In July 2001, TCI agreed to fund a $4.4 million line of credit secured by a second lien on 1,714.16 acres of unimproved land in Tarrant County, Texas. The note receivable bears interest at 15% per annum, requires monthly interest only payments beginning in September 2001 and matures in July 2003. In March 2002, TCI received a $1.8 million principal payment. As of April 2003, TCI had funded $2.9 million of the line of credit and it was classified as nonperforming. In May 2003, TCI received a $433,000 principal paydown. Also during May 2003, TCI received 14.373 acres of unimproved land in Tarrant County, Texas, valued at $1.1 million, as a principal paydown. As of July 2003, the loan has been paid in full.
In August 2001, TCI agreed to fund up to $5.6 million secured by a second lien on an office building in Dallas, Texas. The note receivable bears interest at a variable rate, currently 9.0% per annum, requires monthly interest only payments and matured in January 2003. As of March 2004, TCI has funded a total of $4.3 million. On January 22, 2003, TCI agreed to extend the maturity date until May 1, 2003. No payments have been received and this note is considered nonperforming. The collateral used to secure TCI’s second lien was seized by the first lien holder. On March 11, 2004, TCI agreed to accept an assignment of claims in litigation as security for the note. TCI is also working on securing additional collateral for this note and restructuring the terms of the note. The agreement requires interest to accrue at the default rate of 18%.
In December 2000, TCI funded a $3.0 million mortgage loan secured by a second lien on four office buildings in San Antonio, Texas. The note receivable bore interest at 16.0% per annum, required monthly interest only payments of $40,000 and matured in June 2001. The note was extended until November 2001 with a $750,000 loan principal paydown. With this paydown, the note was renegotiated to replace the existing collateral with new collateral consisting of a 120,000 sq. ft. office building and industrial warehouse in Carrollton, Texas. The note bore interest at 16.0% per annum, required monthly payments of interest only and matured in May 2002. In July 2002, the note was paid off, including accrued but unpaid interest.
In October 2001, TCI funded a $4.0 million loan secured by a 375,152 sq.ft. office building in St. Louis, Missouri. The note receivable bore interest at 9.0% per annum, required monthly interest only payments of $30,000 and matured in February 2002. In February 2002, TCI extended the loan maturity to February 2003. In August 2002, the note was paid off including accrued but unpaid interest.
In January 2002, TCI purchased 100% of the outstanding common shares of ART Two Hickory Corporation (“Two Hickory”), a wholly-owned subsidiary of ARI, a related party, for $4.4 million cash. Two Hickory owns the 96,217 sq. ft. Two Hickory Centre Office Building in Farmers Branch, Texas. ARI has guaranteed that the asset shall produce at least a 12% annual return of the purchase price for a period of three years from the purchase date. If the asset fails to produce the 12% annual return, ARI shall pay TCI any shortfall. In addition, if the asset fails to produce the 12% return for a calendar year and ARI fails to pay the shortfall, TCI may require ARI to repurchase the shares of Two Hickory for the purchase price. Because ARI has guaranteed the 12% return and TCI has the option of requiring ARI to repurchase the entities, management has classified this related party transaction as a note receivable from ARI. In June 2002, the asset was refinanced. TCI received $1.3 million of the proceeds as a principal reduction on its note receivable from ARI.
Also in January 2002, a mortgage loan with a principal balance of $608,000 was paid off, including accrued but unpaid interest. With the payoff of the note, TCI recognized a previously deferred gain on the sale of the property of $608,000.
In March 2002, TCI sold the 174,513 sq.ft. Hartford Office Building in Dallas, Texas, for $4.0 million and provided the $4.0 million purchase price as seller financing and an additional $1.4 million line of credit for leasehold improvements in the form of a first lien mortgage note. The note bears interest at a variable interest rate, currently 6.0% per annum, requires monthly interest only payments of $14,667 and matures in March 2007. As of February 2004, TCI has funded $323,000 of the additional line of credit.
In April 2002, TCI purchased 100% of the following entities: ART One Hickory Corporation (“One Hickory”), Garden Confederate Point, LP (“Confederate Point”), Garden Foxwood, LP (“Foxwood”), and Garden Woodsong, LP (“Woodsong”), all wholly-owned subsidiaries of ARI, a related party, for $10.0 million. One Hickory owns the 120,615 sq. ft. One Hickory Centre Office Building in Farmers Branch, Texas. Confederate Point owns the 206 unit Confederate Apartments in Jacksonville, Florida. Foxwood owns the 220 unit Foxwood Apartments in Memphis, Tennessee. Woodsong owned the 190 unit Woodsong Apartments in
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Smyrna, Georgia. ARI has guaranteed that these assets shall produce at least a 12% return annually of the purchase price for a period of three years from the purchase date. If the assets fail to produce the 12% return, ARI shall pay TCI any shortfall. In addition, if the assets fail to produce the 12% return for a calendar year and ARI fails to pay the shortfall, TCI may require ARI to repurchase the entities for the purchase price. Because ARI has guaranteed the 12% return and TCI has the option of requiring ARI to repurchase the entities, management has classified this related party transaction as a note receivable from ARI. In October 2003, TCI sold One Hickory to IORI for a $12.2 million, less prorations, for a wrap-round promissory note of $12.0 million. This note bears interest at 5.49% interest, requires monthly interest and principal payments and mature in June 2006. This transaction effectively discharged the note receivable TCI had from ARI for the financing of One Hickory. Also, in November 2003, Confederate Point sold the Confederate Apartments and paid $2.1 million to TCI to pay off the loan and accrued but unpaid interest.
Also in April 2002, a mortgage loan with a principal balance of $155,000 was paid off, including accrued but unpaid interest.
In July 2002, a mortgage loan with a principal balance of $2.2 million was paid off, including accrued but unpaid interest.
In July 2002, the Woodsong Apartments were sold. ARI received $2.6 million from the proceeds as payment of principal and accrued but unpaid interest on the note receivable. The funds were received by ARI and the affiliate receivable balance was increased.
In July 2002, TCI entered into an agreement to fund up to $300,000 under a revolving line of credit secured by 100% interest in a partnership of the borrower. The line of credit bears interest at 12.0% per annum, requires monthly interest only payments and matures in June 2005. As of March 2004, TCI has funded all $300,000 of the line of credit.
In September 2002, TCI sold a 36 acre tract of the Palm Desert land parcel for $3.6 million and provided $2.7 million as seller financing in the form of a first lien mortgage note. The note bears interest at 8.0% per annum, requires quarterly interest only payments of $54,000 and matures in September 2004. In March 2003, the note was sold to a financial institution for $2.6 million.
In June 2003, TCI sold the 104 unit Willow Wick Apartments in North Augusta, South Carolina, for $2.7 million and provided $42,000 of the purchaser’s closing costs as seller financing. The note bears interest at a fixed rate of 5% and requires all interest and principal payments be paid at maturity on December 2003. This loan was extended until February 2004 and $10,000 was received in March 2004. Current negotiations are ongoing to extend the loan or collect payment.
In December 2003, TCI purchased a note receivable secured by 33 acres of raw land in Travis County, Texas from ARI for $2.4 million, which reduced ARI’s affiliate payable to Prime and TCI. The note bears interest at 10% per annum, requires interest only payments beginning in November 2007 and matures in October 2008.
Partnership mortgage loans. TCI owns a 60% general partner interest and IORI owns a 40% general partner interest in Nakash Income Associates (“NIA”), which owns a wraparound mortgage note receivable secured by a building occupied by a Wal-Mart in Maulden, Missouri.
Olive Litigation
During May 2003, the class and derivative action originally filed in February 1999 entitled Olive, et al. v. National Income Realty Trust, et al.(the “Olive Litigation”), relating to the operation and management of five entities, was dismissed with prejudice. The Olive Litigation had been the subject to a settlement on April 23, 1990, various amendments thereto and amendments to the Modifications. Although during the course and progress of the Olive Litigation over more than 13 years, several status conferences on this matter were held, there were no court orders or findings on any of the plaintiffs’ allegations in its Original Complaint or any amendments. On October 23, 2001, TCI, IORI and ARI jointly announced a preliminary agreement with the plaintiff’s legal counsel for complete settlement of all disputes in the lawsuit. For further information, see Item 1 “Legal Proceedings” included in TCI’s Second Quarter Report on Form 10-Q for the six months ended June 30, 2002.
Not applicable.
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PART II
TCI’s Common Stock is traded on the New York Stock Exchange (“NYSE”) using the symbol “TCI”. The following table sets forth the high and low sales prices as reported in the consolidated reporting system of the NYSE.
Quarter Ended
March 31, 2004 (through March 19, 2004)
March 31, 2003
June 30, 2003
September 30, 2003
December 31, 2003
March 31, 2002
June 30, 2002
September 30, 2002
December 31, 2002
As of March 19, 2004, the closing price of TCI’s Common Stock as reported in the consolidated reporting system of the NYSE was $15.00 per share.
As of March 19, 2004, TCI’s Common Stock was held by 4,616 holders of record.
TCI paid no dividends in 2003, 2002 or 2001, and management believes no dividends will be paid in 2004. In December 2000, the Board of Directors determined not to pay a fourth quarter dividend to holders of TCI’s Common Stock. The non-payment decision was based on the Board determining that TCI needed to retain cash for acquisitions that were anticipated in 2001 and 2002.
In December 1989, the Board of Directors approved a share repurchase program, authorizing the repurchase of a total of 687,000 shares of TCI’s Common Stock. In October 2000, the Board increased this authorization to 1,409,000 shares. Through December 31, 2001, a total of 409,765 shares had been repurchased at a cost of $3.3 million. In September 2001, the Board approved a private block purchase of 593,200 shares of Common Stock for a total cost of $9.5 million. No shares were repurchased in 2002 or 2003.
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EARNINGS DATA
Rents
Property expense
Operating income
Other income
Gain on real estate
Total other income
Other expense
Income (loss) from continuing operations
Discontinued operations
Net income (loss)
Preferred dividend requirement
Net income (loss) applicable to Common shares
Basic and Diluted Earnings Per Share
Basic
Diluted
Dividends per Common share
Weighted Average Common Shares Outstanding
BALANCE SHEET DATA
Real estate held for investment, net
Real estate held for sale
Notes and interest receivable, net
Total assets
Notes and interest payable
Stockholders’ equity
Book value per share
TCI purchased 10 properties for a total of $36.9 million in 2003, 16 properties for a total of $107.7 million in 2002, 17 properties for a total of $62.5 million in 2001, 18 properties for a total of $103.9 million in 2000, 10 properties for a total of $51.2 million and obtained an additional 64 properties through merger with CMET in 1999. TCI sold 13 properties, two warehouses in the Kelly portfolio and 5 parcels of land for $86.6 million in 2003, 18 properties and a partial land parcel for a total of $117.6 million in 2002, 22 properties, one warehouse in the Kelly portfolio and three partial land parcels in 2001 for a total of $161.5 million, 20 properties in 2000 for a total of $113.5 million, and 11 properties in 1999 for a total of $117.4 million. See ITEM 2. “PROPERTIES—Real Estate” and ITEM 8. “FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.”
Introduction
TCI invests in real estate through acquisitions, leases and partnerships and in mortgage loans on real estate, including first, wraparound and junior mortgage loans. TCI is the successor to a California business trust organized on September 6, 1983, which commenced operations on January 31, 1984. On November 30, 1999, TCI acquired all of the outstanding shares of beneficial interest of CMET, a real estate company, in a tax-free exchange of shares, issuing 1.181 shares of its Common Stock for each outstanding CMET share. TCI accounted for the merger as a purchase.
Prior to January 1, 2000, TCI elected to be treated as a Real Estate Investment Trust (“REIT”) under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the “Code”). During the third quarter of 2000, TCI no longer met the requirement for tax treatment as a REIT due to a concentration of ownership.
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Critical Accounting Policies
Critical accounting policies are those that are both important to the presentation of TCI’s financial condition and results of operations and require management’s most difficult, complex or subjective judgments. TCI’s critical accounting policies relate to the evaluation of impairment of long-lived assets and the evaluation of the collectibility of accounts and notes receivable.
If events or changes in circumstances indicate that the carrying value of a rental property to be held and used or land held for development may be impaired, management performs a recoverability analysis based on estimated undiscounted cash flows to be generated from the property in the future. If the analysis indicates that the carrying value is not recoverable from future cash flows the property is written down to estimated fair value and an impairment loss is recognized. If management decides to sell rental properties or land held for development, management evaluates the recoverability of the carrying amounts of the assets. If the evaluation indicates that the carrying value is not recoverable from estimated net sales proceeds, the property is written down to estimated fair value less costs to sell and an impairment loss is recognized within income from continuing operations. TCI’s estimates of cash flow and fair values of the properties are based on current market conditions and consider matters such as rental rates and occupancies for comparable properties, recent sales data for comparable properties and, where applicable, contracts or the results of negotiations with purchasers or prospective purchasers. TCI’s estimates are subject to revision as market conditions and TCI’s assessments of them change. In the fourth quarter of 2003, TCI recognized $4.4 million and $192,000 as impairment losses, and in the second and third quarter of 2002, TCI recognized $1.9 million and $700,000 as impairment losses.
TCI’s allowance for doubtful accounts receivable and notes receivable is established based on analysis of the risk of loss on specific accounts. The analysis places particular emphasis on past due accounts. Management considers such information as the nature and age of the receivable, the payment history of the tenant or other debtor, the financial condition of the tenant or other debtor and TCI’s assessment of its ability to meet its lease or interest obligations. TCI’s estimate of the required allowance, which is reviewed on a quarterly basis, is subject to revision as these factors change and is sensitive to the effects of economic and market conditions.
TCI’s management periodically discusses criteria for estimates and disclosure of its estimates with the audit committee of TCI’s Board of Directors.
Obligations and Commitments
TCI has contractual obligations and commitments primarily with regards to the payment of mortgages.
The following table aggregates TCI’s expected contractual obligations and commitments subsequent to December 31, 2003. (Dollars in thousands)
Long Term Debt (1)
Capital Lease Obligations
Operating Leases
Purchase Obligations
Other Long-Term Liabilities
Other long-term liabilities represent TCI’s intentions to purchase the interests of general and limited partners formed to construct residential properties.
Liquidity and Capital Resources
Cash and cash equivalents were $6.4 million, $10.6 million and $10.3 million at December 31, 2003, 2002 and 2001, respectively. The principal reasons for the change in cash are discussed in the paragraphs below.
TCI’s principal sources of cash have been and will continue to be from property operations, proceeds from property sales, and the collection of mortgage notes receivable, borrowings and to a lesser extent, distributions from partnerships. Management anticipates that TCI’s cash at December 31, 2003, along with cash that will be generated in 2004 from property operations, will not be sufficient to meet all of TCI’s cash requirements. Management intends to selectively sell income producing real estate, refinance or extend real estate debt and seek additional borrowings against real estate to meet its cash requirements. Historically, management has been successful at extending its current maturity obligations. Management also anticipates funding ongoing real estate construction projects and the acquisition of new real estate from cash generated by property sales, debt refinancings or extensions, and additional borrowings.
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Net cash provided by operations was $3.7 million in 2003 compared to net cash used in operations of $9.1 million in 2002 and $895,000 in 2001. Cash flow from property operations is rents collected less payment for property operating expenses or net rental income. The increase in operating cash from 2002 to 2003 was due to an increase in net rental income from new apartments that finished construction in 2002 and 2003 and an increase in commercial net rental income due to Centura Tower, which was purchased in June 2002. Cash also increased due to less spending on general and administrative expenses from 2002 to 2003. These gains were offset by the sales of real estate during 2002 and 2003 and from higher interest expense paid during 2003. Net cash used in property operations decreased from 2001 to 2002 due lower net rental income from the sale of commercial properties and apartments in 2002 and 2001 and an increase in interest paid in 2002. These decreases in 2002 were offset by lower spending on general and administrative expenses and advisory fees, as well as an increase in interest income collected. Management believes that cash flow may decrease from property operations as a result of selling of income producing properties.
Management expects that funds from existing cash resources, selective sales of income producing properties, refinancing of real estate, and additional borrowings against real estate will be sufficient to meet TCI’s cash requirements associated with its current and anticipated level of operations, maturing debt obligations and existing commitments. To the extent that TCI’s liquidity permits or financing sources are available, management intends to make new real estate investments.
Net cash used in investing activities was $26.9 million in 2003 compared to $67.0 million in 2002 and net cash provided of $36.1 million in 2001. Cash from investing activities increased in 2003 due to TCI spending less on real estate construction and improvements and an increase in payments received from TCI’s advisor. These cash increases were offset by cash decreases due to less collected on notes receivable, less real estate sold, the purchase of marketable securities and increases in deposits on pending real estate purchases. Cash from investing activities decreased from 2001 to 2002 due to a substantial increase in real estate construction in 2002 and an increase in payments made to TCI’s advisor. These decreases in cash were offset by an increase in cash due to higher collections on notes receivable during 2002.
Net cash provided by financing activities was $19.1 million in 2003 compared to $76.3 million in 2002 and net cash used of $47.1 million in 2001. Cash from financing activities decreased in 2003 due to higher payments on notes payable and lower proceeds from notes payable refinancings and property sales as compared to 2002. Cash from financing activities decreased from 2001 to 2002 due to higher proceeds from notes payable, offset by higher payments on notes payable in 2002. 2001 was also lower due to the repurchase of common stock in a private block purchase.
