UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED SEPTEMBER 30, 2001 ------------------ Commission File Number 1-9240 ------ TRANSCONTINENTAL REALTY INVESTORS, INC. -------------------------------------------------------- (Exact Name of Registrant as Specified in Its Charter) Nevada 94-6565852 - --------------------------------- -------------------------------- (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 1800 Valley View Lane, Suite 300, Dallas, Texas 75234 - -------------------------------------------------------------------------------- (Address of Principal Executive Office) (Zip Code) (469) 522-4200 ------------------------------ (Registrant's Telephone Number, Including Area Code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X . No . --- --- APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of Common Stock, as of the latest practicable date. Common Stock, $.01 par value 8,042,629 - ---------------------------- --------------------------------- (Class) (Outstanding at October 31, 2001) 1
PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS - ----------------------------- The accompanying Consolidated Financial Statements have not been audited by independent certified public accountants, but in the opinion of the management of Transcontinental Realty Investors, Inc. ("TCI"), all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of TCI's consolidated financial position, consolidated results of operations and consolidated cash flows at the dates and for the periods indicated, have been included. TRANSCONTINENTAL REALTY INVESTORS, INC. CONSOLIDATED BALANCE SHEETS <TABLE> <CAPTION> September 30, December 31, 2001 2000 -------- -------- (dollars in thousands) <S> <C> <C> Assets Real estate held for investment............................ $693,082 $727,227 Less - accumulated depreciation............................ (88,511) (88,187) -------- -------- 604,571 639,040 Foreclosed real estate held for sale....................... 504 1,824 Notes and interest receivable.............................. 14,339 8,709 Less--allowance for estimated losses....................... (537) (537) -------- -------- 13,802 8,172 Investment in real estate entities......................... 23,520 15,464 Cash and cash equivalents.................................. 35,320 22,323 Other assets (including $4,193 in 2001 and $10,243 in 2000 from affiliates and related parties)................. 31,072 45,062 -------- -------- $708,789 $731,885 ======== ======== </TABLE> The accompanying notes are an integral part of these Consolidated Financial Statements. 2
TRANSCONTINENTAL REALTY INVESTORS, INC. CONSOLIDATED BALANCE SHEETS - Continued <TABLE> <CAPTION> September 30, December 31, 2001 2000 -------- -------- (dollars in thousands) <S> <C> <C> Liabilities and Stockholders' Equity Liabilities Notes and interest payable..................................... $460,275 $501,734 Other liabilities (including $2,628 in 2001 and $491 in 2000 to affiliates and related parties)....................... 25,978 23,722 -------- -------- 486,253 525,456 Commitments and contingencies Minority interest.............................................. 4,225 4,369 Redeemable Preferred Stock Series B; $.01 par value; authorized, 300,000 shares; issued and outstanding 300,000 shares (liquidation preference $1,500).............................. 1,350 1,350 Embedded derivative............................................ 150 150 Stockholders' equity Preferred Stock Series A; $.01 par value; authorized, 6,000 shares; issued and outstanding 5,829 shares (liquidation preference $583)........................ -- -- Common Stock, $.01 par value; authorized, 10,000,000 shares; issued and outstanding 8,042,629 shares in 2001 and 8,636,354 in 2000......................................... 80 86 Paid-in capital................................................ 268,761 278,245 Accumulated distributions in excess of accumulated earnings...................................................... (48,971) (74,712) Unrealized (loss) on marketable equity securities of affiliates.................................................... (3,059) (3,059) -------- -------- 216,811 200,560 -------- -------- $708,789 $731,885 ======== ======== </TABLE> The accompanying notes are an integral part of these Consolidated Financial Statements. 3
TRANSCONTINENTAL REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS <TABLE> <CAPTION> For the Three Months For the Nine Months Ended September 30, Ended September 30, ----------------------------------------------- 2001 2000 2001 2000 ---------- ---------- ---------- ---------- (dollars in thousands, except per share) <S> <C> <C> <C> <C> Property revenue Rents............................... $ 32,423 $ 35,164 $ 103,464 $ 103,855 Property expense Property operations (including $1,910 in 2001 and $2,896 in 2000 to affiliates and related parties)......................... 19,643 19,896 60,084 56,659 ---------- ---------- ---------- ---------- Operating income................. 12,780 15,268 43,380 47,196 Other income Interest and other.................. 1,017 936 2,275 1,928 Equity (loss) of equity investees... (2,164) (185) (4,529) (477) Gain on sale of real estate......... 18,780 11,755 47,529 29,562 ---------- ---------- ---------- ---------- 17,633 12,506 45,275 31,013 Other expense Interest............................ 9,428 12,254 31,380 35,405 Depreciation........................ 4,737 5,397 14,786 14,865 Advisory fee to affiliate........... 1,267 1,353 4,208 3,915 Net income fee to affiliate......... 946 567 2,075 1,319 Incentive fee to affiliate.......... 1,326 -- 2,903 -- General and administrative (including $2,064 in 2001 and $1,595 in 2000 to affiliates and related parties)............... 1,607 1,325 7,531 5,713 Minority interest................... (14) (13) 9 (30) ---------- ---------- ---------- ---------- 19,297 20,883 62,892 61,187 Net income............................ 11,116 6,891 25,763 17,022 Preferred dividend requirement........ (7) (7) (22) (22) ---------- ---------- ---------- ---------- Net income applicable to Common shares.............................. $ 11,109 $ 6,884 $ 25,741 $ 17,000 ========== ========== ========== ========== Earnings per share Net income applicable to Common shares Basic............................. $ 1.29 $ .80 $ 2.98 $ 1.97 Diluted........................... $ 1.28 $ .80 $ 2.97 $ 1.97 ========== ========== ========== ========== Average Common shares used in computing earnings per share Basic............................. 8,603,614 8,633,211 8,625,230 8,630,029 Diluted........................... 8,653,614 8,633,211 8,675,230 8,630,029 ========== ========== ========== ========== </TABLE> The accompanying notes are an integral part of these Consolidated Financial Statements. 4
TRANSCONTINENTAL REALTY INVESTORS, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY <TABLE> <CAPTION> Accumulated Common Stock Distributions Accumulated ----------------- in Excess of Other Paid-in Accumulated Comprehensive Stockholders' Shares Amount Capital Earnings Income Equity --------- ------ ---------- ------------- ------------- ------------- (dollars in thousands, except per share) <S> <C> <C> <C> <C> <C> <C> Balance, January 1, 2001 8,636,354 $86 $278,245 (74,712) (3,059) $200,560 Net income................... -- -- -- 25,763 -- 25,763 Fractional shares............. (525) -- -- -- -- -- Repurchase of Common Stock.... (593,200) (6) (9,484) -- -- (9,490) Preferred dividends ($3.75 per share)............ -- -- -- (22) -- (22) --------- ------ --------- ---------- ------------- -------- Balance, September 30, 2001... 8,042,629 $80 $268,761 (48,971) (3,059) $216,811 ========= ====== ========= ========== ============= ======== </TABLE> The accompanying notes are an integral part of these Consolidated Financial Statements. 5
TRANSCONTINENTAL REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS <TABLE> <CAPTION> For the Nine Months Ended September 30, ---------------------- 2001 2000 -------- -------- (dollars in thousands) <S> <C> <C> Cash Flows from Operating Activities Rents collected.................................................. $103,804 $102,445 Interest collected................................................. 1,142 594 Interest paid...................................................... (30,659) (33,798) Payments for property operations (including $1,910 in 2001 and $2,896 in 2000 to affiliates and related parties)....................................................... (59,420) (58,081) Advisory and net income fee paid to affiliate.................... (6,191) (5,741) Incentive fee paid to affiliate.................................... (1,577) -- General and administrative expenses paid (including $2,064 in 2001 and $1,595 in 2000 to affiliates and related parties)............................................... (7,746) (6,486) Distributions from operating cash flow of equity investees...................................................... 1,134 236 Other............................................................ 2,571 1,917 -------- -------- Net cash provided by operating activities.................. 3,058 1,086 Cash Flows from Investing Activities Collections on notes receivable (including $6.5 million from affiliate in 2000).................................... 2,546 15,017 Funding of notes receivable (including $12.0 million to affiliate in 2000)...................................... (7,980) (12,000) Acquisition of real estate (including $1,470 in 2001 and $1,800 in 2000 to affiliates and related parties)................................................... (8,969) (30,531) Real estate improvements....................................... (9,504) (9,986) Proceeds from sale of real estate.................................. 88,160 33,528 Refunds of (deposits on) pending purchases and financings................................................. (1,078) 1,840 Contributions (to)/from equity investees....................... (8,218) 1,296 -------- -------- Net cash provided by (used in) investing activities........ 54,957 (836) Cash Flows from Financing Activities Payments on notes payable...................................... (55,614) (89,156) Proceeds from notes payable........................................ 7,696 67,981 Deferred financing costs (including $45 in 2001 and $339 in 2000 to affiliates and related parties)............ (430) (914) Payments from advisor.......................................... 12,786 5,465 (Advance to)/from affiliate........................................ 56 (3,300) Dividends to stockholders.......................................... (22) (4,683) Repurchase of Common Stock......................................... (9,490) -- Sale of Common Stock under dividend reinvestment plan.............. -- 90 -------- -------- Net cash used in financing activities...................... (45,018) (24,517) Net increase (decrease) in cash and cash equivalents............... 12,997 (24,267) Cash and cash equivalents, beginning of period..................... 22,323 41,266 -------- -------- Cash and cash equivalents, end of period........................... $ 35,320 $ 16,999 ======== ======== </TABLE> The accompanying notes are an integral part of these Consolidated Financial Statements. 6
TRANSCONTINENTAL REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS - Continued <TABLE> <CAPTION> For the Nine Months Ended September 30, ---------------------- 2001 2000 --------- --------- (dollars in thousands) <S> <C> <C> Reconciliation of net income to net cash used in operating activities Net income................................................... $ 25,763 $ 17,022 Adjustments to reconcile net income to net cash used in operating activities Depreciation and amortization............................ 14,786 14,865 Gain on sale of real estate.............................. (47,529) (29,562) Equity loss of equity investees.......................... 4,529 477 Distributions from operating cash flow of equity investees............................................ 1,134 236 Increase in interest receivable.......................... (197) (403) Decrease in other assets................................. 2,161 1,311 Increase (decrease) in interest payable.................. 155 (482) Increase (decrease) in other liabilities................. 2,256 (2,378) -------- -------- Net cash provided by operating activities................ $ 3,058 $ 1,086 ======== ======== Schedule of noncash investing and financing activities Notes payable assumed on purchase of real estate............. $ 40,776 $ 50,294 Notes payable assumed by buyer on sale of real estate........ (34,161) (16,798) Unrealized loss on marketable equity securities of affiliate................................................ -- (1,256) Limited partnership interest received on sale of real estate...................................... 1,500 -- </TABLE> The accompanying notes are an integral part of these Consolidated Financial Statements. 7
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. BASIS OF PRESENTATION - ------------------------------ TCI is a Nevada corporation and successor to a California business trust which was organized on September 6, 1983. TCI invests in real estate through direct ownership, leases and partnerships. TCI also invests in mortgage loans on real estate. The accompanying Consolidated Financial Statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. Dollar amounts in tables are in thousands, except per share amounts. Operating results for the nine month period ended September 30, 2001, are not necessarily indicative of the results that may be expected for the year ending December 31, 2001. For further information, refer to the Consolidated Financial Statements and notes included in TCI's Annual Report on Form 10-K for the year ended December 31, 2000 (the "2000 Form 10-K"). Certain balances for 2000 have been reclassified to conform to the 2001 presentation. NOTE 2. REAL ESTATE - ---------------------- In 2001, TCI purchased the following properties: <TABLE> <CAPTION> Units/ Purchase Net Cash Debt Interest Maturity Property Location Acres/Sq.Ft. Price Paid Incurred Rate Date - -------------------- ------------------ ------------ ---------- -------- ------------- ------------ -------- <S> <C> <C> <C> <C> <C> <C> <C> Second Quarter Apartments Courtyard Midland, TX 133 Units $ 1,425 $ 425 $ 1,051 /(1)/ 9.25% 04/06 Land Solco-Valley Ranch Dallas, TX 6.07 Acres 1,454 1,525 -- -- -- Limestone Ranch Lewisville, TX 10.5 Acres 505/(2)/ -- -- -- -- Mira Lago Farmers Branch, TX 8.88 Acres 541/(2)/ -- -- -- -- Third Quarter Apartments By the Sea Corpus Christi, TX 153 Units 6,175 862 5,538 /(3)/ 7.07 05/09 Baywalk Galveston, TX 192 Units 6,590 390 5,856 /(4)/ 7.45 02/11 Island Bay Galveston, TX 458 Units 20,360 3,225 16,232 /(4)/ 7.40 07/11 Marina Landing Galveston, TX 256 Units 12,050 518 10,912 /(4)/ 5.30/(5)/ 01/02 Land Seminary West Fort Worth, TX 5.36 Acres 222 232 -- -- -- Fourth Quarter Land Pac Trust Farmers Branch, TX 7.11 Acres 1,175 1,231 -- -- -- - --------------- </TABLE> 8