Management reviews the carrying values of TCI’s properties and mortgage notes receivable at least annually and whenever events or a change in circumstances indicate that impairment may exist. Impairment is considered to exist if, in the case of a property, the future cash flow from the property (undiscounted and without interest) is less than the carrying amount of the property. For notes receivable impairment is considered to exist if it is probable that all amounts due under the terms of the note will not be collected. If impairment is found to exist, a provision for loss is recorded by a charge against earnings. The note receivable review includes an evaluation of the collateral property securing such note. The property review generally includes: (1) selective property inspections; (2) a review of the property’s current rents compared to market rents; (3) a review of the property’s expenses; (4) a review of maintenance requirements; (5) a review of the property’s cash flow; (6) discussions with the manager of the property; and (7) a review of properties in the surrounding area.
Results of Operations
TCI had a net loss of $1.2 million in 2003, including gains on sale of real estate totaling $28.1 million, net income of $4.9 million in 2002, including gains on sale of real estate totaling $43.9 million and net income of $19.8 million in 2001, including gains on sale of real estate totaling $48.9 million. Fluctuations in the components of revenues and expense between 2003, 2002 and 2001 are discussed below.
Rents were $114.4 million in 2003, $95.8 million in 2002, and $115.4 million in 2001. Of the increase in rents from 2002 to 2003, $11.7 million was due to the completion and rental income coming from properties under construction in 2002 and 2003, $3.4 million was due to Centura Tower, which TCI purchased from ARI in June 2002, $1.6 million was from increased rents at TCI’s New Orleans office buildings, and $1.6 million was from increased revenues from Hotel Akademia in Poland. The decrease in rents from 2001 to 2002 is primarily due to decreased rents of $3.9 million and $10.8 million due to the sale of six commercial properties and 15 apartments, respectively, in 2001, and $608,000 and $1.5 million was due to lower occupancies at TCI’s apartments and hotels, respectively. These decreases were offset by increases of $3.0 million and $5.4 million from the purchase of two commercial properties and five apartments, respectively in 2002 and 2001, $1.9 million and $1.0 million was due to the completion of four apartments and one hotel, respectively in 2002, and $623,000 was due to increased rents at TCI’s commercial properties. Rents are expected to increase in 2004 as TCI completes the properties under construction.
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Property operations expenses were $ 73.6 million in 2003, $64.4 million in 2002 and $68.5 million in 2001. Of the increase in property operations from 2002 to 2003 $7.5 million was due to the properties under construction, $1.6 million was due to Centura Tower, which TCI purchased from ARI in June 2002 and $400,000 was due to an increase at TCI’s hotels. The decrease in property operations from 2001 to 2002 is mostly due to 15 apartments being sold in 2001, offset by new construction properties in 2002, and a reduction in property expenses at TCI’s hotels in 2002. Property operating expenses are expected to increase as TCI continues to construct apartments in 2004.
Interest and other income was $6.7 million in 2003, $4.1 million in 2002 and $2.9 million in 2001. The increase in 2003 was due to a $3.8 million litigation settlement TCI received, offset by the pay off of seven of TCI’s loans in 2002. The increase in 2002 was due to TCI funding seven loans in 2002. Interest income in 2004 is expected to decrease due to seven notes maturing in 2004.
Prior to the first quarter of 2001, TCI accounted for its investment in ARI, an affiliate, as an available for sale marketable security. In the first quarter of 2001, TCI began accounting for its investment in ARI using the equity method. Equity losses of investees was $4.3 million in 2003, $3.8 million in 2002 and $628,000 in 2001. The losses from equity investees are primarily attributed to increased operating losses for IORI and ARI. Equity losses may continue with decreases in operating income due to selling of income producing properties.
Interest expense was $38.9 million in 2003, $36.2 million in 2002 and $36.8 million in 2001. Of the increase in interest expense from 2002 to 2003, $3.8 million was due to new loans on construction properties and two new loans on commercial properties. A $3.0 million increase in 2003 due to Centura Tower was offset by interest expense reductions due to the sale of 17 commercial properties in 2002 and 2003. The decrease in interest expense from 2001 to 2002 is due to the sale of six commercial properties and 15 apartments, respectively in 2001, and to principal paydowns and lower variable rates for TCI’s land, commercial and apartment properties, respectively. These decreases were offset by an increase in interest expense due to the purchase of six land parcels, two commercial properties, five apartments and one hotel, respectively subject to debt in 2002 and 2001, the financing and refinancing of four land parcels held for investment, three commercial properties and 17 apartments in 2002, an increase in the interest rate at TCI’s Chicago hotels, and payments for an interest swap agreement TCI entered into in 2002. Interest expense is expected to increase or remain constant as TCI completes construction projects and increases its debt by refinancings.
Depreciation expense was $21.2 million in 2003, $17.1 million in 2002 and $17.1 million in 2001. Of the increase in depreciation expense from 2002 to 2003, $700,000 was due to Centura Tower, which was purchased in June 2002, $600,000 was from completed construction properties in 2002 and 2003, $300,000 was from an increase in TCI’s hotels and $2.4 million was from two commercial properties purchased in 2003. Depreciation expense from 2001 to 2002 was relatively the same, with increases in 2002 due to the purchase of two commercial properties and five apartments in 2002 and 2001, the completion of four apartments and one hotel in 2002, and higher tenant and building improvements at TCI’s commercial properties during 2002. These increases were offset by decreases due to the sale of six commercial properties and 15 apartments in 2001. Depreciation expense is expected to increase or remain constant as TCI completes construction projects during 2004.
TCI recorded asset impairments of $4.7 million in 2003 and $2.6 million for 2002, representing the write down of certain operating properties to current estimated fair value.
The assets for 2003 include the following properties:
Basis
Brandeis was returned to the lien holder via a Deed in Lieu of Foreclosure on February 27, 2004 and the outstanding debt and accrued interest were used as the fair value. The gross impairment for Brandeis was $4.9 million but was reduced by $452,000 for the minority interest portion. Red Cross land was sold on January 30, 2004 and the actual sales price less selling costs was used as the fair value.
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The Red Cross land was under contract to sell in 2002 and the sales price was used as fair value. The fair value determined for four apartments above were agreed upon purchase prices as part of the refinancing transaction with Metra Capital, LLC. The costs to sell were actual fees paid to refinance the properties. TCI refinanced the Plantation Apartments In May 2003, incurring a new note for $2.3 million and discharging debt of $1.9 million. See NOTE 7. “NOTES AND INTEREST PAYABLE.”
Advisory fee expense was $4.9 million in 2003, $4.5 million in 2002, and $5.3 million in 2001. The increase in 2003 was due to higher average gross assets during the year. The decrease in 2002 was due to a $1.4 million operating expense refund from BCM. See NOTE 12. “ADVISORY AGREEMENT.” This decrease was offset by an increase in advisor fees due to a 20% increase in gross assets, the basis of the fee. Advisory fees are expected to decrease as TCI sells properties.
Net income fee to affiliate was $0 in 2003, $374,000 in 2002, and $1.9 million in 2001. The net income fee is payable to TCI’s advisor based on 7.5% of TCI’s net income. TCI had a net loss for 2003, so no net income fee is due.
Incentive fee to affiliate was $3.2 million in 2001. The incentive fee is payable to TCI’s advisor based on 10% of aggregate sales consideration less TCI’s cost of all properties sold during the year. No incentive fee was paid in 2002 or 2003.
Realized losses on investments of $3.1 million were recognized in 2001. TCI recognized a previously unrealized loss on ARI’s marketable equity securities of $3.1 million in 2001.
General and administrative expenses were $9.1 million in 2003, $8.8 million in 2002 and $11.5 million in 2001. The increase in 2003 was due to higher state income taxes offset by decreases in consulting and professional fees and cost reimbursements to the advisor, offset by higher legal costs and franchise taxes. The decrease from 2001 to 2002 was mainly due to decreases in consulting fees, taxes and cost reimbursements to the advisor. General and administrative expenses are expected to remain constant or decrease from decreased litigation and consulting fees.
Loss on foreign currency transaction was $3.3 million and $2.5 million in 2003 and 2002 , respectively. Loss on foreign currency transaction is the result of Hotel Akademia converting long-term debt, which is denominated in Euros, into the functional currency, the Polish Zloty. The Euro has strengthened against the Zloty over the past two years, which has resulted in TCI recognizing this charge.
Income from discontinued operations was $26.6 million in 2003, $44.3 million in 2002 and $703,000 in 2001. Income from discontinued operations relates to 15 properties and 5 parcels of land that TCI sold during 2003, 18 properties that TCI sold during 2002, and eight parcels of land, one apartment, two office buildings and two warehouses designated as held for sale. The following table summarizes revenue and expense information for these properties sold and held-for-sale.
Revenue
Rental
Property operations
Expenses
Interest
Depreciation
Net income (loss) from discontinued operations before gains on sale of real estate
Gain on sale of operations
Equity in investees gain on sale of real estate
Net income from discontinued operations
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Discontinued operations have not been segregated in the consolidated statements of cash flows. Therefore, amounts for certain captions will not agree with respective consolidated statements of operations.
In 2003, 2002 and 2001, gains on sale of real estate totaling $28.1 million, $44.0 million and $48.9 million were recognized. See NOTE 2. “REAL ESTATE.”
Related Party Transactions
Historically, TCI, ARI, IORI, and others have each engaged in and may continue to engage in business transactions, including real estate partnerships, with related parties. Management believes that all of the related party transactions represented the best investments available at the time and were at least as advantageous to TCI as could have been obtained from unrelated parties.
Operating Relationships
TCI received rents of $175,000 in 2003, $88,000 in 2002 and $120,000 in 2001 from BCM for BCM’s lease at Addison Hanger. BCM owns a corporate jet that is housed at the hanger and TCI has available space at the hanger.
Property Transactions
In January 2002, TCI purchased 100% of the outstanding common shares of ART Two Hickory Corporation from ARI, for $4.4 million. See NOTE 3. “NOTES AND INTEREST RECEIVABLE.” The purchase price was determined based upon the market value of the property exchanged, using a market rate multiple of net operating income (“cap rate”) of 7.0%. The business purpose of the transaction was for TCI to make an equity investment in Two Hickory anticipating a profitable return.
In February 2002, TCI sold a $2.0 million senior participation interest in a loan to IORI. See NOTE 3. “NOTES AND INTEREST RECEIVABLE.” Management determined that TCI could benefit from the increase in cash and decrease its notes receivable outstanding portfolio.
In March 2002, TCI paid cash of $600,000 and received from ARI two parcels of land, a 24.5 acre tract of Rasor land, a 16.89 acre tract of Lakeshore Villas land, and the 45,623 sq. ft. Oaktree Village Shopping Center in exchange for the 80,278 sq. ft. Plaza on Bachman Creek Shopping Center. The exchange value prices for the shopping centers were determined based on a cap rate of 10.5% and the value for the Rasor and Lakeshore Villas land was determined on appraised rates of $3.36 and $1.29, respectively, per square foot. The business purpose of the transaction was for TCI to construct apartments on the Rasor and Lakeshore Villas land and to give ample value for the property TCI exchanged, the Oaktree Shopping Center was added to the transaction.
In April 2002, TCI purchased 100% of the following entities from ARI: Garden Confederate Point, L.P., Garden Foxwood, L.P., Garden Woodsong, L.P. and ART One Hickory Corporation for $10.0 million. See NOTE 3. “NOTES AND INTEREST RECEIVABLE.” The purchase price for these entities was determined based on a cap rate of 8.41% for the partnerships and 7.0% for ART One Hickory Corporation. The business purpose of the transaction was for TCI to make an equity investment in the entities anticipating a profitable return.
In June 2002, TCI purchased Centura Tower, Ltd. partnership, which owns the Centura Tower Office Building from ARI for $50.0 million. See NOTE 2. “REAL ESTATE.” The purchase price for the Centura Tower was determined based on appraised value and replacement cost. The business purpose of the transaction was for TCI to acquire a Class A office building with significant upside potential anticipating a profitable return.
Also in June 2002, TCI purchased five parcels of unimproved land from ARI: the Hollywood Casino, Marine Creek, Mason Park, Nashville and Palm Desert land parcels. See NOTE 2. “REAL ESTATE.” The purchase price of the Hollywood Casino land was determined based on an appraised rate of $9.10 per square foot. The business purpose of the transaction was for TCI to consolidate its holdings within the Mercer Crossing development. The purchase price for the Marine Creek, Mason Park, Nashville and Palm Desert land parcels was determined based on appraised rates of $2.00, $3.56, $4.00 and $1.48 per square foot, respectively. The business purpose of the transaction was for TCI to develop apartments on these four tracts of land.
In December 2002, TCI purchased NLP/CH, Ltd. partnership, which owns the Centura land parcel from ARI. See NOTE 2. “REAL ESTATE.” The purchase price was determined based on an appraised rate of $34.89 per square foot. The business purpose of the transaction was for TCI to construct apartments on the land adjacent to its Centura Tower office building.
In March 2003, TCI sold 4135 Beltline to a related party for $4.4 million, including the assumption of debt. Due to the sale being to a related party to TCI and TCI having continued involvement and control of this entity, this transaction has not been recorded as a sale. This property and corresponding debt will continue to be consolidated by TCI.
22
In March 2003, TCI purchased 100% of EQK Cullman, Inc. and EQK Bridgeview Plaza, Inc., which own Cullman Shopping Center and Bridgeview Plaza shopping center, respectively, from ARI with a net purchase price of $10.7 million, including the assumption of debt. The purchase price was determined on cap rates of 10.2% and 10.8%, respectively. The business purpose of the transaction was to pay down an affiliate receivable balance.
In December 2003, TCI sold Transcontinental Parkway Corporation, which owns Parkway Centre shopping center to IORI for $4.0 million, including the assumption of debt. The business purpose of this transaction was to pay down TCI’s payable balance to an affiliate.
In December 2003, TCI sold Transcontinental Brewery, Inc., which owns Eagle Crest land to IORI for $4.0 million. The business purpose of this transaction was to pay down IORI’s receivable from TCI.
In December 2003, TCI sold Transcontinental Treehouse Corporation, which owns Treehouse Apartments, to IORI for $7.5 million, including the assumption of debt. The business purpose of the transaction was to pay down TCI’s payable balance to an affiliate.
In December 2003, TCI sold six properties to subsidiaries of United Housing Foundation, Inc. (“UHF”), a Texas Non-Profit 501(c)3 Corporation. TCI sold 10.72 acres of Marine Creek land for $1.5 million, Limestone at Vista Ridge apartments for $19.0 million, the Cliffs of El Dorado apartments for $13.4 million, the Limestone Canyon apartments for $18.0 million, the Sendero Ridge apartments for $29.4 million and the Tivoli apartments for $16.1 million. Ted Stokely, Chairman of the Board of TCI, is the General Manager of UHF. Richard Humphrey, who is employed by Regis Realty I, LLC, an affiliate, is President of UHF. Due to UHF being considered a related party to TCI and TCI having continued involvement and control of these entities, these transactions have not been recorded as sales. Instead, these transactions will be accounted for on the deposit method and the properties and corresponding debt will continue to be consolidated by TCI. Management is seeking lender approval on the transfer of the notes associated with these property transactions.
Environmental Matters
Under various federal, state and local environmental laws, ordinances and regulations, TCI may be potentially liable for removal or remediation costs, as well as certain other potential costs, relating to hazardous or toxic substances (including governmental fines and injuries to persons and property) where property-level managers have arranged for the removal, disposal or treatment of hazardous or toxic substances. In addition, certain environmental laws impose liability for release of asbestos-containing materials into the air, and third parties may seek recovery for personal injury associated with such materials.
Management is not aware of any environmental liability relating to the above matters that would have a material adverse effect on TCI’s business, assets or results of operations.
Inflation
The effects of inflation on TCI’s operations are not quantifiable. Revenues from property operations tend to fluctuate proportionately with inflationary increases and decreases in housing costs. Fluctuations in the rate of inflation also affect sales values of properties and the ultimate gain to be realized from property sales. To the extent that inflation affects interest rates, TCI’s earnings from short-term investments, the cost of new financings as well as the cost of variable interest rate debt will be affected.
Tax Matters
Prior to the year 2000, TCI elected and in the opinion of management, qualified to be taxed as a REIT as defined under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended. During the third quarter of 2000, due to a concentration in ownership, TCI no longer met the requirements for tax treatment as a REIT under the Code. Under the Code, TCI is prohibited from re-qualifying for REIT tax status for at least five years.
TCI’s future operations, cash flow and fair values of financial instruments are partially dependent upon the then existing market interest rates and market equity prices. Market risk is the changes in the market rates and prices, and the effect of the changes on future operations. Market risk is managed by matching a property’s anticipated net operating income to an appropriate financing.