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 2. REAL ESTATE (Continued) - -------------------- (1) Assumed debt. (2) Land was received from a related party in exchange for the Glenwood Apartments. (3) Assumed debt of $5.4 million and financed the remaining $100,000 from the seller. (4) The Island Bay, Marina Landing and Baywalk Apartments were purchased in a single transaction. TCI assumed the existing debt of $31.3 million on the apartments, financed the remaining $1.7 million from the seller, and issued 30,000 shares of Series C Preferred Stock. See NOTE 7. "PREFERRED STOCK." (5) Variable rate. In the nine months ended September 30, 2000, TCI purchased the following properties: <TABLE> <CAPTION> Units/ Purchase Net Cash Debt Interest Maturity Property Location Acres/Sq.Ft. Price Paid Incurred Rate Date - --------------------- ------------------ -------------- -------- -------- -------- ----------- ----------- <S> <C> <C> <C> <C> <C> <C> <C> First Quarter Apartments Quail Creek Lawrence, KS 95 Units $ 3,250 $1,088 $ 2,254 7.44% 07/03 Apple Lane Lawrence, KS 75 Units 1,575 595 1,005 8.63 05/07 Land Netzer Collin County, TX 20 Acres 400 418 -- -- -- Lamar/Parmer Austin, TX 17.07 Acres 1,500 517 1,030 10.00 12/00/(1)/ Manhattan Farmers Branch, TX 108.9 Acres 10,743 6,144 5,000 14.00 02/01/(2)/ DF Fund Collin County, TX 79.5 Acres 2,545 1,047 1,545 10.00 03/01/(3)/ Second Quarter Apartments Autumn Chase Midland, TX 64 Units 1,338 458 936 9.45/(4)/ 04/05 Primrose Bakersfield, CA 162 Units 4,100 1,189 3,000 9.25/(4)/ 03/07 Paramount Terrace Amarillo, TX 181 Units 3,250 561 2,865 9.38 09/01 Office Building 9033 Wilshire Blvd Los Angeles, CA 44,253 Sq.Ft. 9,225 2,536 6,861 8.07 08/09 Bay Plaza II Tampa, FL 78,882 Sq.Ft. 4,825 4,786 -- -- -- Land Limestone Canyon II Austin, TX 9.96 Acres 504 424 -- -- -- Third Quarter Office Center and Retail Countryside Portfolio/(5)/ Sterling, VA 265,718 Sq.Ft. 44,940 4,825 36,297 7.75 12/02 </TABLE> - --------------- (1) The loan was paid off in March 2001. (2) The loan was paid off in June 2000. (3) The property was sold in September 2000. (4) Variable interest rate. (5) Countryside Portfolio consists of four commercial buildings: the 133,422 sq. ft. Countryside Retail Center, the 72,062 sq. ft. Harmon Office Building, the 35,127 sq. ft. Mimado Office Building and the 25,107 sq. ft. Ambulatory Surgical Center. 9
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 2. REAL ESTATE (Continued) - -------------------- In 2001, TCI sold the following properties: <TABLE> <CAPTION> Units/Sq.Ft./ Sales Net Cash Debt Gain/(Loss) Property Location Acres Price Received Discharged on Sale - ---------------------- ------------------ -------------- ------------ -------- ------------- ------------ <S> <C> <C> <C> <C> <C> <C> First Quarter Apartments Forest Ridge Denton, TX 56 Units $ 2,000 $ 682 $ 1,151 $ 1,014 Heritage Tulsa, OK 136 Units 2,286 206 1,948 1,575 Park at Colonade San Antonio, TX 211 Units 5,800 927 4,066 1,592 Industrial Warehouse Zodiac Dallas, TX 35,435 Sq.Ft. 762 183 564 167 Land McKinney 36 McKinney, TX 1.822 Acres 476 476 -- 355 Round Mountain Austin, TX 110.0 Acres 2,560 2,455 -- 1,047 Second Quarter Apartments Bent Tree Gardens Addison, TX 204 Units 9,000 2,669 6,065/(2)/ 601 Fontenelle Hills Bellevue, NE 338 Units 16,500 3,680 12,454/(2)/ 4,565 Glenwood Addison, TX 168 Units 3,659/(1)/ -- 2,537/(2)/ -- McCallum Glen Dallas, TX 275 Units 8,450 2,633 5,004/(2)/ 1,375/(3)/ Office Buildings Daley San Diego, CA 64,425 Sq.Ft. 6,211 2,412 3,346 836 Waterstreet Boulder, CO 106,257 Sq.Ft. 22,250 7,126 12,949 9,154 Industrial Warehouse Technology Trading Sterling, VA 197,659 Sq.Ft. 10,775 4,120 6,214 4,163 Land Moss Creek Greensboro, NC 4.79 Acres 15 13 -- (71) Third Quarter Apartments McCallum Crossing Dallas, TX 322 Units 11,500 1,841 8,101/(2)/ 4,485 Park Lane Dallas, TX 97 Units 2,750 1,526 1,103 1,827 Carseka Los Angeles, CA 54 Units 4,000 2,138 1,466 1,352 Sunset Lakes Waukegan, IL 414 Units 15,000 6,089 7,243 7,316 Oak Run Pasadena, TX 160 Units 5,800 1,203 4,364 2,227 Office Buildings Chesapeake Center San Diego, CA 57,493 Sq.Ft. 6,575 3,111 2,844 204 Land Eagle Crest Farmers Branch, TX 4.41 Acres 300 291 -- (215) - -------------- </TABLE> (1) The Glenwood Apartments were exchanged with a related party for two parcels of land; the 10.5 acre Limestone Ranch and the 8.88 acre Mira Lago. (2) Debt assumed by purchaser. (3) Excludes a $1.5 million deferred gain from a limited partnership interest in the sold property. 10
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 2. REAL ESTATE (Continued) - -------------------- In the nine months ended September 30, 2000, TCI sold the following properties: <TABLE> <CAPTION> Units/ Sales Net Cash Debt Gain on Property Location Rooms/Sq.Ft. Price Received Discharged Sale - ----------------------- ---------------- ------------- ------- -------- ------------- ------- <S> <C> <C> <C> <C> <C> <C> First Quarter Apartments Hunters Bend San Antonio, TX 96 Units $ 1,683 $ 418 $ 1,127/(1)/ $ 572 Westgate of Laurel Laurel, MD 218 Units 11,290 2,599 7,525/(1)/ 3,575 Second Quarter Apartments Apple Creek Dallas, TX 216 Units 4,300 2,155 1,723 3,240 Villas at Fairpark Los Angeles, CA 49 Units 3,435 792 2,386 1,188 Hotel Chateau Charles Lake Charles, LA 245 Rooms 1,000 928 -- 633 Third Quarter Apartments Villas at Countryside Sterling, VA 102 Units 8,100 2,686 5,334/(1)/ 1,520 Eagle Rock Los Angeles, CA 99 Units 5,600 1,967 3,246 1,021 Woodbridge Denver, CO 194 Units 6,856 3,328 2,845 3,796 Ashley Crest Houston, TX 168 Units 3,950 1,102 2,812/(1)/ 706 Office Building/Warehouse Brookfield Corporate Center Chantilly, VA 63,504 Sq.Ft. 4,850 1,729 2,838 1,369 Shady Trail Dallas, TX 42,900 Sq.Ft. 900 340 521 206 Land McKinney /(2)/ McKinney, TX 255 Acres 8,783 5,035 4,423 2,091 Allen /(3)/ Allen, TX 5.49 Acres 370 86 281 184 </TABLE> - ------------- (1) Debt assumed by purchaser. (2) The McKinney land sale included three parcels of land: the 20 acre Netzer land; the 79.54 acre DF Fund land; and the 156.19 acre OPUBCO land. (3) The Allen land consisted of a partial sale of three parcels of land: a 2.62 acre tract of the Stacy Road land; a 2.23 acre tract of the Sandison land; and a .64 acre tract of the Whisenant land. Construction Projects. In August 2001, TCI obtained a financing commitment of $13.0 million and commenced construction of a 252 unit apartment complex on the Limestone Ranch land parcel in Lewisville, Texas. The mortgage bears interest at a variable rate, currently 4.7% per annum, requires monthly payments of interest only and matures December 2003. The development is expected to cost $16.3 million and is expected to be completed by May 2002. As of October 2001, $3.3 million has been funded. In July 2001, TCI commenced construction of an 80 unit apartment complex on the Watersedge land parcel in Gulfport, Mississippi. The development 11
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 2. REAL ESTATE (Continued) - -------------------- is expected to cost a total of $5.0 million and is expected to be completed by April 2002. As of October 2001, TCI has paid a total of $640,000. NOTE 3. NOTES AND INTEREST RECEIVABLE - -------------------------------------- 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 bears interest at 16.0% per annum, requires 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 June 2001, a mortgage loan with a principal balance of $2.5 million was paid off including accrued but unpaid interest. 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 matures January 2002. In August 2001, TCI agreed to fund up to $5.6 million secured by 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 matures in January 2003. As of October 2001, TCI has funded a total of $1.3 million. In September 2001, a mortgage loan in the amount of $3.0 million matured. TCI agreed to extend the loan until November 2001 accepting a $750,000 loan principal paydown. 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 bears interest at 9.0% per annum, requires monthly interest only payments of $30,000 and matures in February 2002. NOTE 4. INVESTMENT IN REAL ESTATE ENTITIES - ------------------------------------------- In February 2001, TCI entered into a joint venture with UBM Liegenschaftsverwertung GmbH ("UBM"), an Austrian limited liability company, to invest in the construction and ownership of a 165 room hotel in Wroclaw, Poland. UBM invested 2.0 million Euro dollars ($1.8 million) and TCI invested 4.0 million Euro dollars ($3.6 million) and guaranteed a 16 million Euro dollars ($15.0 million) mortgage loan for the project. TCI holds a 66.7% interest. Construction for the project began in the fall of 2000 and completion of the hotel is scheduled for December 2001. 12