TCI is exposed to interest rate risk associated with variable rate notes payable and maturing debt that has to be refinanced. TCI does not hold financial instruments for trading or other speculative purposes, but rather issues these financial instruments to finance its
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portfolio of real estate assets. TCI’s interest rate sensitivity position is managed by TCI’s finance department. Interest rate sensitivity is the relationship between changes in market interest rates and the fair value of market rate sensitive assets and liabilities. TCI’s earnings are affected as changes in short-term interest rates impact its cost of variable rate debt and maturing fixed rate debt. A large portion of TCI’s market risk is exposure to short-term interest rates from variable rate borrowings. The impact on TCI’s financial statements of refinancing fixed debt that matured during 2003 was not material. As permitted, management intends to convert a significant portion of those borrowings from variable rates to fixed rates in 2004. If market interest rates for variable rate debt average 100 basis points more in 2004 than they did during 2003, TCI’s interest expense would increase, and income would decrease by $1.3 million. This amount is determined by considering the impact of hypothetical interest rates on TCI’s borrowing cost. This analysis did not consider the effects of the reduced level of overall economic activity that could exist in such an environment. Further, in the event of a change of such magnitude, management would likely take actions to further mitigate its exposure to the change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, the sensitivity analysis assumes no change in TCI’s financial structure.
The following table contains only those exposures that existed at December 31, 2003. Anticipation of exposures or risk on positions that could possibly arise was not considered. TCI’s ultimate interest rate risk and its effect on operations will depend on future capital market exposures, which cannot be anticipated with a probable assurance level. Dollars in thousands.
Assets
Notes receivable
Variable interest rate-fair value
Instrument’s maturities
Instrument’s amortization
Average rate
Fixed interest rate-fair value
Liabilities
Non-trading Instruments-Equity Price Risk
Notes payable
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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Statements
Report of Independent Certified Public Accountants
Consolidated Balance Sheets—December 31, 2003 and 2002
Consolidated Statements of Operations—Years Ended December 31, 2003, 2002 and 2001
Consolidated Statements of Stockholders’ Equity—Years Ended December 31, 2003, 2002 and 2001
Consolidated Statements of Cash Flows—Years Ended December 31, 2003, 2002 and 2001
Notes to Consolidated Financial Statements
Financial Statement Schedules
Schedule III—Real Estate and Accumulated Depreciation
Schedule IV—Mortgage Loans on Real Estate
All other schedules are omitted because they are not required, are not applicable or the information required is included in the Consolidated Financial Statements or the notes thereto.
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REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors of
Dallas, Texas
We have audited the accompanying consolidated balance sheets of Transcontinental Realty Investors, Inc. and Subsidiaries as of December 31, 2003 and 2002 and the related consolidated statements of operations, stockholders’ equity, other comprehensive income/(loss) and cash flows for each of the three years in the period ended December 31, 2003. We have also audited the schedules listed in the accompanying index. These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and schedules are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and schedules. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedules. We believe that our audits provide a reasonable basis for our opinion.
As described in Note 22, Transcontinental Realty Investors, Inc.’s management has indicated its intent to both sell income producing properties and refinance or extend debt secured by real estate, to meet its liquidity needs.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Transcontinental Realty Investors, Inc. and Subsidiaries as of December 31, 2003 and 2002, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.
Also, in our opinion, the schedules referred to above present fairly, in all material respects, the information set forth therein.
As discussed in Note 19, in 2002 the Company changed its method of accounting for discontinued operations.
BDO SEIDMAN, LLP
March 30, 2004
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TRANSCONTINENTAL REALTY INVESTORS, INC.
CONSOLIDATED BALANCE SHEETS
Real estate held for investment
Less—accumulated depreciation
Notes and interest receivable
Performing (including $18,793 in 2003 and $12,574 in 2002 from related parties)
Nonperforming, nonaccruing
Less—allowance for estimated losses
Investment in real estate entities
Marketable equity securities, at market value
Cash and cash equivalents
Other assets (including $4,819 in 2003 and $19,187 in 2002 from affiliates and related parties)
Liabilities related to assets held for sale
Other liabilities (including $ 607 in 2003 and $5,272 in 2002 to affiliates and related parties)
Commitments and contingencies
Minority interest
Preferred Stock
Series A; $.01 par value; authorized, 6,000 shares; issued and outstanding 0 shares in 2003 and 5,829 shares in 2002 (liquidation preference $0)
Series C; $.01 par value; authorized, issued and outstanding 30,000 shares; (liquidation preference $3,000)
Common Stock, $.01 par value; authorized, 10,000,000 shares; issued and outstanding 8,113,669 shares in 2003 and 8,072,594 shares in 2002
Paid-in capital
Accumulated deficit
Accumulated other comprehensive income (loss)
The accompanying notes are an integral part of these Consolidated Financial Statements.
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CONSOLIDATED STATEMENTS OF OPERATIONS
Property revenue
Interest and other income
Equity loss of equity investees
Gain on debt extinguishment
Gain on condemnation award
Gain on sale of real estate
Provision for asset impairment
Provision for losses
Discount on sale of note receivables
Advisory fees
Net income fee
Incentive fees
General and administrative
Realized loss on investments
Loss on foreign currency transactions
Net income (loss) from continuing operations
Discontinued Operations
Income (loss) from operations
Basic earnings (loss) per share
Diluted earnings
Weighted average Common shares used in computing earnings per share
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CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
Accumulated
Deficit
Comprehensive
Income
Stockholders’
Equity
Balance, January 1, 2001
Issuance of Series C Preferred Stock, 30,000 shares
Comprehensive income
Realized (loss) on marketable equity securities of affiliate
Net income
Fractional shares
Repurchase of Common Stock
Series A Preferred Stock cash dividend ($5.00 per share)
Series B Preferred Stock cash dividend ($.38 per share)
Series C Preferred Stock cash dividends ($.95 per share)
Balance, December 31, 2001
Unrealized (loss) on foreign currency translation
Issuance of Common Stock upon exercise of stock options
Series C Preferred Stock cash dividends ($5.00 per share)
Balance, December 31, 2002
Net loss
Conversion of 5,829 Series A Preferred Stock into Common Stock
Balance, December 31, 2003
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CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash Flows from Operating Activities
Reconciliation of net loss to net cash used by operating activities
Net Income/(Loss)
Adjustments to reconcile net loss to net cash provided by <used in> operating activities
Depreciation and amortization
Provision for loss
Amortization of deferred borrowing costs
Equity in loss of equity investees
Distributions from operating cash flow of equity investees
Gain on extinguishment of debt
Loss on foreign currency transaction
Loss allocated to minority interest
Increase in interest receivable
<Increase> decrease in other assets
Increase <decrease> in interest payable
Increase in other liabilities
Net cash provided by <used in> operating activities
Cash Flows from Investing Activities
Collections on notes receivable (including $1,241 in 2003 and $1,333 in 2002 from affiliates)
Funding of notes receivable (including $14,481 in 2002 and $1,970 in 2001 from affiliates)
Acquisitions of real estate
Real estate improvements
Real estate construction (including $4,050 in 2003 and $4,678 in 2002 to affiliates)
Proceeds from sale of real estate
Payments made under interest rate swap agreement
Purchase of marketable equity securities
Refunds/(deposits) on pending purchase
Payments (to) from advisor
Net advance to affiliates
Contributions to equity investees
Net cash provided by (used in) investing activities
Cash Flows from Financing Activities
Payments on notes payable
Proceeds from notes payable
Payments to minority interests
Dividends paid
Deferred financing costs
Proceeds from exercise of stock options
Net cash provided by (used in) financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents, beginning of year
Cash and cash equivalents, end of year
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CONSOLIDATED STATEMENTS OF CASH FLOWS—Continued
Supplemental Disclosures of Cash Flow Information:
Cash paid for interest
Notes payable assumed on purchase of real estate
Notes payable assumed by buyer on sale of real estate
Series B Preferred Stock issued in conjunction with purchase of real estate
Series C Preferred Stock issued in conjunction with purchase of real estate
Limited partnership interest received on sale of real estate
Funds collected by affiliate on sale of note receivable
Notes receivable provided on sale of real estate
Real estate refinancing proceeds received by affiliate
Real estate received on exchange with related party
Real estate received from related party as payment of debt
Notes receivable payments received by affiliate and added to affiliate receivable balance
Issuance of note payable for which cash proceeds were received by the advisor
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The accompanying Consolidated Financial Statements of Transcontinental Realty Investors, Inc. and consolidated entities have been prepared in conformity with accounting principles generally accepted in the United States of America, the most significant of which are described in NOTE 1. “SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.” The Notes to Consolidated Financial Statements are an integral part of the Consolidated Financial Statements. The data presented in the Notes to Consolidated Financial Statements are as of December 31 of each year and for the year then ended, unless otherwise indicated. Dollar amounts in tables are in thousands, except per share amounts.
Certain balances for 2002 and 2001 have been reclassified to conform to the 2003 presentation.
Organization and business. Transcontinental Realty Investors, Inc. (“TCI”), a Nevada corporation, is successor to a California business trust which was organized on September 6, 1983, and commenced operations on January 31, 1984. TCI invests in real estate through direct ownership, leases and partnerships and it also invests in mortgage loans on real estate. In October 2001, TCI announced a preliminary agreement for the acquisition of TCI by American Realty Investors, Inc. (“ARI”). See NOTE 22. “COMMITMENTS AND CONTINGENCIES AND LIQUIDITY.”
Basis of consolidation. The Consolidated Financial Statements include the accounts of TCI and controlled subsidiaries and partnerships. All significant intercompany transactions and balances have been eliminated.
Accounting estimates. In the preparation of Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States of America it is necessary for management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the Consolidated Financial Statements and the reported amounts of revenues and expense for the year then ended. Actual results could differ from those estimates.
Interest recognition on notes receivable. It is TCI’s policy to cease recognizing interest income on notes receivable that have been delinquent for 60 days or more. In addition, accrued but unpaid interest income is only recognized to the extent that the net realizable value of the underlying collateral exceeds the carrying value of the receivable.
Allowance for estimated losses. Valuation allowances are provided for estimated losses on notes receivable considered to be impaired. Impairment is considered to exist when it is probable that all amounts due under the terms of the note will not be collected. Valuation allowances are provided for estimated losses on notes receivable to the extent that the Company’s investment in the note exceeds the estimated fair value of the collateral securing such note.
Recent Accounting pronouncements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” which disclosures are effective for financial statements issued after December 15, 2002. While the Company has various guarantees included in contracts in the normal course of business, these guarantees would not represent significant commitments or contingent liabilities of the indebtedness of entities outside of the consolidated company.
In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”), which requires the consolidation of variable interest entities, as defined. FIN 46 is applicable to financial statements to be issued by the Company after 2003; however, disclosures are required currently if TCI expects to consolidate any variable interest entities. TCI does not currently believe that any entities will be consolidated as a result of FIN 46.
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires the issuer to classify a financial instrument that is within the scope of the standard as a liability if such financial instrument embodies an obligation of the issuer. The adoption of SFAS No. 150 is not expected to require TCI to reclass any financial instruments currently on our balance sheet.
Real estate held for investment and depreciation. Real estate held for investment is carried at cost. Statement of Financial Accounting Standards No. 144 (“SFAS No. 144”) requires that a property be considered impaired, if the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the property. If impairment exists, an impairment loss is recognized, by a charge against earnings, equal to the amount by which the carrying amount of the property exceeds the fair value of the property. If impairment of a property is recognized, the carrying amount of the property is reduced by the amount of the impairment, and a new cost for the property is established. Such new cost is depreciated over the property’s remaining useful life. Depreciation is provided by the straight-line method over estimated useful lives, which range from five to 40 years.
Real estate held for sale. Foreclosed real estate is initially recorded at new cost, defined as the lower of original cost or fair value minus estimated costs of sale. SFAS No. 144 also requires that properties held for sale be reported at the lower of carrying amount or fair value less costs of sale. If a reduction in a held for sale property’s carrying amount to fair value less costs of sale is required, a provision for loss is recognized by a charge against earnings. Subsequent revisions, either upward or downward, to a held for sale property’s estimated fair value less costs of sale is recorded as an adjustment to the property’s carrying amount, but not in excess of the property’s carrying amount when originally classified as held for sale. A corresponding charge against or credit to earnings is recognized. Properties held for sale are not depreciated.
Foreign Currency Translation. Foreign currency denominated assets and liabilities of subsidiaries with local functional currencies are translated to United States dollars at year-end exchange rates. The effects of translation are recorded in the cumulative translation component of shareholders’ equity. Subsidiaries with a United States dollar functional currency remeasure monetary assets and liabilities at year-end exchange rates and non-monetary assets and liabilities at historical exchange rates. The effects of remeasurement are included in income. Exchange gains and losses arising from transactions denominated in foreign currencies are translated at average exchange rates. The effects of these exchange adjustments resulted in losses of $3.3 million in 2003 and $2.5 million in 2002.
Revenue recognition on the sale of real estate. Sales of real estate are recognized when and to the extent permitted by Statement of Financial Accounting Standards No. 66, “Accounting for Sales of Real Estate” (“SFAS No. 66”), as amended by SFAS No. 144. Until the requirements of SFAS No. 66 for full profit recognition have been met, transactions are accounted for using either the deposit, the installment, the cost recovery or the financing method, whichever is appropriate.
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Investment in noncontrolled equity investees. The equity method is used to account for investments in partnerships which TCI does not control but for which significant influence can be exerted, and for its investment in the shares of common stock of Income Opportunity Realty Investors, Inc., (“IORI”) and ARI. Under the equity method, an initial investment, recorded at cost, is increased by a proportionate share of the investee’s operating income and any additional advances and decreased by a proportionate share of the investee’s operating losses and distributions received.
Operating segments. Management has determined reportable operating segments to be those that are used for internal reporting purposes, which disaggregates operations by type of real estate.
Fair value of financial instruments. The following assumptions were used in estimating the fair value of notes receivable and notes payable. For performing notes receivable, the fair value was estimated by discounting future cash flows using current interest rates for similar loans. For nonperforming notes receivable, the estimated fair value of TCI’s interest in the collateral property was used. For notes payable, the fair value was estimated using current rates for mortgages with similar terms and maturities.
Cash equivalents. For purposes of the Consolidated Statements of Cash Flows, all highly liquid investments purchased with an original maturity of three months or less are considered to be cash equivalents.
Earnings per share. Income (loss) per share is presented in accordance with Statement of Financial Accounting Standards No. 128, “Earnings Per Share.” Income (loss) per share is computed based upon the weighted average number of shares of Common Stock outstanding during each year. Diluted net income per share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the year. Dilutive common equivalent shares consist of stock options and convertible preferred stock. The weighted average common shares used to calculate diluted earnings per share for the years ended December 31, 2001 include 301,548 shares to reflect the dilutive effect of options and convertible preferred stock to purchase shares of common stock. For the year ended December 31, 2003 and 2002, 251,886 and 223,784 weighted average shares, respectively, were excluded from the calculation of dilutive earnings per share because the effect of their inclusion would be antidilutive.
Stock-based employee compensation. TCI accounts for stock-based compensation utilizing the intrinsic value method in accordance with the provisions of Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees,” and related interpretations. Accordingly, no compensation expense is recognized for fixed option plans because the exercise prices of employee stock options equal or exceed the market prices of the underlying stock on the dates of grant.
The following table represents the effect on net income and earnings per share if TCI had applied the fair value based method and recognition provisions of Statement of Financial Accounting Standards No. 123 (“SFAS No. 123”), “Accounting for Stock-Based Compensation,” to stock-based employee compensation:
(dollars in thousands,
except per share amounts)
Net income (loss) applicable to common shares, as reported
Deduct: Stock-based employee compensation expense determined under fair value based methods for all awards, net of related tax effects
Proforma net income applicable to common shares
Net income (loss) per share
Basic, as reported
Basic, pro forma
Diluted, as reported
Diluted, pro forma
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Sq. Ft./Acres
In 2002, TCI purchased the following properties:
Purchase
Price
Net
Cash Paid
Blue Lakes Villas(1)
DeSoto Ranch(1)
Echo Valley(1)
Spy Glass(1)
Vistas at Pinnacle Park(1)
Centura(2)
Oak Tree Village(5)
Hollywood Casino(2)
Lakeshore Villas(5)
Marine Creek(2)
Mason Park(2)
Nashville(2)
Palm Desert(2)
Rasor(5)
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In 2002, TCI sold the following properties:
Net Cash
Received
4242 Cedar Springs
Camelot
Country Crossing
Gladstell Forest
Grove Park
Heritage on the River
Primrose
Southgreen
Trails of Windfern
Hartford
Jefferson
NASA
Plaza Tower
Savings of America
Windsor Plaza
Central Storage
Chelsea Square
Plaza on Bachman Creek(2)
Notes and interest receivable consisted of the following:
Performing
Interest receivable
Interest income is not recognized on nonperforming notes receivable. For the year 2001, unrecognized interest income on nonperforming notes totaled $192,500.
Notes receivable at December 31, 2003, mature from 2004 through 2008 with interest rates ranging from 4.25% to 18.0% per annum, with a weighted average rate of 10.88%. Notes receivable are generally nonrecourse and are generally collateralized by real estate. Scheduled principal maturities of $22.3 million are due in 2004.
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In July 2003, an unsecured loan of $22,000 was made to an individual. The note bears interest at a fixed rate of 12% and requires all interest and principal payments be paid at maturity in January 2004. This note, including accrued and unpaid interest, was paid in full in March 2004.
In January 2002, a mortgage loan with a principal balance of $608,000 was paid off, including accrued but unpaid interest. With the payoff of the note, TCI recognized a previously deferred gain on the sale of the property of $608,000.
In July 2002, TCI entered into an agreement to fund up to $300,000 under a revolving line of credit secured by 100% interest in a partnership of the borrower. The line of credit bears interest at 12.0% per annum and requires monthly interest only payments, and matures in June 2005. As of February 2004, TCI has funded $300,000 of the line of credit.