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 4. INVESTMENT IN REAL ESTATE ENTITIES (Continued) - ------------------------------------------- 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 of $500,000 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 and receipt of the distribution in July, TCI recognized a previously deferred gain on the sale of the apartments of $540,000. In June 2001, in conjunction with the sale of the 275 unit McCallum Glen Apartments in Dallas, Texas, TCI received a 30% limited partner interest in the acquiring partnership. TCI is to receive payments of $12,500 monthly from the partnership and its remaining investment of $1.5 million in June 2003. In July 2001, TCI entered into a partnership to construct a 392 lot, single family subdivision in Tarrant County, Texas. TCI will invest $4.4 million cash in the partnership and the partnership shall obtain a $7.0 million mortgage loan for the project. TCI will hold a 24% interest. As of October 2001, TCI has invested $3.3 million in the partnership. In October 2001, TCI entered into a partnership agreement to construct a 248 unit apartment complex in Arlington, Texas, with Capstone American Properties. TCI will invest $2.1 million cash in the partnership and the partnership shall obtain a $13.5 million mortgage loan for the project. TCI will hold a 24% interest. As of October 2001, TCI has invested $1.7 million in the partnership. Prior to the first quarter of 2001, TCI accounted for its investment in American Realty Investors, Inc. ("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. NOTE 5. INVESTMENTS IN EQUITY INVESTEES - ---------------------------------------- Real estate entities. TCI's investment in real estate entities at September 30, 2001, included equity securities of two publicly traded real estate entities, Income Opportunity Realty Investors, Inc. ("IORI") and ARI, and interests in real estate joint venture partnerships. Basic Capital Management, Inc. ("BCM"), TCI's advisor, serves as advisor to IORI and ARI. TCI accounts for its investment in IORI and ARI and the joint venture partnerships using the equity method. 13
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 5. INVESTMENTS IN EQUITY INVESTEES (Continued) - ---------------------------------------- TCI's investment in real estate entities, accounted for using the equity method, at September 30, 2001 was as follows: <TABLE> <CAPTION> Percentage Carrying Equivalent of TCI's Value of Investee Market Value Ownership at Investment at Book Value at of Investment at Investee September 30, 2001 September 30, 2001 September 30, 2001 September 30, 2001 - -------- ------------------- ------------------ ------------------ ------------------ <S> <C> <C> <C> <C> IORI....... 24.0% $ 3,648 $ 8,564 $ 4,494 ARI........ 6.3% 10,132 5,149 8,276 ------- ------- ------- 13,780 $13,713 $12,770 ======= ======= Other...... 9,740 ------- $23,520 ======= </TABLE> The difference between the carrying value of TCI's investment and the equivalent investee book value is being amortized over the life of the properties held by each investee. Management continues to believe that the market value of each of IORI and ARI undervalues their assets and, therefore, TCI may continue to increase its ownership in these entities. Set forth below is summarized results of operations of equity investees for the nine months ended September 30, 2001 <TABLE> <S> <C> Revenues.................................... $136,366 Equity in income of partnerships............ 9,184 Property operating expenses................. 126,118 Depreciation................................ 14,103 Interest expense............................ 60,698 -------- (Loss) before gains on sale of real estate.. (55,369) Gain on sale of real estate................. 62,860 -------- Net income.................................. $ 7,491 ======== </TABLE> TCI's share of equity investees' loss before gains on the sale of real estate was $4.5 million for the nine months ended September 30, 2001, and its share of equity investees' gains on sale of real estate was $4.0 million for the nine months ended September 30, 2001. NOTE 6. NOTES AND INTEREST PAYABLE - ----------------------------------- In 2001, TCI financed the following property: <TABLE> <CAPTION> Debt Debt Net Cash Interest Maturity Property Location Acres Incurred Discharged Received Rate Date - ---------------- ---------- ---------- -------- ---------- -------- ---------- -------- <S> <C> <C> <C> <C> <C> <C> <C> Second Quarter Land Red Cross Dallas, TX 2.89 Acres $4,500 $ -- $4,328 12.5%/(1)/ 10/02 </TABLE> - ------------------ (1) Variable rate. 14
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 6. NOTES AND INTEREST PAYABLE (Continued) - ----------------------------------- In the first nine months of 2000, TCI financed/refinanced the following properties: <TABLE> <CAPTION> Debt Debt Net Cash Interest Maturity Property Location Units/Sq.Ft. Incurred Discharged Received Rate Date - ------------------------- --------------- -------------- -------- ---------- -------- ---------- -------- <S> <C> <C> <C> <C> <C> <C> <C> First Quarter Apartments Crescent Place Houston, TX 120 Units $2,165 $1,722 $ 370 7.04%/(1)/ 03/30 Madison @ Bear Creek Houston, TX 180 Units 3,500 2,625 730 7.04/(1)/ 03/30 Office Buildings Westgrove Air Plaza Addison, TX 78,326 Sq.Ft. 2,087 1,180 742 9.02/(1)/ 01/05 Venture Center Atlanta, GA 38,772 Sq.Ft. 2,700 1,113 1,592 8.75 03/10 Second Quarter Apartments Country Crossing Tampa, FL 227 Units 3,825 2,645 985 9.65/(1)/ 06/03 Fontenelle Hills /(2)/ Bellevue, NE 338 Units 2,010 -- 1,967 8.51 06/10 Office Building Technology Trading Sterling, VA 197,659 Sq.Ft. 6,300 3,881 2,065 8.26/(1)/ 05/05 Warehouses 5360 Tulane Atlanta, GA 67,850 Sq.Ft. 375 208 134 9.65/(1)/ 04/03 Space Center San Antonio, TX 101,500 Sq.Ft. 1,125 691 402 9.65/(1)/ 04/03 Third Quarter Office Building Jefferson Washington, DC 71,876 Sq.Ft. 9,875 8,955 557 9.50 07/25 </TABLE> - ------------------ (1) Variable interest rate. (2) Second lien on property. NOTE 7. PREFERRED STOCK - ------------------------ In conjunction with the purchase of the Baywalk, Island Bay and Marina Landing Apartments, TCI issued 30,000 share 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 rate of $5.00 per share or $1.25 per quarter through September 2002, then $6.00 per share or $1.50 per quarter through September 2003, then $7.00 per share 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. NOTE 8. OPERATING SEGMENTS - --------------------------- Significant differences among the accounting policies of the operating segments as compared to the Consolidated Financial Statements principally involve the calculation and allocation of administrative 15
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 8. OPERATING SEGMENTS (Continued) - --------------------------- expenses. Management evaluates the performance of each of the operating segments and allocates resources to each based on its operating income and cash flow. Items of income not reflected in the segments are interest, equity in partnerships and gains on sales of real estate which totaled $17.6 million and $45.3 million for the three and nine months ended September 30, 2001, and $12.5 million and $31.0 million for the three and nine months ended September 30, 2000. Expenses not reflected in the segments are general and administrative expenses, minority interest, incentive fees, advisory fees, and net income fees which totaled $5.1 million and $16.7 million for the three and nine months ended September 30, 2001, and $3.2 million and $10.9 million for the three and nine months ended September 30, 2000. Also excluded from segment assets are assets of $100.8 million at September 30, 2001, and $83.5 million at September 30, 2000, which are not identifiable with an operating segment. There are no intersegment revenues and expenses. Presented below is the operating income of each operating segment for the three and nine months ended September 30, 2001 and 2000, and each segment's assets at September 30. <TABLE> <CAPTION> Three Months Ended Commercial September 30, 2001 Land Properties Apartments Hotels Total - ----------------------------- ------- ---------- ---------- ------- -------- <S> <C> <C> <C> <C> <C> Rents........................ $ 141 $ 17,097 $ 13,440 $ 1,745 $ 32,423 Property operating expenses.. 355 9,469 8,636 1,183 19,643 ------- -------- -------- ------- -------- Operating income............. $ (214) $ 7,628 $ 4,804 $ 562 $ 12,780 ======= ======== ======== ======= ======== Depreciation................. $ -- $ 3,126 $ 1,313 $ 298 $ 4,737 Interest..................... 516 5,049 3,562 301 9,428 Real estate improvements..... 239 2,632 2,932 26 5,829 Assets....................... 60,902 312,100 212,729 19,342 605,073 <CAPTION> Commercial Property Sales: Land Properties Apartments Total ------- ---------- ---------- --------- <S> <C> <C> <C> <C> Sales price.................. $ 300 $ 6,575 $ 39,050 $ 45,925 Cost of sales................ (515) (6,371) (21,843) (28,729) ------- -------- -------- -------- Gain on sale................. (215) $ 204 $ 17,207 $ 17,196/(1)/ ======= ======== ======== ======== </TABLE> - ---------------------- (1) Excludes TCI's share of gains on sale of real estate recognized by an equity investee of $1.0 million and a previously deferred gain on the sale of the Park at Colonnade Apartments of $540,000. <TABLE> <CAPTION> Nine Months Ended Commercial September 30, 2001 Land Properties Apartments Hotels Total - ----------------------------- ------- ---------- ---------- ------- --------- <S> <C> <C> <C> <C> <C> Rents........................ $ 465 $ 52,701 $ 45,274 $ 5,024 $103,464 Property operating expenses.. 920 28,621 27,011 3,532 60,084 ------- -------- -------- ------- -------- Operating income............. $ (455) $ 24,080 $ 18,263 $ 1,492 $ 43,380 ======= ======== ======== ======= ======== Depreciation................. $ -- $ 9,666 $ 4,289 $ 831 $ 14,786 Interest..................... 1,345 16,877 12,159 999 31,380 Real estate improvements..... 1,332 4,917 3,013 242 9,504 Assets....................... 60,902 312,100 212,729 19,342 605,073 <CAPTION> Commercial Property Sales: Land Properties Apartments Total ------- ---------- ------------ ---------- <S> <C> <C> <C> <C> Sales price.................. $ 3,351 $ 46,573 $ 86,745 $ 136,669 Cost of sales................ (2,235) (32,049) (58,816) (93,100) ------- -------- -------- ---------- Gain on sale................. $ 1,116 $ 14,524 $ 27,929 $ 43,569/(1)/ ======= ======== ======== ========== </TABLE> 16
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 8. OPERATING SEGMENTS (Continued) - --------------------------- - ----------- (1) Excludes TCI's share of gains on sale of real estate recognized by an equity investee of $4.0 million. <TABLE> <CAPTION> Three Months Ended Commercial September 30, 2000 Land Properties Apartments Hotels Total - ----------------------------- ------- ---------- ---------- ------- -------- <S> <C> <C> <C> <C> <C> Rents........................ $ 194 $ 15,136 $ 19,178 $ 656 $ 35,164 Property operating expenses.. 194 8,133 11,562 7 19,896 ------- -------- -------- ------- -------- Operating income............. $ -- $ 7,003 $ 7,616 $ 649 $ 15,268 ======= ======== ======== ======= ======== Depreciation................. $ -- $ 2,819 $ 2,328 $ 250 $ 5,397 Interest..................... 837 5,555 5,464 398 12,254 Real estate improvements..... 94 3,358 172 113 3,737 Assets....................... 57,879 329,676 245,486 19,504 652,545 </TABLE> <TABLE> <CAPTION> Commercial Property Sales: Land Properties Apartments Total ------- ---------- ---------- --------- <S> <C> <C> <C> <C> Sales price.................. $ 9,153 $ 5,750 $ 24,506 $ 39,409 Cost of sales................ (6,878) (4,175) (17,463) (28,516) ------- ------- -------- --------- Gain on sale................. $ 2,275 $ 1,575 $ 7,043 $ 10,893/(1)/ ======= ======= ======== ========= </TABLE> - ------------------------- (1) Excludes TCI's share of gains recognized by an equity affiliate of $862,000. <TABLE> <CAPTION> Nine Months Ended Commercial September 30, 2000 Land Properties Apartments Hotels Total - ----------------------------- ------- ---------- ---------- ------- --------- <S> <C> <C> <C> <C> <C> Rents........................ $ 532 $ 44,534 $ 57,137 $ 1,652 $103,855 Property operating expenses.. 468 22,690 33,356 145 56,659 ------- -------- -------- ------- -------- Segment operating income..... $ 64 $ 21,844 $ 23,781 $ 1,507 $ 47,196 ======= ======== ======== ======= ======== Depreciation................. $ -- $ 7,895 $ 6,226 $ 744 $ 14,865 Interest..................... 2,812 15,410 16,012 1,171 35,405 Real estate improvements..... 84 7,768 1,270 864 9,986 Assets....................... 57,879 329,676 245,486 19,504 652,545 </TABLE> <TABLE> <CAPTION> Commercial Property Sales: Land Properties Apartments Hotels Total ------- ---------- ---------- ------- -------- <S> <C> <C> <C> <C> <C> Sales price.................. $ 9,153 $ 5,750 $ 45,214 $ 1,000 $ 61,117 Cost of sales................ (6,878) (4,175) (29,596) (367) (41,016) ------- ------- -------- ------- -------- Gain on sale................. $ 2,275 $ 1,575 $ 15,618 $ 633 $ 20,101/(1)/ ======= ======= ======== ======= ======== - -------------------- </TABLE> (1) Excludes a $4.8 million previously deferred gain on the sale of land and TCI's share of gains recognized by an equity affiliate of $4.6 million. NOTE 9. COMMITMENTS AND CONTINGENCIES - -------------------------------------- Liquidity. Although management anticipates that TCI will generate excess cash from operations in 2001, due to increased rental rates and occupancy 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. 17
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 9. COMMITMENTS AND CONTINGENCIES (Continued) - -------------------------------------- Commitments. In January 2001, TCI exercised its option under the loan documents to extend the maturity date of three loans with a principal balance of $30.6 million secured by three office buildings in New Orleans, Louisiana. The lender has disputed TCI's right to extend the loans. This dispute is subject to litigation pending in the United States District Court for the Eastern District of Louisiana. Litigation. TCI is involved in various lawsuits arising in the ordinary course of business. Except for the Olive Litigation (see PART II. OTHER INFORMATION, ITEM 1. "LEGAL PROCEEDINGS), 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. NOTE 10. INCOME TAXES - --------------------- Financial statement income varies from taxable income principally due to the accounting for income and losses of investees, gains and losses from asset sales, depreciation on owned properties, amortization of discounts on notes receivable and payable and the difference in the allowance for estimated losses. TCI had a loss for federal income tax purposes (after utilization of operating loss carryforwards) in the three and nine months ended September 30, 2001 and 2000; therefore, it recorded no provision for income taxes. ------------------------- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ----------------------------------------------------------------------- RESULTS OF OPERATIONS --------------------- Introduction - ------------ TCI invests in real estate through acquisitions, leases and partnerships. TCI also invests in mortgage loans. TCI is the successor to a business trust organized on September 6, 1983, and commenced operations on January 31, 1984. Liquidity and Capital Resources - ------------------------------- Cash and cash equivalents totaled $35.3 million at September 30, 2001, compared with $22.3 million at December 31, 2000. TCI's principal sources of cash have been and will continue to be from property operations, proceeds from property sales, the collection of mortgage notes receivable and borrowings. Management anticipates that TCI's cash on hand, as well as cash generated from property operations, the sale of properties and the refinancing of certain of TCI's mortgage debt will be sufficient to meet TCI's cash requirements, including debt service obligations and expenditures for property maintenance and improvements. 