In March 2001, TCI funded a $3.5 million mortgage loan secured by a second lien on a retail center in Montgomery County, Texas. In June 2001, an additional $1.5 million was funded. The note receivable bore interest at 16.0% per annum, required monthly interest only payments of $67,000 and matured in September 2001. In October 2001, TCI extended the loan until February 2002, receiving $100,000 as an extension fee. In December 2001, TCI received a $1.5 million principal payment. In February 2002, TCI sold a $2.0 million senior participation interest in the loan to IORI, a related party. TCI and IORI received 43% and 57%, respectively, of the remaining principal and interest payments. Also in February 2002, TCI received $23,000 as an extension fee and the loan was extended until April 2002. In April 2002, the loan was extended until July 2002. In July 2002, the loan was extended until September 2002. In August 2002, the loan was paid off, including accrued but unpaid interest.
In June 2001, in conjunction with the sale of 275 unit McCallum Glen Apartments in Dallas, Texas, TCI funded a $1.5 million mortgage loan secured by a second lien on the apartments. The note receivable bore interest at 10% per annum, required monthly interest only payments and matured in June 2003. In May 2002, the loan was paid off. TCI agreed to a 5% discount on the note and recognized a loss of $75,000 from the note. TCI also recognized a previously deferred gain of $1.5 million on the sale of the property.
In July 2001, TCI agreed to fund a $4.4 million line of credit secured by a second lien on 1,714.16 acres of unimproved land in Tarrant County, Texas. The note receivable bears interest at 16.0% per annum, requires monthly interest only payments beginning in September 2001 and matures in July 2003. In March 2002, TCI received a $1.8 million principal payment. In July 2003, this loan was paid off, including accrued but unpaid interest.
Also in July 2001, TCI funded a $1.7 million mortgage loan secured by a second lien on 44.6 acres of unimproved land in Fort Worth, Texas. The note receivable bears interest at 16.0% per annum, requires monthly payments of accrued interest beginning September 2001 and each month thereafter and matured January 2002. In January 2002, the note was extended until November 2002. In May 2003, the loan was paid off, including accrued but unpaid interest.
In October 2001, TCI funded a $4.0 million loan secured by a second lien on a 375,752 sq. ft. office building in St. Louis, Missouri. The note receivable bore interest at 9.0% per annum, required monthly interest only payments of $30,000 and matured in February 2002. In February 2002, TCI extended the loan maturity to February 2003. In August 2002, the loan was paid off, including accrued but unpaid interest.
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In December 2001, TCI provided $608,000 of purchase money financing in conjunction with the sale of the Madison at Bear Creek Apartments in Houston, Texas. The note receivable bore interest at 7% per annum, required payment of the entire outstanding principal and all accrued and unpaid interest in January 2002. The loan was secured by a second lien on the property. The note was paid in full according to the terms in January 2002.
Also in December 2000, TCI funded a $3.0 million mortgage loan secured by a second lien on four office buildings in San Antonio, Texas. The note receivable bore interest at 16.0% per annum, required monthly payments of interest only and matured in June 2001. In June 2001, the note was extended until November 2001 with a $750,000 loan principal paydown. With the paydown, the note was renegotiated to replace the existing collateral with new collateral consisting of a 120,000 sq.ft. office building and industrial warehouse in Carrollton, Texas. The renegotiated note originally was to mature in May 2002. In February 2002, the maturity date on the loan was extended to July 2002. In July 2002, the loan was paid off, including accrued but unpaid interest.
Related Party. In December 2003, TCI purchased a note receivable secured by a second lien on 33 acres of raw land in Travis County, Texas at par value from ARI for $2.4 million as a paydown on an affiliate loan balance. This note bears interest at 10%, requires interest only payments in November 2007 and matures in October 2008.
In April 2002, TCI purchased 100% of the following entities: ART One Hickory Corporation (“One Hickory”), Garden Confederate Point, LP (“Confederate Point”), Garden Foxwood, LP (“Foxwood”), and Garden Woodsong, LP (“Woodsong”), all wholly-owned subsidiaries of ARI, a related party, for $10.0 million. One Hickory owns the 120,615 sq. ft. One Hickory Centre Office Building in Farmers Branch, Texas. Confederate Point owns the 206 unit Confederate Apartments in Jacksonville, Florida. Foxwood owns the 220 unit Foxwood Apartments in Memphis, Tennessee. Woodsong owned the 190 unit Woodsong Apartments in Smyrna, Georgia. ARI has guaranteed that these assets shall produce at least a 12% return annually of the purchase price for a period of three years from the purchase date. If the assets fail to produce the 12% return, ARI shall pay TCI any shortfall. In addition, if the assets fail to produce the 12% return for a calendar year and ARI fails to pay the shortfall, TCI may require ARI to repurchase the entities for the purchase price. Because ARI has guaranteed the 12% return and TCI has the option of requiring ARI to repurchase the entities, management has classified this related party transaction as a note receivable from ARI. In October 2003, TCI sold One Hickory to IORI for $12.2 million, less prorations, for a wrap-round promissory note of $12.0 million. This note bears interest at 5.49% interest, requires monthly interest and principal payments and matures in June 2006. This transaction effectively discharged the note receivable TCI had from ARI for the financing of One Hickory. Also, in November 2003, Confederate Point sold the Confederate Apartments and paid $2.1 million to TCI to pay off the loan and accrued but unpaid interest.
In July 2002, the Woodsong Apartments were sold. ARI received $2.8 million from the proceeds as payment of principal and accrued but unpaid interest on the note receivable. The $2.6 million received by ARI is included in other assets on the accompanying balance sheet.
In December 2001, TCI purchased 100% of the outstanding common shares of National Melrose, Inc. (“NM”), a wholly-owned subsidiary of ARI, a related party, for $2.0 million cash. NM owns the 41,840 sq. ft. Executive Court Office Building in Memphis, Tennessee. ARI has guaranteed that the asset will produce at least a 12% annual return of the purchase price for a period of three years from the purchase date. If the asset fails to produce the 12% annual return, ARI will pay TCI any shortfall. In addition, if the asset fails to produce 12% return for a calendar year, TCI may require ARI to repurchase the shares of NM for the purchase price. Management has classified this related party transaction as a note receivable from ARI.
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Activity in the allowance for estimated losses was as follows:
Balance January 1,
Fully reserved notes receivable
Balance December 31,
Investment in equity method real estate entities consisted of the following:
American Realty Investors, Inc. (“ARI”)
Income Opportunity Realty Investors, Inc. (“IORI”)
Sacramento Nine (“SAC 9”)
TCI owns an approximate 6.5% interest in ARI, a publicly held real estate company, having a market value of $104.0 million at December 31, 2003. At December 31, 2003, ARI had total assets of $558.7 million and owned 24 apartments, 10 commercial properties, seven hotels and 39 parcels of unimproved land. In 2003, ARI sold 12 apartments, five commercial properties, two hotels and 18 parcels of unimproved land for a total of $197.5 million, receiving net cash of $37.8 million after paying off $96.5 million in mortgage debt and the payment of various closing costs. ARI recognized gains of $63.0 million on the sales of which TCI’s equity share was $4.1 million. In 2002, ARI sold 18 apartments, five commercial properties and 13 parcels of unimproved land for a total of $287.4 million, receiving net cash of $22.2 million after paying off $155.0 million in mortgage debt and the payment of various closing costs. ARI recognized gains of $50.5 million on the sales of which TCI’s equity share was $3.3 million.
Based on the ownership percentage of TCI’s investment in ARI and ARI’s market value, TCI’s investment in ARI has a market value of approximately $6.8 million at December 31, 2003. The carrying value of this investment is approximately $9.7 million at December 31, 2003. Management continues to believe that the market value of ARI temporarily undervalues its assets and therefore, no impairment of TCI’s investment in ARI has been recorded.
TCI owns an approximate 24.0% interest in IORI, a publicly held real estate investment company. At December 31, 2003, IORI had total assets of $101.1 million and owned eight apartments in Texas, four office buildings (three in Texas and one in Virginia), one industrial warehouse in Texas, and one parcel of unimproved land in Texas. In 2003, IORI sold three office buildings and a parcel of unimproved land for a total of $55.7 million, receiving net cash of $10.1 million after paying off $9.5 million in mortgage debt and the payment of various closing costs. IORI recognized gains of $3.0 million on the sales of which TCI’s equity share was $715,000. In 2002, IORI sold two office buildings for a total of $19.2 million, receiving net cash of $8.6 million after paying off $9.3 million in mortgage debt and the payment of various closing costs. IORI recognized gains of $6.8 million on the sales of which TCI’s equity share was $1.6 million.
Prior to the first quarter of 2002, TCI accounted for its investments in Tri-City, Nakash and Jor-Trans on the equity method. TCI was a 63.7% limited partner and IORI was a 36.3% general partner in Tri-City, and TCI is a 60% general partner and IORI is a 40% limited partner in Nakash. TCI owns a 55% limited and general partnership interest in Jor-Trans. TCI makes all partnership operating and policy decisions of the partnerships and TCI has the right to approve the sale or refinancing of principal assets, or approve the acquisition of partnership assets. For Tri-City, IORI as general partner only had protective rights in the partnership. TCI and IORI share two of the same members of the Board of Directors. Consequently, because TCI has a greater than 50% ownership over the operations of Tri- City, Nakash and Jor-Trans, the operations of the partnership have been consolidated. In the first quarter of 2002, TCI began accounting for its investment in Tri-City, Nakash and Jor-Trans using a consolidated basis. The effect of these consolidations increased TCI’s assets, liabilities, and minority interest in 2002 by $5.4 million, $3.9 million and $1.5 million, respectively. In November 2002, Tri-City sold it’s only asset, a shopping center, for $4.2 million. Tri-City received net cash of $1.9 million after the payment of various closing costs. TCI received a distribution of $1.2 million of the net proceeds and recognized a gain of $431,000 on its investment in Tri-City. Also, in July 2003, TCI sold the Jor-Trans partnership and the Lincoln Court Apartments to the 45% limited partner in Jor-Trans for $1.8 million. TCI recognized a gain of $1.7 million on this transaction and has withdrawn from the partnership.
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TCI is a non-controlling 30% general partner in SAC 9, which at December 31, 2003 owned an office building in Rancho Cordova, California.
In March 2001, in conjunction with the sale of the 211 unit Park at Colonade Apartments in San Antonio, Texas, TCI received a 23% limited partner interest in the acquiring partnership. TCI is to receive payments of $5,000 monthly from the partnership, a $50,000 distribution in June 2001 which was received and its remaining investment in March 2002. In July 2001, TCI assigned its limited partnership interest to the general partner, receiving a discounted payoff of $490,000. In conjunction with this assignment, TCI recognized a previously deferred gain on the sale of the apartments of $540,000.
Set forth below are summarized financial data for the entities accounted for using the equity method:
Real estate, net of accumulated depreciation ($97,270 in 2003 and $111,029 in 2002)
Other assets
Other liabilities
Shareholders/partners’ capital
Rents and interest income
Operating expenses
Interest expense
Income (loss) before gain on sale of real estate
TCI’s equity share of:
In March 2003, TCI obtained a loan in the amount of $5.0 million to acquire equity securities of Realty Korea CR-REIT Co., Ltd. No. 1 representing approximately a 9.2% ownership interest. As of May 2003, the loan was paid in full. This investment is considered an available-for-sale security. The change in market value between the date of purchase and December 31, 2003 was not material.
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Notes and interest payable consisted of the following:
Estimated
Fair Value
Book
Value
Interest payable
Scheduled principal payments are due as follows:
2004
2005
2006
2007
2008
Thereafter
Notes payable at December 31, 2003, bore interest at rates ranging from 3.3% to 17.9% per annum, and mature between 2004 and 2044. The mortgages were collateralized by deeds of trust on real estate having a net carrying value of $773.0 million.
In 2003, TCI financed/refinanced the following properties:
Sq. Ft./
Units/Acres
Debt
Incurred
Discharged
Received/
(Paid)
Rate
Maturity
Date
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In 2002, TCI financed/refinanced the following properties:
Metra
Addison Hanger (5)
Sheboygan
McKinney 36 (6)
Sandison (6)
Solco-Allen (6)
Stacy Road (6)
State Highway 121 (6)
Watters Road (6)
Whisenant (6)
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Throughout the period in which TCI qualified as a REIT for tax purposes, TCI charged rent to Regis Hotel Corporation, a related party, for TCI’s four hotel properties that were managed by Regis Hotel Corporation. As of December 31, 2000, when TCI no longer qualified as a REIT, the receivable from these rents totaled $2.1 million. During 2002 and 2003, this receivable was reduced by management fees earned by Regis Hotel Corporation. As of December 31, 2003 and 2002, the receivable from Regis Hotel Corporation was $1.7 million and $1.7 million, respectively.
During 2003, ARI sold properties with fair value totaling $10.7 million to TCI. Each of these property sales was approved by TCI’s Board of Directors. TCI’s affiliate receivables from ARI and BCM were reduced by $8.1 million as a result of these transfers. See NOTE 2. REAL ESTATE.
In March 2003, TCI sold a note receivable for $2.6 million to a third party. The proceeds of this sale were received by BCM. The funds were added to TCI’s affiliate receivable from BCM. See NOTE 3. NOTES AND INTEREST RECEIVABLE.
In May 2003, TCI sold a piece of raw land in Texas. The proceeds of the sale were received by BCM. The funds were used to increase TCI’s affiliate receivable from BCM $2.0 million. See NOTE 2. REAL ESTATE.
In June 2003, TCI received the proceeds from the refinancing of an ARI property. This transaction was used to reduce TCI’s affiliate receivables from ARI and BCM by $757,000. See NOTE 7. NOTES AND INTEREST PAYABLE.
In July 2003, TCI paid $1.7 million to BCM for prior year’s legal fees incurred by Gene Phillips. Mr. Phillips is a related party and advisor to TCI.
In August 2003, TCI sold three Chicago hotels to a related party for $13.5 million, including the assumption of debt. Due to the sale being to a related party to TCI and TCI having continued involvement and control of this entity, this transaction has not be been recorded as a sale. These hotels and corresponding debt will continue to be consolidated by TCI.
In September 2003, TCI sold a shopping center to a third party. The proceeds of the sale were received by ARI. The funds were used to increase TCI’s affiliate receivable from Prime and ARI by $1.6 million. See NOTE 2. REAL ESTATE.
In September 2003, TCI sold a piece of raw land in California. The proceeds of the sale were received by an affiliate. The funds were used to increase TCI’s affiliate receivable from Prime by $2.6 million. See NOTE 2. REAL ESTATE.
In November 2003, TCI financed a raw piece of land in Texas. The proceeds of the financing were received by ARI. The funds were used to increase TCI’s affiliate receivable from Prime and ARI by $1.2 million. See NOTE 7. NOTES AND INTEREST PAYABLE.
In November 2003, TCI received the proceeds of the sale of an ARI apartment complex. $2.1 million was used to pay off TCI’s note receivable from ARI and $1.1 million was used to reduce TCI’s affiliate receivable from ARI. See NOTE 3. NOTES AND INTEREST RECEIVABLE.
In November 2003, ARI paid $6.3 million in principal, accrued interest and closing costs on behalf of TCI as payment of the notes payable on five tracts of land in Collin County, Texas. These funds were applied to the affiliate receivable from ARI.
In December 2003, TCI sold Treehouse Apartments and Parkway Centre to IORI for $11.5 million, including the assumption of debt. This transaction was used to reduce TCI’s affiliate payable to Prime by $4.8 million. See NOTE 2. REAL ESTATE.
In December 2003, TCI sold Eagle Crest land to IORI for $4.0 million. This transaction was used to reduce TCI’s intercompany payable to IORI by $4.0 million. See NOTE 2. REAL ESTATE.
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In December 2003, TCI purchased a note receivable secured by a second lien on raw land for $2.4 million. This transaction was approved by TCI’s Board of Directors. TCI’s affiliate receivables from ARI and Prime were reduced by $2.4 million as a result of this transaction. See NOTE 3. NOTES AND INTEREST RECEIVABLE.
In December 2003, TCI’s Board of Directors approved the payment to Regis of a six percent (6%) construction management fee on all construction projects in process at December 31, 2003, to be applied to all construction costs incurred during 2003 on each project. The resulting calculation of $4.1 million was treated as a reduction in the affiliate receivable balance from Prime.
In December 2003, TCI sold six properties to subsidiaries of United Housing Foundation, Inc. (“UHF”), a Texas Non-Profit 501(c)3 Corporation. TCI sold 10.72 acres of Marine Creek land for $1.5 million, the Limestone at Vista Ridge apartments for $19.0 million, the Cliffs of El Dorado apartments for $13.4 million, the Limestone Canyon apartments for $18.0 million, the Sendero Ridge apartments for $29.4 million, and Tivoli apartments for $16.1 million. All of the transactions include the assumption of debt and notes receivable to TCI for the remainder of the purchase price. Ted Stokely, Chairman of the Board of TCI, is the General Manager of UHF. Richard Humphrey, who is employed by Regis Realty I, LLC, an affiliate, is President of UHF. Due to UHF being considered a related party to TCI and TCI having continued involvement and control of these entities, these transactions will not be recorded as sales. Instead, these transactions will be accounted for on the deposit method and the properties and corresponding debt will continue to be consolidated by TCI. All of these transactions were approved by TCI’s Board of Directors. Mr. Stokely abstained from voting on all of these transactions. Management is seeking lender approval on the transfer of the notes associated with these property transactions.
During 2002, TCI’s Board of Directors authorized the Chief Financial Officer of the Company to advance funds either to or from the Company, through BCM, in an amount up to $15.0 million, on the condition that such advances shall be repaid in cash or transfers of assets within 90 days. Several property transfers from BCM or Prime were made during 2003 and 2002 to reduce the affiliate balance. Each of these transactions was approved by TCI’s Board of Directors.
Affiliate receivable with Prime and Regis Hotel Corporation are included within Other Assets, and the affiliate payable to ARI and IORI is included within Other Liabilities in the accompanying consolidated balance sheet. Prime replaced BCM as the contractual advisor in July 2003 and assumed all of BCM’s affiliate balances and obligations from TCI. The following table reconciles the beginning and ending balances of affiliate receivables (payables) as of December 31, 2003:
Cash transfers
Cash repayments
Advance through property transfers
Repayments through property transfers
Fees payable to Advisor
Advance through sale of note receivable
Repayment through purchase of note receivable
Repayment through affiliate refinance
Advance through property sale receipts
Repayment through property sale receipts
Advance through receipt of refinancing proceeds
Repayments through payments on debt
Other additions
Other reductions
In addition, Other Assets includes $1.7 million due from Regis Property Management, a related party.
Returns on Metra Properties. As described in Note 5, TCI sold residential properties during 2002 to partnerships controlled by Metra. The partnership agreement for each of these partnerships states that the Metra Partners, as defined, receive cash flow distributions at least quarterly in an amount sufficient to provide them with a 15 percent cumulative compounded annual rate of return on their invested capital, as well as a cumulative annual amount of 0.50% of the average outstanding balance of the mortgage indebtedness secured by any of these residential properties. These distributions to the Metra Partners have priority over distributions to any of the other partners.
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TCI’s Series A Cumulative Convertible Preferred Stock consists of a maximum of 6,000 shares with a par value of $.01 per share and a liquidation preference of $100.00 per share. Dividends are payable at the rate of $5.00 per year or $1.25 per quarter to stockholders of record on the 15th day of each March, June, September and December when and as declared by the Board of Directors. The Series A Preferred Stock may be converted after November 1, 2003, into Common Stock at the daily average closing price of the Common Stock for the prior five trading days. At December 31, 2002 and 2001, 5,829 shares of Series A Preferred Stock were issued and outstanding. On November 13, 2003, the 5,829 shares of Series A Preferred Stock outstanding were converted into 41,075 shares of TCI common stock. The Series A Preferred Stock was eliminated on November 21, 2003.
In conjunction with the purchase of the Baywalk, Island Bay and Marina Landing Apartments, TCI issued 30,000 shares of Series C Preferred Stock. TCI’s Series C Cumulative Convertible Preferred Stock consists of a maximum of 30,000 shares with a liquidation preference of $100.00 per share. Dividends are payable at the annual rate of $5.00 per share or $1.25 per quarter through September 2002, then $6.00 per share annually or $1.50 per quarter through September 2003, then $7.00 per share annually or $1.75 per quarter thereafter. After September 30, 2006, the Series C Preferred Stock may be converted into Common Stock at 90% of the daily average closing price of the Common Stock for the prior five trading days. The Series C Preferred Stock is redeemable for cash at any time at the option of TCI. At December 31, 2003, 30,000 shares of Series C Preferred Stock were issued and outstanding.
In December 2000, the Board of Directors determined not to pay a fourth quarter dividend to holders of TCI’s Common Stock. The non-payment decision was based on the Board determining that TCI needed to retain cash for acquisitions that were anticipated in 2001 and 2002. No dividends were paid on the Common Stock of TCI in 2003, 2002 or 2001.
In October 2000, TCI’s stockholders approved the 2000 Stock Option Plan (“2000 Plan”). The 2000 Plan is administered by the Stock Option Committee, which currently consists of two Independent Directors of TCI. The exercise price per share of an option will not be less than 100% of the fair market value per share on the date of grant thereof. As of December 31, 2003, TCI had 300,000 shares of Common Stock reserved for issuance under the 2000 Plan. No options have been granted under the 2000 Plan.
In October 2000, TCI’s stockholders approved the Director’s Stock Option Plan (the “Director’s Plan”) which provides for options to purchase up to 140,000 shares of TCI’s Common Stock. Options granted pursuant to the Director’s Plan are immediately exercisable and expire on the earlier of the first anniversary of the date on which a Director ceases to be a Director or 10 years from the date of grant. Each Independent Director was granted an option to purchase 5,000 Common shares at an exercise price of $14.875 per share on October 10, 2000, the date stockholders approved the plan. On January 1, 2001, 2002 2003 and 2004, each Independent Director was granted an option to purchase 5,000 Common shares. The exercise price was $17.64, $16.05 and $8.875 per Common shares for 2003, 2002 and 2001, respectively. Each Independent Director will be awarded an option to purchase an additional 5,000 shares on January 1 of each year.
Number
of Shares
Exercise
Outstanding at January 1,
Granted
Exercised
Canceled
Outstanding at December 31,
The fair value of each option is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
Dividend yield
Expected volatility
Risk-free interest rate
Expected lives (in years)
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The weighted average fair value per share of options granted in 2003 and 2002 was $11.82 and $10.51, respectively.
Basic Capital Management, Inc. (“BCM”), an affiliate, served as advisor to TCI from March 28, 1989 to June 30, 2003. Effective July 1, 2003, BCM was replaced as contractual advisor to TCI by Prime Asset Management, Inc., (“PAMI”). PAMI is owned by Realty Advisors (79%) and Syntek West (21%), related parties. Syntek West is owned by Gene Phillips. Effective August 18, 2003, PIAMI changed its name to Prime Income Asset Management, Inc., (“PIAMI”). On October 1, 2003, Prime Income Asset Management, LLC (“Prime”), which is owned 100% by PIAMI, replaced PIAMI as the advisor to TCI. Prime is indirectly owned by a trust for the children of Gene E. Phillips. Mr. Phillips is not an officer or director of BCM or PIAMI or Prime, but serves as a representative of the trust, is involved in daily consultation with the officers of Prime and has significant influence over the conduct of Prime’s business, including the rendering of advisory services and the making of investment decisions for itself and for TCI.
Under the Advisory Agreement, Prime is required to annually formulate and submit for Board approval a budget and business plan containing a twelve-month forecast of operations and cash flow, a general plan for asset sales and purchases, lending, foreclosure and borrowing activity and other investments. Prime is required to report quarterly to the Board on TCI’s performance against the business plan. In addition, all transactions require prior Board approval unless they are explicitly provided for in the approved business plan or are made pursuant to authority expressly delegated to Prime by the Board.
The Advisory Agreement also requires prior Board approval for the retention of all consultants and third party professionals, other than legal counsel. The Advisory Agreement provides that Prime shall be deemed to be in a fiduciary relationship to the stockholders and contains a broad standard governing Prime’s liability for losses incurred by TCI.
The Advisory Agreement provides for Prime to be responsible for the day-to-day operations and to receive an advisory fee comprised of a gross asset fee of .0625% per month (.75% per annum) of the average of the gross asset value (total assets less allowance for amortization, depreciation or depletion and valuation reserves) and an annual net income fee equal to 7.5% of net income.
The Advisory Agreement also provides for Prime to receive an annual incentive sales fee. Prime or an affiliate of Prime is to receive an acquisition commission for supervising the purchase or long-term lease of real estate. Prime or an affiliate of Prime is also to receive a mortgage brokerage and equity refinancing fee for obtaining loans to or refinancing of TCI’s properties. In addition, Prime receives reimbursement of certain expenses incurred by it in the performance of advisory services for TCI.
The Advisory Agreement requires Prime or any affiliate of Prime to pay to TCI one-half of any compensation received from third parties with respect to the origination, placement or brokerage of any loan made by TCI.
Under the Advisory Agreement, all or a portion of the annual advisory fee must be refunded if the Operating Expenses of TCI (as defined in the Advisory Agreement) exceed certain limits specified in the Advisory Agreement. In 2003 and 2002, Prime and BCM, respectively, were required to refund to TCI $1.3 and $1.4 million of Prime and BCM’s respective advisory fees. BCM was not required to refund any of its 2001 advisory fee.
Additionally, if management were to request that Prime render services other than those required by the Advisory Agreement, Prime or an affiliate of Prime would be separately compensated for such additional services on terms to be agreed upon from time to time. As discussed in NOTE 13. “PROPERTY MANAGEMENT,” Triad Realty Services, Ltd. (“Triad”), an affiliate of Prime, provides property management services and as discussed in NOTE 14. “REAL ESTATE BROKERAGE,” Regis Realty, Inc. (“Regis”), a related party, provided, on a non-exclusive basis, brokerage services until December 2002. Since January 1, 2003, Regis Realty I, LLC, a related party, provided brokerage services.
Triad provides property management services for a fee of 5% or less of the monthly gross rents collected on residential properties and 3% or less of the monthly gross rents collected on commercial properties under its management. Triad subcontracts with other entities for property-level management services at various rates. The general partner of Triad is BCM. The limited partner of Triad is Highland Realty Services, Inc. (“Highland”), a related party. Triad subcontracted to Regis, a related party, which is a company owned by Highland, the property-level management and leasing of 39 of TCI’s commercial properties, and its five hotels until December 2002. Since January 1, 2003, Regis Realty I, LLC, provided property management services. Regis was and Regis Realty I, LLC is entitled to receive property and construction management fees and leasing commissions in accordance with the terms of its property-level management agreement with Triad.
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During 2002 and 2003, Regis provided construction management services for TCI’s properties under construction. Regis charged fees of 6% of certain construction costs. Those fees totaled $4.1 million and $4.7 million for 2003 and 2002, respectively.
Regis also provided brokerage services on a non-exclusive basis until December 2003. Regis was and Regis Realty I, LLC is entitled to receive a commission for property purchases and sales, in accordance with a sliding scale of total brokerage fees to be paid by TCI.
Revenue, fees and cost reimbursements to BCM or Prime and their affiliates:
Fees
Advisory
Property acquisition
Real estate brokerage
Mortgage brokerage and equity refinancing
Cost reimbursements
Rent revenue
Costs incurred by BCM and Prime related to TCI, ARI and IORI are allocated based on the relative book values of each company’s assets.
Fees paid to Regis, a related party:
Construction supervision
Property and construction management and leasing commissions
During the third quarter of 2000, due to a concentration of ownership, TCI no longer met the requirements for tax treatment as a Real Estate Investment Trust (REIT), as defined by Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the “Code”), under the Code, and is prohibited from re-qualifying for REIT tax status for at least five years.
TCI had net income for federal income tax purposes before the application of operating loss carryforwards in 2003, 2002 and 2001; therefore, TCI recorded no provision for income taxes. TCI’s tax basis in its net assets differs from the amount at which its net assets are reported for financial statement purposes, principally due to the accounting for gains and losses on property sales, depreciation on owned properties and investments in joint venture partnerships. At December 31, 2003, TCI’s tax basis in its net assets was exceeded by their net basis for financial statement purposes by approximately $87.4 million and TCI’s tax basis in its net liabilities was exceeded by their net basis for financial statement purposes by approximately $91.9 million. As a result, aggregate future income for income tax purposes will be less than such amount for financial statement purposes by approximately $4.5 million. Additionally, at December 31, 2003, TCI has current and prior year tax net operating loss carryforwards of $33.8 million expiring through the year 2018. Also, TCI’s state income tax expense is included in general and administrative expenses on the income statement.
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At December 31, 2003, TCI had a net deferred tax asset of $14.6 million due to tax deductions available to it in future years. However, as management cannot determine that it is more likely than not that TCI will realize the benefit of the deferred tax asset, a 100% valuation allowance has been established.
NOTE 17. RENTS UNDER OPERATING LEASES
Operations include the leasing of commercial properties (office buildings, industrial warehouses and shopping centers). The leases thereon expire at various dates through 2020. The following is a schedule of minimum future rents on non-cancelable operating leases at December 31, 2003:
NOTE 18. OPERATING SEGMENTS
Significant differences among the accounting policies of the operating segments as compared to the Consolidated Financial Statements principally involve the calculation and allocation of general and administrative expenses. Management evaluates the performance of the operating segments and allocates resources to each of them based on their operating income and cash flow. Items of income that are not reflected in the segments are interest, other income, gain on debt extinguishment, gain on condemnation award, equity in partnerships, and equity gains on sale of real estate totaling $16.4 million, $5.3 million and $2.3 million for 2003, 2002 and 2001, respectively. Expenses that are not reflected in the segments are provision for losses, advisory, net income and incentive fees, general and administrative, realized loss on investments, minority interests, foreign currency transaction loss and discontinued operations totaling $13.2 million, $15.7 million and $25.8 million for 2003, 2002 and 2001, respectively. Excluded from operating segment assets are assets of $99.2 million at December 31, 2003 and $100.3 million at December 31, 2002, which are not identifiable with an operating segment. There are no intersegment revenues and expenses. See “NOTE 2. “REAL ESTATE” and NOTE 3. “NOTES AND INTEREST RECEIVABLE.”
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Presented below is the operating income of each operating segment and each segments’ assets for the years 2003, 2002 and 2001.
2003
Property operating expenses
Segment operating income (loss)
Real estate improvements and construction
Property Sales
Sales price
Cost of sales
Gain on sale
2002
2001
Effective January 1, 2002, TCI adopted Statement of Financial Accounting Standard No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which established a single accounting model for the impairment or disposal of long-lived assets, including discontinued operations. This statement requires that the operations related to properties that have been sold or properties that are intended to be sold be presented as discontinued operations in the statement of operations for all periods presented, and properties intended to be sold are to be designated as “held-for-sale” on the balance sheet.
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For 2003, 2002 and 2001, income (loss) from discontinued operations relates to 17 properties that TCI sold during 2003 and 18 properties that TCI sold during 2002. The following table summarizes revenue and expense information for these properties sold.
Net income (loss) from discontinued operations
Equity in gain on sale of real estate by equity investees
The following is a tabulation of TCI’s quarterly results of operations for the years 2003, 2002, 2001 (unaudited):
Interest income
Income (loss) in equity partnerships
Net loss from continuing operations
Basic and Diluted Earnings (Loss) Per Share
In the first quarter of 2003, TCI recognized $1.5 million for TCI’s share of gains recognized by ARI, equity investee. In the second quarter of 2003, gains on sale of real estate totaling $8.7 million were recognized on the sale of Willow Wick Apartments, McLeod Industrial, Tricon consolidated warehouses, Solco-Valley Ranch land, and TCI’s share of gains recognized by ARI. In the third quarter of 2003, gains on sale of real estate totaling $11.8 million were recognized on the sale of Lincoln Court Apartments, Quail Creek Apartments, Stone Oak Apartments, Bonita Plaza Office Building, K-Mart Sheboygan, Oak Tree Village shopping center, Palm Desert land, and TCI’s share of gains recognized by ARI and IORI. In the fourth quarter of 2003, gains on sale of real estate totaling $6.1 million were recognized on Summerfield Apartments, Treehouse Apartments, Remington Office Building, Parkway shopping center, Kelly 301 Hilltop, Kelly 108th street, Eagle Crest land, Sendero Ranch land, Highway 121/Watters Road land and TCI’s share of gains recognized by ARI and IORI. Also in the fourth quarter of 2003, TCI recognized $3.8 million for a litigation settlement, $4.4 million for gain on extinguishment of debt and $4.8 million for a condemnation award.
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In the first quarter of 2002, gains on sale of real estate totaling $5.4 million were recognized on the sale of the Primrose Apartments, Central Storage Industrial Warehouse, a deferred gain on the sale of Madison at Bear Creek Apartments, and TCI’s share of gains recognized by ARI and IORI, equity investees. In the second quarter of 2002, gains on sale of real estate totaling $7.3 million were recognized on the sale of Southgreen Apartments, Jefferson Office Building, NASA Office Building, Windsor Plaza Office Building, a deferred gain on the sale of McCallum Glen Apartments, and TCI’s share of gains recognized by ARI. In the third quarter of 2002, gains on sale of real estate totaling $13.7 million were recognized on the sale of 4242 Cedar Springs, Camelot, Country Crossing, Gladstell Forest, and Heritage on the River Apartments, Savings of America Office Building, and TCI’s share of gains recognized by ARI. In the fourth quarter of 2002, gains on sale of real estate totaling $17.5 million were recognized on Grove Park and Trails of Windfern Apartments, Plaza Tower Office Building, Chelsea Square Shopping Center, and TCI’s share of gains recognized by ARI.