18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ----------------------------------------------------------------------- RESULTS OF OPERATIONS (Continued) --------------------- Liquidity and Capital Resources (Continued) - ------------------------------- Net cash provided by operating activities was $3.1 million for the nine months ended September 30, 2001, compared to $1.1 million for the nine months ended September 30, 2000. The primary factors affecting TCI's cash from operations are discussed in the following paragraphs. Cash from property operations (rents collected less payments for expenses applicable to rental income) of $44.4 million in the nine months ended September 30, 2001, approximated the $44.4 million in 2000. Interest collected increased to $1.1 million in the nine months ended September 30, 2001, from $594,000 in 2000. The increase was primarily due to TCI funding two loans in the fourth quarter of 2000 and three loans funded in 2001. Interest paid decreased to $30.7 million in the nine months ended September 30, 2001, from $33.8 million in the nine months ended September 30, 2000. Of the decreases, $5.1 million was from the sale of 33 properties in 2001 and 2000 subject to debt, and $1.2 million was from loan payoffs and principal paydowns in 2001 and 2000. These decreases were offset by increases of $3.2 million from the purchase of 20 properties in 2001 and 2000 subject to debt. Advisory, incentive and net income fees paid increased to $7.8 million in the nine months ended September 30, 2001, from $5.7 million in the nine months ended September 30, 2000. The increase was primarily due to an increase in incentive fees of $1.6 million. The incentive fee is equal to 10% of the amount by which the aggregate sales consideration for all TCI's properties sold during the year exceeds the total cost of the property plus a simple 8% annual return to TCI's net investment in such property. General and administrative expenses paid increased to $7.7 million in the nine months ended September 30, 2001, from $6.5 million in the nine months ended September 30, 2000. This increase was mainly due to an increase in legal fees and consulting fees. In the first nine months of 2001, TCI sold 12 apartments, two warehouses, three office buildings and four parcels of unimproved land for a total of $136.7 million, receiving net cash of $43.8 million after the payoff of existing debt and the payment of various closing costs. The purchasers assumed $34.2 million in mortgage debt. Also in the first nine months of 2001, TCI financed a parcel of unimproved land for $4.5 million, receiving $4.3 million in cash after the payment of various closing costs. Further in the first nine months of 2001, TCI purchased five apartments and four parcels of unimproved land for a total of $49.3 million, paying $7.1 million in cash, including various closing costs, and assumed existing mortgage debt of $37.8 million. 19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ----------------------------------------------------------------------- RESULTS OF OPERATIONS (Continued) --------------------- Liquidity and Capital Resources (Continued) - ------------------------------- In the fourth quarter of 2001, TCI purchased one parcel of unimproved land for $1.2 million in cash. In September 2001, the Board of Directors approved a private block purchase of 593,200 shares of Common Stock for a total of $9.5 million. 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 mortgage note receivable review includes an evaluation of the collateral property securing each note. The property review generally includes: (1) selective property inspections; (2) a review of the property's current rents compared to market rents; (3) a review of the property's expenses; (4) a review of maintenance requirements; (5) a review of the property's cash flow; (6) discussions with the manager of the property; and (7) a review of properties in the surrounding area. Recent Accounting Pronouncements - -------------------------------- In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long Lived Assets." SFAS No. 144 requires that those long-lived assets be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations. Therefore discontinued operations will no longer be measured at net realizable value or include amounts for operating losses that have not yet occurred. SFAS No. 144 is effective for financial statements issued for fiscal years beginning after December 15, 2001, and, generally, is to be applied prospectively. Results of Operations - --------------------- TCI had net income of $11.1 million and $25.7 million in the three and nine months ended September 30, 2001, including gains on sale of real estate totaling $18.8 million and $47.5 million, compared to net income of $6.9 million and $17.0 million in the corresponding periods in 2000, including gains on sale of real estate totaling $11.8 million and $29.6 million. Fluctuations in this and other components of revenues and expense between the 2001 and 2000 periods are discussed below. Rents in the three months ended September 30, 2001, decreased to $32.4 million compared to $35.2 million in 2000. Of this decrease, $6.1 million was due to the sale of 26 apartments in 2001 and 2000 and $1.3 million was due to the sale of six commercial properties in 2001 and 2000. These decreases were offset by increases of $308,000 due to the purchase of 11 apartments in 2001 and 2000 and $2.5 million was due to 20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ----------------------------------------------------------------------- RESULTS OF OPERATIONS (Continued) --------------------- Results of Operations (Continued) - --------------------- the purchase of seven commercial properties in 2001 and 2000. Decreases in rents of $53,000 also was due to decreased parking revenues for TCI's land properties. Rental rates and occupancies increased by $63,000 for TCI's apartments and by $752,000 for TCI's commercial properties. In 2000, TCI leased its four hotels to Regis Hotel Corporation, an affiliate of Basic Capital Management, Inc., at an annual base rent totaling $503,477 per year plus 30% of the hotel's gross revenues. Beginning January 1, 2001, TCI no longer leased the hotels and recognized revenues based on the operations of the hotels. From this change, rents increased at TCI's hotels by $1.1 million. Rents in the nine months ended September 30, 2001, decreased to $103.5 million compared to $103.9 million in 2000. Of this decrease, $14.6 million was due to the sale of 26 apartments in 2001 and 2000 and $1.8 million was due to the sale of six commercial properties in 2001 and 2000. Decreases in rents of $67,000 also were due to decreased parking revenues for TCI's land properties. These decreases were offset by increases of $1.1 million due to the purchase of 11 apartments in 2001 and 2000 and $7.8 million was due to the purchase of seven commercial properties in 2001 and 2000. Rental rates and occupancies increased by $1.7 million for TCI's apartments, $2.2 million for TCI's commercial properties and $3.4 million at TCI's hotels. Rents for the remaining quarter of 2001, are expected to decrease as TCI selectively sells properties. Property operations expense decreased in the three months ended September 30, 2001, to $19.6 million from $19.9 million compared to the corresponding period in 2000. Of this decrease, $3.3 million was due to the sale of 26 apartments in 2001 and 2000 and $585,000 was due to the sale of six commercial properties. These decreases were offset by increases of $255,000 due to the purchase of 11 apartments in 2001 and 2000 and $1.3 million due to the purchase of seven commercial properties in 2001 and 2000. Apartment operating expenses increased by $131,000 due to increased leasing costs and utilities and an increase of $645,000 was due to increased leasing, utility and maintenance costs at TCI's commercial properties. Hotel operating expenses increased by $1.2 million and an increase of $161,000 was due to increases in maintenance and taxes for TCI's land properties. Property operations expenses increased in the nine months ended September 30, 2001, to $60.1 million from $56.7 million compared to the corresponding period in 2000. Of this increase, $931,000 was due to the purchase of 11 apartments in 2001 and 2000 and $3.8 million was due to the purchase of seven commercial properties in 2001 and 2000. An increase of $2.8 million was due to increased leasing, utility and maintenance costs at TCI's commercial properties. Hotel operating expenses increased by $3.4 million and increases of $452,000 were due to increases in maintenance