Net income applicable to Common shares
In the first quarter of 2001, gains on sale of real estate totaling $6.5 million were recognized on the sale of Heritage Apartments, Forest Ridge Apartments, Park at Colonade Apartments, the Zodiac Warehouse, a portion of the McKinney 36 land parcel, a portion of the Round Mountain land parcel, and TCI’s share of gains recognized by ARI, an equity investee. In the second quarter of 2001, gains on sale of real estate totaling $22.3 million were recognized on the sale of Glenwood Apartments, Fontenelle Hills Apartments, Bent Tree Gardens Apartments, McCallum Glen Apartments, Moss Creek lots land parcel, Waterstreet Office Building, Technology Trading Center, Daley Office Building, and TCI’s share of gains recognized by ARI. In the third quarter of 2001, gains on sale of real estate totaling $18.8 million were recognized on the sale of Park Lane Apartments, McCallum Crossing Apartments, Carseka
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Apartments, Sunset Lakes Apartments, Oak Run Apartments, a portion of the Eagle Crest land parcel, Chesapeake Office Building, and TCI’s share of gains recognized by ARI. In the fourth quarter of 2001, gains on sale of real estate totaling $6.7 million were recognized on the sale of South Cochran Apartments, Madison at Bear Creek Apartments, Summerstone Apartments, Valley Rim Office Building, a previously deferred gain on the sale of Town and Country Shopping Center, and TCI’s share of gains recognized by ARI. See NOTE 2. “REAL ESTATE” and NOTE 5. “INVESTMENT IN EQUITY METHOD REAL ESTATE ENTITIES.”
During the first quarter of 2002, TCI entered into an interest rate swap agreement with a bank. This agreement contains a notional amount of $12.8 million and requires TCI to pay the bank a fixed rate of 4.3%, and requires the bank to pay to TCI based on the 30 day LIBOR rate. This agreement was entered into in order to effectively fix the rate on TCI’s debt associated with the Limestone Canyon property. The swap agreement expires on December 9, 2004.
TCI has not designated the interest rate swap agreement as a hedge, as defined within Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and as such, changes in the fair value of the swap agreement are recognized in earnings during the period of change and reflected in the statement of operations as interest expense.
The fair value of the swap agreement at December 31, 2003 represents a liability to the Company of $370,000 and is included within other liabilities in the accompanying balance sheet. Amounts paid or received under the swap agreement are settled monthly and are reflected as a reduction in the liability when paid. Interest expense at December 31, 2003, was decreased by $191,000 representing both amounts paid to the bank under the agreement and decreases in the fair value of the related liability.
In February 1990, TCI, together with National Income Realty Trust, CMET and IORI, three real estate entities which, at the time, had the same officers, directors or trustees and advisor as TCI, entered into a settlement (the “Settlement”) of a class and derivative action entitled Olive et al. v. National Income Realty Trust et al. (the “Olive Litigation”), relating to the operation and management of each of the entities. On April 23, 1990, the Court granted final approval of the terms of the Settlement. The Settlement was modified in 1994 (the “Modification”), which was amended on January 27, 1997, by Amendment to the Modification, effective January 9, 1994 (the “First Amendment”).
In October 2000, plaintiffs’ counsel asserted that loans made by TCI to BCM and American Realty Trust, Inc. breached the Modification. The Board believes that the provisions of the Settlement, Modification and the First Amendment terminated on April 28, 1999. However, the Court ruled that certain provisions continue to be effective after the termination date. This ruling was appealed by TCI and IORI.
On October 23, 2001, TCI, IORI and ARI jointly announced a preliminary agreement with the plaintiff’s legal counsel for complete settlement of all disputes in the lawsuit. In February 2002, the court granted final approval of the proposed settlement (the “Second Amendment”). Under the Second Amendment, the appeal was dismissed with prejudice and ARI agreed to either (i) acquire all of the outstanding shares of IORI and TCI not currently owned by ARI for a cash payment or shares of ARI preferred stock or (ii) make a tender offer for all of the outstanding common shares of IORI and TCI not currently owned by ARI. At that time, TCI had the same advisor as ARI and IORI. Two of the directors of IORI also served as directors for ARI and TCI.
On November 15, 2002, ARI commenced, through subsidiaries, a tender offer for shares of common stock of TCI and IORI. The price per share was $17.50 for TCI shares and $19.00 for IORI shares. The tender offers were completed on March 19, 2003. ARI acquired 265,036 IORI shares and 1,213,226 TCI shares. The completion of the tender offer fulfilled the obligations under the Second Amendment and the Olive Litigation was dismissed with prejudice.
Partnership Buyouts. TCI is the limited partner in 12 partnerships formed to construct residential properties. As permitted in the respective partnership agreements, TCI intends to purchase the interests of the general and any other limited partners in these partnerships subsequent to the completion of these projects. The amounts paid to buyout the nonaffiliated partners are limited to development fees earned by the nonaffiliated partners, and are set forth in the respective partnership agreements. The total amount of the expected buyouts as of December 31, 2003 is approximately $2.3 million.
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Liquidity. Although management anticipates that TCI will generate excess cash from operations in 2004, due to increased rental rates at its properties, such excess, however, will not be sufficient to discharge all of TCI’s debt obligations as they mature. Management intends to selectively sell income producing real estate, refinance real estate and incur additional borrowings against real estate to meet its cash requirements.
Other Litigation. TCI is also involved in various other lawsuits arising in the ordinary course of business. Management is of the opinion that the outcome of these lawsuits will have no material impact on TCI’s financial condition, results of operations or liquidity.
At December 31, 2003, TCI was in default on a second lien note secured by Bay Plaza office building. TCI paid off this second lien note in February 2004.
At December 31, 2003, TCI was in default on a loan secured by Marine Creek land. TCI refinanced this land in February 2004 and paid off this loan in February 2004.
TCI was in default on loans secured by the three hotels in Chicago. The total principal amount of $9.6 million matured at the end of February 2003 and had been in default since August 2002 due to the hotels not achieving the necessary debt service coverage ratios. Because of the default, the lender began charging default interest at the rate of 12% per annum. In March 2003, TCI sold the three hotels to a related party and placed them in bankruptcy. New terms are being negotiated with the lender and TCI expects these hotels to emerge as viable assets. The sale of the hotels was not recorded due to TCI retaining control and having continued involvement.
In 2002, TCI was in default on a $1.0 million loan secured by interests in the partnership which owns the Tivoli Apartments in Dallas, Texas. TCI attempted to negotiate an extension for this loan maturing in December 2002. In January 2003, the lender commenced a lawsuit against TCI to collect the amount. In August 2003, TCI settled with the lender for $1.0 million, which paid off the principal and accrued interest of this note.
TCI was in default on a $5.3 million loan secured by the Majestic Hotel in San Francisco, California. TCI ceased making monthly payments of principal and interest in May 2002. In March 2003, TCI sold the hotel to a related party, who placed it in bankruptcy. New terms are being negotiated with the lender and TCI expects this hotel to emerge as a viable asset. The sale of the hotel was not recorded due to TCI retaining control and having continued involvement.
In January 2001, TCI exercised its option under the loan documents to extend the maturity date of three loans with a principal balance of $30.0 million secured by three office buildings in New Orleans, Louisiana. The lender has disputed TCI’s right to extend the loans. This dispute was the subject of litigation pending in the United States District Court for the Eastern District of Louisiana. On September 11, 2003, TCI settled with the lender. On September 18, 2003, TCI paid $5.0 million to lender, which gave TCI the right to retire the remaining debt outstanding on the three office buildings on or before December 10, 2003 for $20.0 million. TCI paid the remaining $20.0 million on December 10, 2003, which resulted in a $4.4 million gain on extinguishment of debt.
NOTE 23. SUBSEQUENT EVENTS
In 2004, TCI sold the following property:
Sq. Feet /Acres
Sales
Gain/(Loss)
on Sale
Countryside Retail
Countryside Harmon
In February 2004, TCI received $1.9 million as a deposit on the Sandstone Apartments in Mesa, Arizona. The buyer has the option to purchase the property within 90 days of receipt of the deposit.
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In 2004, TCI refinanced or financed the following properties:
Dominion/Hollywood
Marine Creek (2)
Also in 2004, TCI guaranteed a $10 million line of credit for its parent, ARI. TCI pledged assets, in the form of securities and partnership interests in construction properties, as additional collateral for this line of credit.
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SCHEDULE III
REAL ESTATE AND ACCUMULATED DEPRECIATION
Cost CapitalizedSubsequent to
Acquisition
Gross Amounts of Which
Carried at End of Year
Life on
Which
In Latest
Statement
of Operationis Computed
Property/Location
Building &
Improvements
(1)
Total
Date of
Construction
Held for Investment:
4400, Midland, TX
Apple Lane, Lawrence, KS
Arbor Point, Odessa, TX
Ashton Way, Midland, TX
Autumn Chase, Midland, TX
Baywalk, Galveston, TX
Blue Lake Villas, Waxahachie, TX
Bluffs At Vista Ridge
Breakwater Bay, Beaumont, TX
By the Sea, Corpus Christi, TX
Capitol Hill, Little Rock, AR
Cliffs of Eldorado, McKinney, TX
Courtyard, Midland, TX
Coventry, Midland, TX
DeSoto Ranch, DeSoto, TX
Echo Valley, Dallas, TX
El Chapparal, San Antonio, TX
Fairway View Estates, El Paso, TX
Fairways, Longview, TX
Falcon Lakes, Arlington, TX
Fountain Lake, Texas City, TX
Fountains of Waterford, Midland, TX
Harper’s Ferry, Lafayette, LA
Heather Creek, Mesquite, TX
Hunters Glen, Midland, TX
In the Pines, Gainesville, FL
Island Bay, Galveston, TX
Kingsland Ranch, Houston, TX
Limestone Canyon, Austin, TX
Limestone Ranch, Lewisville, TX
Marina Landing, Galveston, TX
Mountain Plaza, El Paso, TX
Oak Park IV, Clute, TX
Paramount Terrace, Amarillo, TX
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(Continued)
Cost Capitalized
Subsequent to
Life onWhich
Plantation, Tulsa, OK
Quail Oaks, Balch Springs, TX
River Oaks, Wiley, TX
Sendero Ridge, San Antonio, TX
Somerset, Texas City, TX
Southgate, Odessa, TX
Spy Glass, Mansfield, TX
Sunchase, Odessa, TX
Terrace Hills, El Paso, TX
Timbers, Tyler, TX
Tivoli, Dallas, TX
Verandas at City View, Fort Worth, TX
Vistas at Pinnacle Park, Dallas, TX
Waters Edge IV, Gulfport, MS
Westwood, Odessa, TX
Willow Creek, El Paso, TX
Will-O-Wick, Pensacola, FL
Windsong, Fort Worth, TX
Woodview, Odessa, TX
1010 Commons, New Orleans, LA
225 Baronne, New Orleans, LA
4135 Beltline, Addison, TX
9033 Wilshire Blvd., Los Angeles, CA
Ambulatory Surgery Center, Sterling, VA
AMOCO, New Orleans, LA
Atrium, Palm Beach, FL
Bay Plaza, Tampa, FL
Bay Plaza II, Tampa, FL
Brandeis, Omaha, NE
Centura, Farmers Branch, TX
Corporate Point, Chantilly, VA
Durham Center, Durham, NC
Eton Square, Tulsa, OK
Forum, Richmond, VA
Institute Place, Chicago, IL
Lexington Center, Colorado Springs, CO
Mimado, Sterling, VA
One Steeplechase, Sterling, VA
Parkway North, Dallas, TX
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Acquired
Signature Athletic Club, Dallas, TX
Venture Center, Atlanta, GA
Westgrove Air Plaza, Addison, TX
5360 Tulane, Atlanta, GA
5700 Tulane, Atlanta, GA
Addison Hangar, Addison, TX
Addison Hanger II, Addison, TX
Encon, Fort Worth, TX
Space Center, San Antonio, TX
Texstar, Arlington, TX
Cullman SC
Dunes Plaza, Michigan City, IN
Fiesta, San Angelo, TX
K-Mart, Cary, NC
Promenade, Highlands Ranch, CO
Sadler Square, Amelia Island, FL
Akademia, Wroclaw, Poland
The Majestic, Chicago, IL
City Suites, Chicago, IL
Majestic Inn, San Francisco, CA
Willows, Chicago, IL
1013 Commons, New Orleans, LA
2301 Valley Branch, Farmers Branch, TX
Alamo Springs, Dallas, TX
Dominion, Dallas, TX
Fruitland, Fruitland Park, FL
Hollywood Casino, Farmers Branch, TX
Lakeshore Villas, Harris County, TX
Lamar Parmer/LimestoneII, Austin, TX
Las Colinas, Las Colinas, TX
Lemon Carlisle, Dallas, TX
Manhattan, Farmers Branch, TX
Marine Creek, Ft. Worth, TX
Mason Park, Houston, TX
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of Operation
is Computed
Mira Lago, Farmers Branch, TX
Maumelle Town Center, Maumelle, AR
Nakash
Nashville, Nashville, TN
Pac-Trust, Dallas, TX
Pulaski, Pulaski County, AR
Rasor, Plano, TX
Round Mt, Austin, TX
Seminary West, Fort Worth, TX
Shefield Village, Grand Prairie, Texas
West End, Dallas, TX
Investment Properties
Properties Held for Sale
Countryside Retail Center, Sterling, VA
Harmon, Sterling, VA
Kelly Warehouses, Dallas, TX
McKinney 36, Collin County, TX
Ogden, Ogden, UT
Red Cross, Dallas, TX
Sandison, Collin County, TX
Sandstone, Mesa, AZ
Solco Allen, Collin County, TX
Stacy Road, Allen, TX
State Highway 121, Collin County, TX
Watters Road, Collin County, TX
Whisenant, Collin County, TX
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Reconciliation of Real Estate
Balance at January 1,
Additions
Purchases, improvements and construction
Real estate added from consolidation of partnerships
Deductions
Sale of real estate
Asset impairments
Asset retirements
Sale of foreclosed properties
Balance at December 31,
Reconciliation of Accumulated Depreciation
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SCHEDULE IV
MORTGAGE LOANS ON REAL ESTATE
Description
Final
Periodic Payment Terms
Prior
Liens
Face
Amount of
Mortgage
Carrying
Amounts of
Mortgage (1)
Principal
Loans
Subject to
Delinquent
Principalor Interest
FIRST MORTGAGE LOANS
400 St. Paul
Secured by an office building in Dallas, TX. Includes LOC of $250,000.
Executive Court
Secured by a 41,840 sq. ft. office building in Memphis, TN.
WRAPAROUND MORTGAGE LOANS
Pinemont
Secured by an office building in Houston, TX.
Secured by a shopping Center in Malden, MO.
JUNIOR MORTGAGE LOANS
Dallas Fund XVII
Secured by an assignment of litigation proceeds. Nonperforming
Pioneer Development
Secured by 33.33 acres of unimproved land in Travis County, TX.
Foxwood
Secured by an apartment building in Memphis, TN.
One Hickory
Secured by an office building in Farmers Branch, TX.
Two Hickory
OTHER
Mehrdad Moayedi
Unsecured
North Augusta Plans
Apartment Development Services
Secured by 100% interest in partnership.
Allowance for estimated losses
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New mortgage loans
Mortgages added from consolidation of partnerships
Collections of principal
Mortgages eliminated from consolidation of partnerships
Discount on sale of note receivable
Write off of principal due to discount for early payoff
As required by rule 13a-15(b), TCI’s management, including the Acting Principal Executive Officer and Principal Accounting Officer, conducted an evaluation as of the end of the period covered by this report, of the effectiveness of TCI’s disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e). Based on that evaluation, the chief executive officer and the chief financial officer concluded that TCI’s disclosure controls and procedures were effective as of the end of the period covered by this report. As required by rule 13a-15(d), TCI’s management, including the Acting Principal Executive Officer and Principal Accounting Officer, also conducted an evaluation of TCI’s internal controls over financial reporting to determine whether any changes occurred during the fourth fiscal quarter that have materially affected, or are reasonably likely to materially affect, TCI’s internal control over financial reporting. Based on the evaluation, there has been no such change during the fourth fiscal quarter.
It should be noted that any system of controls, however well designed and operated, can only provide reasonable, and not absolute, assurance that the objectives of the system will be met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events.
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PART III
Directors
The affairs of Transcontinental Realty Investors, Inc. (“TCI”) are managed by a Board of Directors. The Directors are elected at the annual meeting of stockholders or appointed by the incumbent Board and serve until the next annual meeting of stockholders or until a successor has been elected or approved.
After December 31, 2003, a number of changes occurred in the composition of the Board of Directors of TCI, the creation of certain Board committees, the adoption of Committee charters, the adoption of a Code of Ethics for Senior Financial Officers, and the adoption of Guidelines for Director Independence. Also, the composition of the members of the Board of Directors changed with the resignation of Earl D. Cecil (on February 29, 2004) as well as the election of independent directors, Ted R. Munselle and Sharon Hunt on February 20, 2004.
It is the Board’s objective that a majority of the Board consist of independent directors. For a director to be considered independent, the Board must determine that the Director does not have any direct or indirect material relationship with TCI. The Board has established guidelines to assist it in determining director independence which conform to, or are more exacting than, the independence requirements in the New York Stock Exchange listing rules. The independence guidelines are set forth in TCI’s “Corporate Governance Guidelines.” The text of this document has been posted on TCI’s internet website at http://www.transconrealty-invest.com and is available in print to any shareholder who requests it. In addition to applying these guidelines, the Board will consider all relevant facts and circumstances in making an independent determination.
All members of the Audit Committee and Nominating and Corporate Governance Committee must be independent directors. Members of the Audit Committee must also satisfy additional independence requirements, which provide (i) that they may not accept, directly or indirectly, any consulting, advisory, or compensatory fee from TCI or any of its subsidiaries other than their Director’s compensation (other than in their capacity as a member of the Audit Committee, the Board of Directors, or any other committee of the Board), and (ii) no member of the Audit Committee may be an “affiliated person” of TCI or any of its subsidiaries, as defined by the Securities and Exchange Commission.
The current Directors of TCI are listed below, together with their ages, terms of service, all positions and offices with TCI or its former advisor, BCM or Prime, which took over as contractual advisor for BCM on July 1, 2003, their principal occupations, business experience and directorships with other companies during the last five years or more. The designation “Affiliated”, when used below with respect to a Director, means that the Director is an officer, director or employee of BCM, Prime or an officer of TCI or an officer or director of an affiliate of TCI. The designation “Independent”, when used below with respect to a Director, means that the Director is neither an officer of TCI nor a director, officer or employee of BCM or Prime, although TCI may have certain business or professional relationships with such Director as discussed in ITEM 13. “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS—Certain Business Relationships.”
TED P. STOKELY: Age 70, Director (Affiliated) (since April 1990) and Chairman of the Board (since January 1995).
General Manager (since January 1995) of ECF Senior Housing Corporation, a nonprofit corporation; General Manager (since January 1993) of Housing Assistance Foundation, Inc., a nonprofit corporation; Part-time unpaid consultant (since January 1993) and paid consultant (April 1992 to December 1992) of Eldercare Housing Foundation (“Eldercare”), a nonprofit corporation; General Manager (since April 2002) of Unified Housing Foundation, Inc., a nonprofit corporation; Director and Chairman of the Board of ARI (since November 2002); and Director (since April 1990) and Chairman of the Board (since January 1995) of IORI.
HENRY BUTLER: Age 53, Director (Affiliated) (since December 2001).
Broker—Land Sales (since 1992) of BCM; Owner/Operator (1989 to 1991) of Butler Interests, Inc.; Director (since July 2003) of ARI; and Director (December 2001 to July 2003) of IORI.
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MARTIN L. WHITE: Age 64, Director (Independent) (since January 1995).
Chief Executive Officer (since 1995) of Builders Emporium, Inc.; Chairman and Chief Executive Officer (since 1993) of North American Trading Company Ltd.; President and Chief Operating Officer (since 1992) of Community Based Developers, Inc.; and Director (January 1995 to March 2004) of IORI.
TED R. MUNSELLE: Age 48, Director (Independent) (since February 2004).
Vice President and Chief Financial Officer of Landmark Nurseries, Inc.; Employed in the accounting industry from 1997 until October 1998; Certified Public Accountant in the State of Texas; and Director (since February 2004) of ARI.
SHARON HUNT: Age 61, Director (Independent) (since February 2004).
Licensed Realtor in Dallas, Texas with Cook Realtors; President and Owner of Sharon’s Pretzels, Inc.; Director (since 1991) of a 501(c)(3) non-profit corporation involved in the acquisition, renovation and operation of real estate; and Director (since February 2004) of ARI.
Board Committees
The Board of Directors held 10 meetings during 2003. For such year, no incumbent Director attended fewer than 75% of the aggregate of (1) the total number of meetings held by the Board during the period for which he had been a Director and (2) the total number of meetings held by all committees of the Board on which he served during the period that he served.
The Board of Directors has standing Audit, Compensation and Governance and Nominating Committees. The Audit Committee was formed on February 19, 2003, and its function is to review TCI’s operating and accounting procedures. A Charter of the Audit Committee has also been adopted by the Board. The current members of the Audit Committee, all of whom are independent within the meaning of the SEC Regulations, the listing standards of the New York Stock Exchange, Inc. and TCI’s Corporate Governance Guidelines, are Messrs. White and Munselle and Ms. Hunt. Mr. Ted R. Munselle, a member of the Committee is qualified as an Audit Committee financial expert within the meaning of SEC Regulations, and the Board has determined that he has accounting and related financial management expertise within the meaning of the listing standards of the New York Stock Exchange, Inc. The predecessor Audit Committee met nine times during 2003.
The Governance and Nominating Committee is responsible for developing and implementing policies and practices relating to corporate governance, including reviewing and monitoring implementation of TCI’s Corporate Governance Guidelines. In addition, the Committee develops and reviews background information on candidates for the Board and makes recommendations to the Board regarding such candidates. The Committee also prepares and supervises the Board’s annual review of director independence and the Board’s performance self-evaluation. The Charter of the Governance and Nominating Committee was adopted on March 22, 2004. The members of the Committee are Messrs. Munselle (Chairman) and White and Ms. Hunt.
The Board has also formed a Compensation Committee of the Board of Directors, adopted a Charter for the Compensation Committee on March 22, 2004, and selected Ms. Hunt (Chairman) and Messrs. Munselle and White as the members of such Committee.
The members of the Board of Directors on the date of this Report and the Committees of the Board on which they serve are identified below:
Governance and
Nominating Committee
Ted P. Stokley
Ted R. Munselle
Sharon Hunt
Martin L. White
Henry A. Butler
During February 2004, the Board adopted its Corporate Governance Guidelines. The Guidelines adopted by the Board meet or exceed the new listing standards adopted during the year by the New York Stock Exchange, Inc. Pursuant to the Guidelines, the Board undertook its annual review of director independence, and during this review, the Board considered transactions and relationships between each director or any member of his or her immediate family and TCI and its subsidiaries and affiliates, including those reported under Certain Relationships and Related Transactions below. The Board also examined transactions and
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relationship between directors or their affiliates and members of TCI’s senior management or their affiliates. As provided in the Guidelines, the purpose of such review was to determine whether such relationships or transactions were inconsistent with the determination that the director is independent.
Executive Officers
The following persons currently serve as executive officers of TCI: Mark Branigan, Executive Vice President—Residential; Louis J. Corna Executive Vice President—Tax and General Counsel; and Ronald E. Kimbrough, Executive Vice President and Chief Financial Officer. Their positions with TCI are not subject to a vote of stockholders. Their ages, terms of service, all positions and offices with TCI or Prime, other principal occupations, business experience and directorships with other companies during the last five years or more are set forth below.
MARK W. BRANIGAN: Age 49, Executive Vice President—Residential (since June 2001), Executive Vice President and Chief Financial Officer (August 2000 to June 2001), Vice President—Director of Construction (August 1999 to August 2000) and Executive Vice President—Residential Asset Management (January 1992 to October 1997).
Executive Vice President—Residential (since July 2003) of Prime and Prime Income Asset Management, Inc. (“PIAMI”); Executive Vice President—Residential (since June 2001), Executive Vice President and Chief Financial Officer (August 2000 to June 2001), Vice President—Director of Construction (August 1999 to August 2000) and Executive Vice President—Residential Management (January 1992 to October 1997) of BCM, American Realty Trust, Inc. (“ART”) and IORI; Executive Vice President and Chief Financial Officer (August 2000 to June 2001) and Director (September 2000 to June 2001) of ARI; and real estate consultant (November 1997 to July 1999).
LOUIS J. CORNA: Age 56, Executive Vice President—General Counsel (since February 2004); Secretary (since February 2004); Executive Vice President—Tax (since October 2001), Executive Vice President and Chief Financial Officer (June 2001 to October 2001), and Senior Vice President—Tax (December 2001 to June 2001).
Executive Vice President—Residential (since July 2003) of Prime and PIAMI; Executive Vice President—General Counsel (since February 2004), Secretary (since February 2004), Executive Vice President—Residential (since June 2001), Executive Vice President and Chief Financial Officer (June 2001 to October 2001), and Senior Vice President—Tax (December 2000 to June 2001) of BCM, ARI and IORI; Private Attorney (January 2000 to December 2000); Vice President—Taxes and Assistant Treasurer (March 1998 to January 2000) of IMC Global, Inc.; and Vice President—Taxes (July 1991 to February 1998) of Whitman Corporation.
RONALD E. KIMBROUGH: Age 51, Acting Principal Executive Officer, Executive Vice President and Chief Financial Officer (since January 2002).
Acting Principal Executive Officer, Executive Vice President and Chief Financial Officer (since July 2003) of Prime and PIAMI; Acting Principal Executive Officer, Executive Vice President and Chief Financial Officer (since January 2002) of BCM, ARI and IORI; Controller (from September 2000 to January 2002) of BCM; Vice President and Treasurer (from January 1998 to September 2000) of Syntek West, Inc. and One Realco Corporation; and Consultant (1997).
Officers
Although not an executive officer, Robert A. Waldman at December 31, 2003 served as Senior Vice President, Secretary and General Counsel. His position with TCI was not subject to a vote of stockholders. His age, term of service, all positions and offices with TCI, Prime or BCM, other principal occupations, business experience and directorships with other companies during the last five years or more is set forth below. On February 5, 2004, Mr. Waldman resigned from the company.
ROBERT A. WALDMAN: Age 51, (Resigned on February 5, 2004) Senior Vice President and General Counsel (since July 2003) of Prime and PIAMI; Senior Vice President and General Counsel (since January 1995), Vice President (December 1990 to January 1995) and Secretary (December 1993 to February 1997 and since June 1999).
Senior Vice President and General Counsel (since January 1995), Vice President (December 1990 to January 1995) and Secretary (December 1993 to February 1997 and since June 1999) of IORI; Senior Vice President, Secretary and General Counsel (since August 2000) of ARI; Senior Vice President and General Counsel (since January 1995), Vice President (January 1993 to January 1995) and Secretary (since December 1989) of ART; and Senior Vice President and General Counsel (since November 1994), Vice President and Corporate Counsel (November 1989 to November 1994), and Secretary (since November 1989) of BCM.
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In addition to the foregoing officers, TCI has several vice presidents and assistant secretaries who are not listed herein.
Code of Ethics
TCI has adopted a code of ethics entitled “Code of Business Conduct and Ethics” that applies to all directors, officers, and employees (including those of the contractual Advisor to TCI). In addition, TCI has adopted a code of ethics entitled “Code of Ethics for Senior Financial Officers” that applies to the principal executive officer, president, principal financial officer, chief financial officer, principal accounting officer, and controller.
The text of these documents has been posted on TCI’s internet website at http://www.transconrealty-invest.com and are available in print to any shareholder who requests them.
Compliance with Section 16(a) of the Securities Exchange Act of 1934
Under the securities laws of the United States, the Directors, executive officers, and any persons holding more than ten percent of TCI’s shares of Common Stock are required to report their share ownership and any changes in that ownership to the Securities and Exchange Commission (the “Commission”). Specific due dates for these reports have been established and TCI is required to report any failure to file by these dates during 2003. All of these filing requirements were satisfied by TCI’s Directors and executive officers and ten percent holders. In making these statements, TCI has relied on the written representations of its incumbent Directors and executive officers and its ten percent holders and copies of the reports that they have filed with the Commission.
The Advisor
Although the Board of Directors is directly responsible for managing the affairs of TCI and for setting the policies which guide it, TCI’s day-to-day operations are performed by Prime under the supervision of the Board. The duties of Prime include, among other things, locating, investigating, evaluating and recommending real estate and mortgage note investment and sales opportunities as well as financing and refinancing sources. Prime also serves as a consultant to the Board in connection with the business plan and investment decisions made by the Board.
BCM served as TCI’s advisor from March 1989 to June 30, 2003. Effective July 1, 2003, BCM was replaced as contractual advisor to TCI by PAMI under the same terms as BCM’s advisory agreement. PIAMI is owned by Realty Advisors (79%) and Syntek West, Inc. (21%), related parties. Syntek West, Inc. is owned by Gene Phillips. Effective August 18, 2003, PAMI changed its name to Prime Income Asset Management, Inc., (“PIAMI”). On October 1, 2003, Prime, which is owned 100% by PIAMI, replaced PIAMI as the advisor to TCI. The duties of Prime include, among other things, locating, investigating, evaluating and recommending real estate and mortgage note investment and sales opportunities, as well as financing and refinancing sources. Prime also serves as a consultant in connection with TCI’s business plan and investment decisions made by the Board.
Prime is a company of which Messrs. Branigan, Corna, and Kimbrough serve as executive officers. Prime is indirectly owned by a trust for the children of Gene E. Phillips. Mr. Phillips is not an officer or director of Prime, but serves as a representative of the trust, is involved in daily consultation with the officers of Prime and has significant influence over the conduct of Primes’s business, including the rendering of advisory services and the making of investment decisions for itself and for TCI.
Under the Advisory Agreement, Prime is required to annually formulate and submit, for Board approval, a budget and business plan containing a twelve-month forecast of operations and cash flow, a general plan for asset sales and purchases, lending, foreclosure and borrowing activity, and other investments, and Prime is required to report quarterly to the Board on TCI’s performance against the business plan. In addition, all transactions require prior Board approval, unless they are explicitly provided for in the approved business plan or are made pursuant to authority expressly delegated to Prime by the Board.
The Advisory Agreement also requires prior Board approval for the retention of all consultants and third party professionals, other than legal counsel. The Advisory Agreement provides that Prime shall be deemed to be in a fiduciary relationship to the stockholders; contains a broad standard governing Prime’s liability for losses by TCI; and contains guidelines for Prime’s allocation of investment opportunities as among itself, TCI and other entities it advises.
The Advisory Agreement provides for Prime to be responsible for the day-to-day operations of TCI and to receive an advisory fee comprised of a gross asset fee of .0625% per month (.75% per annum) of the average of the gross asset value (total assets less allowance for amortization, depreciation or depletion and valuation reserves) and an annual net income fee equal to 7.5% of TCI’s net income.
The Advisory Agreement also provides for Prime to receive an annual incentive sales fee equal to 10% of the amount, if any, by which the aggregate sales consideration for all real estate sold by TCI during such fiscal year exceeds the sum of: (1) the cost of each
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such property as originally recorded in TCI’s books for tax purposes (without deduction for depreciation, amortization or reserve for losses), (2) capital improvements made to such assets during the period owned, and (3) all closing costs, (including real estate commissions) incurred in the sale of such real estate; provided, however, no incentive fee shall be paid unless (a) such real estate sold in such fiscal year, in the aggregate, has produced an 8% simple annual return on the net investment including capital improvements, calculated over the holding period before depreciation and inclusive of operating income and sales consideration and (b) the aggregate net operating income from all real estate owned for each of the prior and current fiscal years shall be at least 5% higher in the current fiscal year than in the prior fiscal year.
Additionally, pursuant to the Advisory Agreement Prime or an affiliate of Prime is to receive an acquisition commission for supervising the acquisition, purchase or long-term lease of real estate equal to the lesser of (1) up to 1% of the cost of acquisition, inclusive of commissions, if any, paid to nonaffiliated brokers or (2) the compensation customarily charged in arm’s-length transactions by others rendering similar property acquisition services as an ongoing public activity in the same geographical location and for comparable property, provided that the aggregate purchase price of each property (including acquisition fees and real estate brokerage commissions) may not exceed such property’s appraised value at acquisition.
The Advisory Agreement requires Prime or any affiliate of Prime to pay to TCI, one-half of any compensation received from third parties with respect to the origination, placement or brokerage of any loan made by TCI; provided, however, that the compensation retained by Prime or any affiliate of Prime shall not exceed the lesser of (1) 2% of the amount of the loan commitment or (2) a loan brokerage and commitment fee which is reasonable and fair under the circumstances.
The Advisory Agreement also provides that Prime or an affiliate of Prime is to receive a mortgage or loan acquisition fee with respect to the acquisition or purchase of any existing mortgage loan by TCI equal to the lesser of (1) 1% of the amount of the loan purchased or (2) a brokerage or commitment fee which is reasonable and fair under the circumstances. Such fee will not be paid in connection with the origination or funding of any mortgage loan by TCI.
Under the Advisory Agreement, Prime or an affiliate of Prime also is to receive a mortgage brokerage and equity refinancing fee for obtaining loans or refinancing on properties equal to the lesser of (1) 1% of the amount of the loan or the amount refinanced or (2) a brokerage or refinancing fee which is reasonable and fair under the circumstances; provided, however, that no such fee shall be paid on loans from Prime or an affiliate of Prime without the approval of TCI’s Board of Directors. No fee shall be paid on loan extensions.
Under the Advisory Agreement, Prime receives reimbursement of certain expenses incurred by it in the performance of advisory services.
Under the Advisory Agreement, all or a portion of the annual advisory fee must be refunded by the Advisor if the Operating Expenses of TCI (as defined in the Advisory Agreement) exceed certain limits specified in the Advisory Agreement based on the book value, net asset value and net income of TCI during the fiscal year. BCM, as advisor at the time, was required to refund $1.4 million of the 2002 advisory fee under this provision.
Additionally, if management were to request that Prime render services to TCI other than those required by the Advisory Agreement, Prime or an affiliate of Prime separately would be compensated for such additional services on terms to be agreed upon from time to time. As discussed below, under “Property Management”, TCI has hired Triad Realty Services, Ltd. (“Triad”), an affiliate of BCM, to provide property management services for TCI’s properties. Also as discussed below, under “Real Estate Brokerage” TCI had engaged, on a non-exclusive basis, Regis Realty, Inc. (“Regis”), a related party, to perform brokerage services for TCI until December 2002. Beginning January 1, 2003, Regis Realty I LLC performs brokerage services for TCI.
Prime may assign the Advisory Agreement only with the prior consent of TCI.
The directors and principal officers of Prime are set forth below.
Mickey N. Phillips:
Ryan T. Phillips:
Mark W. Branigan:
Louis J. Corna:
Ronald E. Kimbrough:
Dan S. Allred:
Mickey N. Phillips is Gene E. Phillips’ brother and Ryan T. Phillips is Gene E. Phillips’ son. Gene E. Phillips serves as a representative of the trust established for the benefit of his children, which indirectly owns Prime and, in such capacity, has substantial contact with the management of Prime and input with respect to its performance of advisory services to TCI.