and taxes for TCI's land parcels. These increases were offset by decreases of $7.1 million due to the sale of 26 apartments in 2001 and 2000 and $684,000 due to the sale of six commercial properties in 2001 and 2000. Apartment operating expenses 21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ----------------------------------------------------------------------- RESULTS OF OPERATIONS (Continued) --------------------- Results of Operations (Continued) - --------------------- decreased by $164,000 due to decreased maintenance and tax expenses. Property operating expenses for the remaining quarter of 2001 are expected to decrease as TCI selectively sells properties. Interest and other income increased to $1.0 million and $2.3 million in the three and nine months ended September 30, 2001, compared to $936,000 and $1.9 million in 2000. The increase was primarily due to TCI funding two loans in the fourth quarter of 2000 and three loans in 2001. Interest income for the remaining quarter of 2001 is expected to increase from the additional loan funded in October 2001. In the three and nine months ended September 30, 2001, gains on sale of real estate totaling $18.8 million and $47.5 million were recognized. The gains included $1.6 million on the sale of the Heritage Apartments, $167,000 on the sale of Zodiac Warehouse, $355,000 on the sale of a tract of the McKinney 36 land parcel, $1.0 million on the sale of Forest Ridge Apartments, $1.6 million on the sale of Park at Colonade Apartments, $1.0 million on the sale of a tract of the Round Mountain land parcel, $4.6 million on the sale of Fontenelle Apartments, $601,000 on the sale of Bent Tree Gardens Apartments, $9.2 million on the sale of Waterstreet Office Building, $4.2 million on the sale of Technology Trading Center, $1.4 million on the sale of McCallum Glen Apartments, $836,000 on the sale of Daley Office Plaza, $204,000 on the sale of Chesapeake Office Center, $4.5 million on the sale of McCallum Crossing Apartments, $1.4 million on the sale of Carseka Apartments, $7.3 million on the sale of Sunset Lake Apartments, $2.2 million on the sale of Oak Run Manor Apartments, $1.8 million on the sale of Park Lane Apartments, and $4.0 million in gains on sale of real estate from an equity investee. These gains were offset by a loss of $71,000 on the Moss Creek land parcel, and a loss of $215,000 on the sale of a tract of the Eagle Crest land parcel. In the three and nine months ended September 30, 2000, gains on sale of real estate totaling $11.8 million and $29.6 million were recognized, including $572,000 on the sale of Hunters Bend Apartments, $3.6 million on the sale of Westgate of Laurel Apartments, $3.2 million on the sale of Apple Creek Apartments, $1.2 million on the sale of Villas at Fairpark Apartments, $633,000 on the sale of Chateau Charles Hotel, a $4.8 million previously deferred gain on the sale of McKinney land, TCI's share of gains recognized by an equity affiliate of $4.6 million, $1.4 million on the sale of Brookfield Corporate Center, $706,000 on the sale of Ashley Crest Apartments, $184,000 on the partial sale of Stacy Road land, $1.0 million on the sale of Eagle Rock Apartments, $206,000 on the sale of Shady Trail Warehouse, $2.1 million on the sale of the McKinney land, $3.8 million on the sale of the Woodbridge Apartments and $1.5 million on the sale of Villas at Countryside Apartments. Interest expense decreased to $9.4 million in the three months ended September 30, 2001, from $12.3 million in 2000. Of this decrease, $1.7 million was due to the sale of 26 apartments in 2001 and 2000, $592,000 was due to the sale of six commercial properties in 2001 and 2000 and 22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ----------------------------------------------------------------------- RESULTS OF OPERATIONS (Continued) --------------------- Results of Operations (Continued) - --------------------- $60,000 was due to the sale of two land parcels subject to debt in 2000. Decreases of $182,000 was due to the refinancing of six commercial properties in 2000, $26,000 was due to the refinancing of three apartments in 2000 and $409,000 was due to land loan payoffs and principal paydowns in 2001 and 2000. Of the remaining decreases, $255,000 was due to lower variable interest rates at TCI's apartments, $600,000 was due to lower variable interest rates at TCI's commercial properties, and $97,000 was due to lower variable interest rates at TCI's hotels. The decrease was offset by increases of $79,000 due to the purchase of 11 apartments in 2001 and 2000, $868,000 due to the purchase of seven commercial properties in 2001 and 2000 and $148,000 due to the financing of one land parcel in 2001. Interest expense decreased to $31.4 million in the nine months ended September 30, 2001, compared to $35.4 million in 2000. Of this decrease, $4.2 million was due to the sale of 26 apartments in 2001 and 2000, $591,000 was due to the sale of six commercial properties in 2001 and 2000, and $283,000 was due to the sale of two land parcels subject to debt in 2000. A decrease of $157,000 was due to the refinancing of six commercial properties in 2000, and an increase of $136,000 was due to the refinancing of three apartment properties in 2000, and decreases of $1.5 million were due to land loan payoffs and principal paydowns in 2001 and 2000. Of the remaining decrease, $132,000 was due to lower variable interest rates at TCI's apartments, $885,000 was due to lower variable interest rates at TCI's commercial properties and $172,000 was due to lower variable interest rates at TCI's hotels. These decreases were offset by increases of $343,000 due to the purchase of 11 apartments in 2001 and 2000, $3.1 million due to the purchase of seven commercial properties in 2001 and 2000 and $325,000 due to the refinancing of one land parcel in 2001. Interest expense for the remaining quarter of 2001 is expected to decrease as TCI selectively sells properties. Depreciation expense decreased to $4.7 million and $14.8 million in the three and nine months ended September 30, 2001, from $5.4 million and $14.9 million in 2000. Of these decreases, $985,000 and $1.9 million were due to the sale of 26 apartments in 2001 and 2000 and $243,000 and $285,000 were due to the sale of six commercial properties, and decreases of $44,000 and $105,000 were due to fully depreciated building and land improvements at TCI's apartments. These decreases were offset by increases of $14,000 and $91,000 due to the purchase of 10 apartments in 2001 and 2000 and $323,000 and $1.2 million due to the purchase of seven commercial properties in 2001 and 2000. Increases of $227,000 and $885,000 were due to building and tenant improvements at TCI's commercial properties, and increases of $48,000 and $87,000 were due improvements at TCI's hotels. Depreciation expense for the remaining quarter of 2001 is expected to decrease as TCI selectively sells properties. Advisory fee decreased to $1.3 million in the three months ended September 30, 2001, from $1.4 million in 2000 and increased to $4.2 23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ----------------------------------------------------------------------- RESULTS OF OPERATIONS (Continued) --------------------- Results of Operations (Continued) - --------------------- million in the nine months ended September 30, 2001, from $3.9 million in 2000. The three month decrease was due to a decrease in TCI's gross assets from 2000 and the nine month increase was due to an increase in TCI's gross assets, the basis for such fee. Advisory fees for the remaining quarter of 2001 are expected to decrease with decreases in TCI's gross assets. Net income fee to affiliate was $946,000 and $2.1 million in the three and nine months ended September 30, 2001, as compared to $567,000 and $1.3 million in 2000. The net income fee is payable to TCI's advisor based on 7.5% of TCI's net income. Incentive fee to affiliate was $1.3 million and $2.9 million in the three and nine months ended September 30, 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. Incentive fees are expected to increase as TCI selectively sells properties. General and administrative expenses increased to $1.6 million and $7.5 million in the three and nine months ended September 30, 2001, from $1.3 million and $5.7 million in 2000. These increases were mainly due to an increase in legal fees and other professional fees. 