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Property Management
Since February 1, 1990, affiliates of BCM have provided property management services to TCI. Currently, Triad provides such property management services. Triad subcontracts with other entities for the provision of property-level management services to TCI. The general partner of Triad is BCM. The limited partner of Triad is Highland Realty Services, Inc. (“Highland”), a related party. Triad subcontracted the property-level management and leasing of 39 of TCI’s commercial properties to Regis which was a company owned by Highland, until December 2002. Regis was entitled to receive property and construction management fees and leasing commissions in accordance with the terms of its property-level management agreement with Triad, until December 2002. Regis also was entitled to receive real estate brokerage commissions in accordance with the terms of a non-exclusive brokerage agreement. Since January 1, 2003, Regis Realty I, LLC (“Regis I”), provided these services. Regis I is owned by Highland. Regis Hotel Corporation, a related party, managed TCI’s five hotels, until December 2002. Since January 1, 2003, Regis Hotel I, LLC, managed TCI’s five hotels. The sole member of Regis I and Regis Hotel I, LLC is Highland.
Real Estate Brokerage
Regis also provided real estate brokerage services to TCI (on a non-exclusive basis), until December 2002. Regis was entitled to receive a real estate commission for property purchases and sales in accordance with the following sliding scale of total fees to be paid: (1) maximum fee of 4.5% on the first $2.0 million of any purchase or sale transaction of which no more than 3.5% would be paid to Regis or affiliates; (2) maximum fee of 3.5% on transaction amounts between $2.0 million-$5.0 million of which no more than 3% would be paid to Regis or affiliates; (3) maximum fee of 2.5% on transaction amounts between $5.0 million-$10.0 million of which no more than 2% would be paid to Regis or affiliates; and (4) maximum fee of 2% on transaction amounts in excess of $10.0 million of which no more than 1.5% would be paid to Regis or affiliates. Beginning January 1, 2003, Regis I provides these services. The sole member of Regis I is Highland.
ITEM 11. EXECUTIVE COMPENSATION
TCI has no employees, payroll or benefit plans and pays no compensation to its executive officers. The executive officers of TCI, who are also officers or employees of Prime, TCI’s advisor, are compensated by Prime. Such executive officers perform a variety of services for Prime and the amount of their compensation is determined solely by Prime. Prime does not allocate the cash compensation of its officers among the various entities for which it serves as advisor. See ITEM 10. “DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT—The Advisor” for a more detailed discussion of the compensation payable to Prime.
The only remuneration paid by TCI is to the Directors who are not officers or directors of Prime or its affiliated companies. The Independent Directors (1) review the business plan of TCI to determine that it is in the best interest of stockholders, (2) review the advisory contract, (3) supervise the performance of the advisor and review the reasonableness of the compensation paid to the advisor in terms of the nature and quality of services performed, (4) review the reasonableness of the total fees and expenses of TCI and (5) select, when necessary, a qualified independent real estate appraiser to appraise properties acquired.
Each Independent Director receives compensation in the amount of $30,000 per year, plus reimbursement for expenses. The Chairman of the Board receives an additional fee of $3,000 per year. In addition, each Independent Director receives an additional fee of $1,000 per day for any special services rendered by him to TCI outside of his ordinary duties as Director, plus reimbursement of expenses.
During 2003, $91,113 was paid to the Independent Directors in total Directors’ fees for all services, including the annual fee for service during the period January 1, 2003 through December 31, 2003, and 2003 special service fees as follows: Earl D. Cecil, $32,255; Ted P. Stokely, $37,103; and Martin L. White, $32,250.
Director’s Stock Option Plan
TCI has established a Director’s Stock Option Plan (“Director’s Plan”) for the purpose of attracting and retaining Directors who are not officers or employees of TCI or BCM. The Director’s Plan provides for the grant of options that are exercisable at fair market value of TCI’s Common Stock on the date of grant. The Director’s Plan was approved by stockholders at their annual meeting on October 10, 2000, following which each then-serving Independent Director was granted options to purchase 5,000 shares of Common Stock of TCI. On January 1 of each year, each Independent Director receives options to purchase 5,000 shares of Common Stock. The options are immediately exercisable and expire on the earlier of the first anniversary of the date on which a Director ceases to be a Director or 10 years from the date of grant.
As of March 1, 2004, TCI had 140,000 shares of Common Stock reserved for issuance under the Director’s Stock Option Plan of which 30,000 options were outstanding.
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Performance Graph
The following performance graph compares the cumulative total stockholder return on TCI’s shares of Common Stock with the Dow Jones US Total Market Index (“DJ Total Market Index”) and the Dow Jones Real Estate Investment Index (“DJ Real Estate Index”). The comparison assumes that $100 was invested on December 31, 1998, in TCI’s shares of Common Stock and in each of the indices and further assumes the reinvestment of all distributions. Past performance is not necessarily an indicator of future performance.
COMPARISON OF FIVE YEARS CUMULATIVE TOTAL RETURN
TCI
DJ Real Estate Index
DJ Total U.S. Market Index
Securities Authorized for Issuance Under Equity Compensation Plans
The following table provides information as of December 31, 2003 regarding compensation plans (including individual compensation arrangements) under which equity securities of TCI are authorized for issuance.
Plan Category
Number of Securities to
be Issued Upon Exercise
of Outstanding Options,Warrants and Rights
(a)
Weighted-Average
Exercise Price of
Outstanding Options,
Warrants and Rights
(b)
Number of Securities
Remaining Available for
Future Issuance Under Equity
Compensation Plans
(Excluding Securities
Reflected in Column (a))
(c)
2000 Stock Option Plan approved by stockholders
Directors Stock Option Plan approved by stockholders
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Security Ownership of Certain Beneficial Owners
The following table sets forth the ownership of TCI’s Common Stock, both beneficially and of record, both individually and in the aggregate, for those persons or entities known to be beneficial owners of more than 5% of the outstanding shares of Common Stock as of the close of business on March 19, 2004.
Name and Address of Beneficial Owner
Amount and
Nature
of Beneficial
Ownership
Approximate
Percent of
Class(1)
EQK Holdings, Inc.(2)
1800 Valley View Lane
Suite 300
Dallas, Texas 75234
Transcontinental Realty Acquisition Corporation (3)
Suite 100
Security Ownership of Management. The following table sets forth the ownership of TCI’s Common Stock, both beneficially and of record, both individually and in the aggregate, for the Directors and executive officers of TCI as of the close of business on March 19, 2004.
Name of Beneficial Owner
Nature of
Beneficial
Mark W. Branigan
Louis J. Corna
Ronald E. Kimbrough
Ted P. Stokely
Ted Munselle
All Directors and Executive Officers as a group (9 individuals)
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Certain Business Relationships
In February 1989, the Board of Directors voted to retain BCM as TCI’s advisor. See ITEM 10. “DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR TO THE REGISTRANT—The Advisor.” Effective July 1, 2004, Prime replaced BCM as the contractual advisor to TCI. Prime is indirectly owned by a trust for the children of Gene E. Phillips. Mr. Phillips is not an officer or director of Prime, but serves as a representative of the trust, is involved in daily consultation with the officers of Prime and has significant influence over the conduct of Prime’s business, including the rendering of advisory services and the making of investment decisions for itself and for TCI.
Since February 1, 1991, affiliates of BCM have provided property management services to TCI. Currently, Triad provides such property management services. The general partner of Triad is BCM. The limited partner of Triad is Highland, a related party. Triad subcontracted the property-level management and leasing of 39 of TCI’s commercial properties, and its five hotels to Regis, a related party, which is a company owned by Highland, until December 2002. Since January 1, 2003, Regis I provided this service.
Regis also provided real estate brokerage services for TCI, on a non-exclusive basis, and receives brokerage commissions in accordance with the brokerage agreement, until December 2002. Since January 1, 2003, Regis I provided this service.
Two of TCI’s Directors also serve as directors of IORI. The Directors owe fiduciary duties to IORI as well as to TCI under applicable law. At December 31, 2003, TCI owned approximately 24.0% of the outstanding common shares of IORI. Prime also serves as advisor to ARI. Messrs. Stokely, White, Munselle and Hunt serve also as Directors of ARI and Messrs. Stokley and White serve also as Directors of IORI. Messrs. Branigan, Corna, and Kimbrough serve as executive officers of ARI.
Historically, TCI has engaged in and may continue to engage in business transactions, including real estate partnerships, with related parties. Management believes that all of the related party transactions represented the best investments available at the time and were at least as advantageous to TCI as could have been obtained from unrelated third parties.
In the year ended December 31, 2003, TCI received $175,000 in rent from BCM for BCM’s lease at Addison Hanger. BCM owns a corporate jet that is housed at the hanger and TCI has available space at the hanger.
In March 2002, TCI paid cash of $600,000 and received from ARI two parcels of land, a 24.5 acre tract of Rasor land, a 16.89 acre tract of Lakeshore Villas land, and the 45,623 sq. ft. Oaktree Village Shopping Center in exchange for the 80,278 sq. ft. Plaza on Bachman Creek Shopping Center. The exchange value prices for the shopping centers were determined based on a cap rate of 10.5% and the value for the Rasor and Lakeshore Villas land was determined on appraised rates of $3.36 and $1.29, respectively, per square foot. The business purpose of the transaction was for TCI to construct apartments on the Rasor and Lakeshore Villas land and to give ample value for the property TCI exchanged, the Oaktree Shopping Center was added to the transaction. See NOTE 2. “REAL ESTATE.”
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In October 2002, a short term working capital loan to BCM for a total of $4.0 million was assumed by TCI. The loan is secured on the Red Cross land, requires quarterly payments and was due in October 2002. This loan was extended to and paid in full in September 2003. See NOTE 7. “NOTES AND INTEREST PAYABLE.”
In December 2002, TCI purchased the NLP/CH, Ltd. partnership, which owns the Centura land parcel, from ARI. See NOTE 2. “REAL ESTATE.” The purchase price was determined based on an appraised rate of $34.89 per share foot. The business purpose of the transaction was for TCI to construct apartments on the land.
As more fully described in ITEM 2. “PROPERTIES-Real Estate,” TCI is a partner with IORI in Nakash Income Associates. TCI owns 345,728 shares of IORI’s Common Stock, an approximate 24.0% interest. At December 31, 2003, the market value of the IORI common shares was $5.3 million.
At December 31, 2003, TCI owned 746,972 shares of ARI common stock which were primarily purchased in open market transactions in 1990 and 1991 at a total cost of $1.6 million. The officers of TCI also serve as officers of ARI. BCM also serves as advisor to ARI and at March 19, 2004, ARI owned approximately 64.5% of TCI’s outstanding Common Stock. At December 31, 2003, the market value of the ARI common shares owned by TCI was $6.8 million.
In February 2002, a short term working capital loan to BCM for a total of $2.5 million was assumed by TCI. The loan is secured by the Stone Oak Apartments in San Antonio, Texas, requires all principal and interest due and payable on April 28, 2003. TCI sold Stone Oak Apartments in July 2003 and paid the principal and accrued interest in full.
In 2003, TCI paid BCM and Prime, its affiliates and related parties $6.2 million in advisory, incentive and net income fees, $845,000 in mortgage brokerage and equity refinancing fees, $117,000 in property acquisition fees, $1.5 million in real estate brokerage commissions, $4.1 million in construction supervision fees and $2.1 million in property and construction management fees and leasing commissions, net of property management fees paid to subcontractors, other than affiliates of BCM or Prime. In addition, as provided in the Advisory Agreement, BCM and Prime received cost reimbursements of $1.6 million.
In addition, from time-to-time, TCI and its affiliates have made advances to each other, which generally have not had specific repayment terms and have been reflected in TCI’s financial statements as other assets or other liabilities. At December 31, 2003, TCI had receivables of $3.1 million, $1.7 million and $608,000 from Prime, GS Realty, and ARI, respectively. Also at December 31, 2003, TCI owed $706,000 and $260,000 to GS Realty and IORI, respectively.
Restrictions on Related Party Transactions
Article FOURTEENTH of TCI’s Articles of Incorporation provides that TCI shall not, directly or indirectly, contract or engage in any transaction with (1) any director, officer or employee of TCI, (2) any director, officer or employee of the advisor, (3) the advisor or (4) any affiliate or associate (as such terms are defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended) of any of the aforementioned persons, unless (a) the material facts as to the relationship among or financial interest of the relevant individuals or persons and as to the contract or transaction are disclosed to or are known by the Board of Directors or the appropriate committee thereof and (b) the Board of Directors or committee thereof determines that such contract or transaction is fair to TCI and simultaneously authorizes or ratifies such contract or transaction by the affirmative vote of a majority of independent directors of TCI entitled to vote thereon. Article FOURTEENTH defines an “Independent Director” as one who is neither an officer or employee of TCI nor a director, officer or employee of TCI’s advisor.
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The following table sets for the aggregate fees for professional services rendered to or for TCI by BDO Seidman, LLP for 2003 and 2002:
Type of Fee
Audit Fees
Audit Related Fees
Tax Fees
All Other Fees
The audit fees for 2003 and 2002, respectively, were for professional services rendered for the audits and reviews of the consolidated financial statements of TCI. Tax fees for 2003 and 2002, respectively, were for services related to federal and state tax compliance and advice. Other fees for 2002 were primarily for 8K reviews and filings and assistance related to a tender offer of TCI and IORI by ARI.
The audit committee has established policies and procedures for the approval and pre-approval of audit services and permitted non-audit services. The Audit Committee has the responsibility to engage and terminate TCI’s independent auditors, to pre-approve their performance of audit services and permitted non-audit services, to approve all audit and non-audit fees, and to set guidelines for permitted non-audit services and fees. All fees for 2003 and 2002 were pre-approved by the Audit Committee or were within the pre-approved guidelines for permitted non-audit services and fees established by the Audit Committee, and there were no instances of waiver of approved requirements or guidelines during the same periods.
Under the Sarbanes-Oxley Act of 2002 (the “SO Act”), and the rules of the Securities and Exchange Commission (the “SEC”), the Audit Committee of the Board of Directors is responsible for the appointment, compensation and oversight of the work of the independent auditor. The purpose of the provisions of the SO Act and the SEC rules for the Audit Committee role in retaining the independent auditor is two-fold. First, the authority and responsibility for the appointment, compensation and oversight of the auditors should be with directors who are independent of management. Second, any non-audit work performed by the auditors should be reviewed and approved by these same independent directors to ensure that any non-audit services performed by the auditor do not impair the independence of the independent auditor. To implement the provisions of the SO Act, the SEC issued rules specifying the types of services that an independent may not provide to its audit client, and governing the Audit Committee’s administration of the engagement of the independent auditor. As part of this responsibility, the Audit Committee is required to preapprove the audit and non-audit services performed by the independent auditor in order to assure that they do not impair the auditor’s independence. Accordingly, the Audit Committee has adopted a preapproval policy of audit and non-audit services (the “Policy”), which sets forth the procedures and conditions pursuant to which services to be performed by the independent auditor are to be preapproved. Consistent with the SEC rules establishing two different approaches to preapproving non-prohibited services, the Policy of the Audit Committee covers Preapproval of audit services, audit-related services, international administration tax services, non-U.S. income tax compliance services, pension and benefit plan consulting and compliance services, and U.S. tax compliance and planning. At the beginning of each fiscal year, the Audit Committee will evaluate other known potential engagements of the independent auditor, including the scope of work proposed to be performed and the proposed fees, and the approval and rejection of each service, taking into account whether services are permissible under applicable law and the possible impact of each non-audit service on the independent auditor’s independence from management. Typically, in addition to the generally preapproved services, other services would include due diligence for an acquisition that may or may not have been known at the beginning of the year. The Audit Committee has also delegated to any member of the Audit Committee designated by the Board or the financial expert member of the Audit Committee responsibilities to preapprove services to be performed by the independent auditor not exceeding $25,000 in value or cost per engagement of audit and non-audit services, and such authority may only be exercised when the Audit Committee is not in session.
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PART IV
All other schedules are omitted because they are not applicable or because the required information is shown in the Consolidated Financial Statements or the Notes thereto.
Consolidated Financial Statements of Income Opportunity Realty Investors, Inc. (incorporated by reference to Item 8 of Income Opportunity Realty Investors, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2003).
Consolidated Financial Statements of American Realty Investors, Inc. (incorporated by reference to Item 8 of American Realty Investors, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2003).
Current Report on Form 8-K for event occurring on October 1, 2003 (dated October 14, 2003) reporting under Item 5 “Other Events and Regulation FD Disclosure.
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The following documents are filed as Exhibits to this Report:
Exhibit
Description of Exhibit
Certificate of Amendment to the Articles of Incorporation of Transcontinental Realty Investors, Inc.,
(incorporated by reference to the Registrant’s Current Report on Form 8-K, dated June 3, 1996).
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: March 30, 2004
By:
/s/ RONALD E. KIMBROUGH
Executive Vice President and
Chief Financial Officer
(Principal Financial and Accounting Officer
and Acting Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.
Signature
Title
/s/ TED P. STOKELY
Chairman of the Board and Director
/s/ HENRY A. BUTLER
Director
/s/ MARTIN L. WHITE
/s/ TED R. MUNSELLE
/s/ SHARONHUNT
Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer and Acting Principal Executive Officer)
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EXHIBIT INDEX
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