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 increased to $2.2 million and $4.5 million in the three and nine months ended September 30, 2001, from $185,000 and $477,000 in the three and nine months ended September 30, 2000. The losses from equity investees are primarily attributed to increased operating losses for IORI and TCI's accounting for its investment in ARI. Tax Matters - ----------- Financial statement income varies from taxable income principally due to the accounting for income and losses of investees, gains and losses from asset sales, depreciation on owned properties, amortization of discounts on notes receivable and payable and the difference in the allowance for estimated losses. TCI had a loss for federal income tax purposes (after utilization of operating loss carryforwards) in the three and nine months ended September 30, 2001 and 2000; therefore, it recorded no provision for income taxes. 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 24
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ----------------------------------------------------------------------- RESULTS OF OPERATIONS (Continued) --------------------- Inflation (Continued) - --------- inflation affects interest rates, TCI's earnings from short-term investments and the cost of new financings as well as the cost of variable interest rate debt, will be affected. 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. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS - ------------------------------------------------------------------- At September 30, 2001, TCI's exposure to a change in interest rates on its debt is as follows: <TABLE> <CAPTION> Weighted Effect of 1% Average Increase In Balance Interest Rate Base Rates --------- -------------- ------------ <S> <C> <C> <C> Notes payable: Variable rate.......... $130,742 7.52% $1,307 ========= ====== Total decrease in TCI's annual net income...... $1,307 ====== Per share................ $ .15 ====== ------------------------------- </TABLE> PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS - ------------------------- In February 1990, TCI, together with National Income Realty Trust, Continental Mortgage and Equity Trust ("CMET") and Income Opportunity Realty Investors, Inc. ("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., 25
ITEM 1. LEGAL PROCEEDINGS (Continued) - ------------------------- 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"). On January 27, 1997, the parties entered into an Amendment to the Modification effective January 9, 1997 (the "Olive Amendment"). The Olive Amendment provided for the settlement of additional matters raised by plaintiffs' counsel in 1996. The Court issued an order approving the Olive Amendment on July 3, 1997. The Olive Amendment provided that TCI's Board retain a management/compensation consultant or consultants to evaluate the fairness of the BCM advisory contract and any contract of its affiliates with TCI, CMET and IORI, including, but not limited to, the fairness to TCI, CMET and IORI of such contracts relative to other means of administration. In 1998, the Board engaged a management/compensation consultant to perform the evaluation which was completed in September 1998. In 1999, plaintiffs' counsel asserted that the Board did not comply with the provision requiring such engagement and requested that the Court exercise its retained jurisdiction to determine whether there was a breach of this provision of the Olive Amendment. In January 2000, the Board engaged another management/compensation consultant to perform the required evaluation again. The evaluation was completed in April 2000 and was provided to plaintiffs' counsel. The Board believes that any alleged breach of the Olive Amendment has been fully remedied by the Board's engagement of this second consultant. Although several status conferences on this matter were held, there has been no court order resolving whether there was any breach of the Olive Amendment. In June 2000, plaintiffs' counsel asserted that loans made by TCI to BCM and American Realty Trust, Inc. breached the provisions of the Modification. The Board believes that the provisions of the Settlement, Modification and the Olive Amendment terminated on April 28, 1999. However, in September 2000, the Court ruled that certain provisions of the Modification continue to be effective after the termination date. This ruling has been appealed to the United States Court of Appeals for the Ninth Circuit by TCI and IORI. See ITEM 5. "OTHER INFORMATION" for information on a preliminary agreement to settle the pending issues in this case. ITEM 5. OTHER INFORMATION - ------------------------- 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. Under the proposal, ARI would 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. ARI will pay $17.50 cash per TCI share and $19.00 cash 26
ITEM 5. OTHER INFORMATION (Continued) - ------------------------- per IORI share for the stock held by non-affiliated stockholders. ARI would issue one share of Series G Preferred Stock with a liquidation value of $20.00 per share for each share of TCI Common Stock for stockholders who elect to receive ARI preferred stock in lieu of cash. ARI would issue one share of Series H Preferred Stock with a liquidation value of $21.50 per share for each share of IORI Common Stock for stockholders who elect to receive ARI preferred stock in lieu of cash. The preferred shares will be convertible into ARI common stock during a six month period commencing on the first anniversary of the effective date of the transaction. Upon the acquisition of IORI and TCI shares, TCI and IORI would become wholly-owned subsidiaries ARI. The transaction is subject to the negotiation of a definitive merger agreement, approval of the court and a vote of the shareholders of all three entities. TCI has the same board as IORI and the same advisor as IORI and ARI. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K - ----------------------------------------- (a) Exhibits: Exhibit Number Description - ------- --------------------------------------------------------- 3.0 Certificate of Designation of Transcontinental Realty Investors, Inc. setting forth the Voting Powers, Designations, Preference, Limitations, Restrictions and Relative Rights of Series C Cumulative Convertible Preferred Stock, dated September 28, 2001. (b) Reports on Form 8-K as follows: A Current Report on Form 8-K, dated October 10, 2001, was filed with respect to Item 2. "Acquisition and Disposition of Assets," and Item 7. "Financial Statements and Exhibits," which reports the disposition of 11 apartments, two warehouses, three office buildings and four parcels of unimproved land. A Current Report on Form 8-K, dated October 9, 2001, was filed with respect to Item 5. "Other Events and Regulation FD Disclosures," which reports the purchase of 593,200 shares of TCI Common Stock. 27
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. TRANSCONTINENTAL REALTY INVESTORS, INC. Date: November 9, 2001 By: /s/ Karl L. Blaha -------------------------- -------------------------------- Karl L. Blaha President Date: November 9, 2001 By: /s/ Brent Horak -------------------------- -------------------------------- Brent Horak Vice President and Chief Financial Officer (Principal Financial Officer) 28
TRANSCONTINENTAL REALTY INVESTORS, INC. EXHIBITS TO QUARTERLY REPORT ON FORM 10-Q For the Quarter ended September 30, 2001 Exhibit Page Number Description Number - ------- ----------------------------------------------------- ------- 3.0 Certificate of Designation of Transcontinental 30 Realty Investors, Inc. setting forth the Voting Powers, Designations, Preference, Limitations, Restrictions and Relative Rights of Series C Cumulative Convertible Preferred Stock, dated September 28, 2001. 29