1 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, 1997 ---------------------- 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.) 10670 North Central Expressway, Suite 300, Dallas, Texas 75231 - -------------------------------------------------------------------------------- (Address of Principal Executive Office) (Zip Code) (214) 692-4700 ------------------------------- (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 3,899,487 - ---------------------------- --------------------------------- (Class) (Outstanding at October 31, 1997) 1
2 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. (the "Company"), all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of the Company'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, 1997 1996 -------- -------- Assets (dollars in thousands) <S> <C> <C> Notes and interest receivable Performing ...................................... $ 4,453 $ 9,075 Nonperforming, nonaccruing ...................... 404 457 -------- -------- 4,857 9,532 Less - allowance for estimated losses .............. (891) (926) -------- -------- 3,966 8,606 Foreclosed real estate held for sale ............... -- 910 Real estate held for sale, net of accumulated depreciation ($76 in 1996) ...................... 281 2,089 -------- -------- 281 2,999 Real estate held for investment, net of accumulated depreciation ($57,319 in 1997 and $50,310 in 1996) ................................ 256,636 217,410 Investment in real estate entities ................. 4,290 4,578 Cash and cash equivalents .......................... 4,449 960 Other assets (including $412 in 1997 and $960 in 1996 from affiliates) ........................... 10,577 10,818 -------- -------- $280,199 $245,371 ======== ======== Liabilities and Stockholders' Equity Liabilities Notes and interest payable ......................... $193,069 $158,692 Other liabilities (including $167 in 1997 and $535 in 1996 to affiliates) .......................... 12,160 7,320 -------- -------- 205,229 166,012 Stockholders' equity Common stock, $.01 par value, authorized, 10,000,000 shares; issued and outstanding, 3,899,487 shares in 1997 and 3,926,445 shares in 1996 ............ 39 39 Paid-in capital .................................... 217,831 218,133 Accumulated distributions in excess of accumulated earnings ............................ (142,900) (138,813) -------- -------- 74,970 79,359 -------- -------- $280,199 $245,371 ======== ======== </TABLE> The accompanying notes are an integral part of these Consolidated Financial Statements. 2
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, -------------------- ------------------- 1997 1996 1997 1996 ------------- ----------- ----------- --------- (dollars in thousands, except per share) <S> <C> <C> <C> <C> Income Rents ...................... $ 13,781 $ 11,415 $ 39,205 $ 33,561 Interest ................... 510 361 1,283 1,126 ------------- ----------- ----------- --------- 14,291 11,776 40,488 34,687 Expenses Property operations ........ 8,378 7,040 23,403 21,372 Interest ................... 4,242 3,794 12,004 11,217 Depreciation ............... 2,443 2,125 7,048 6,290 Advisory fee to affiliate .. 503 464 1,459 1,410 General and administrative . 713 632 1,977 1,779 Provision for losses ....... -- -- -- 1,579 ------------- ----------- ----------- --------- 16,279 14,055 45,891 43,647 ------------- ----------- ----------- --------- (Loss) from operations ........ (1,988) (2,279) (5,403) (8,960) Equity in income (loss) of investees .................. (97) (56) 680 (102) Gain (loss) on sale of real estate ..................... -- (71) 1,455 1,579 ------------- ----------- ----------- --------- (Loss) before extraordinary gain ....................... (2,085) (2,406) (3,268) (7,483) Extraordinary gain ............ -- 208 -- 256 ------------- ----------- ----------- --------- Net (loss) .................... $ (2,085) $ (2,198) $ (3,268) $ (7,227) ============= =========== =========== ========= Earnings Per Share (Loss) before extraordinary gain ....................... $ (.53) $ (.60) $ (.83) $ (1.86) Extraordinary gain ............ -- $ .05 -- .06 ------------- ----------- ----------- --------- Net (loss) .................... $ (.53) $ (.55) $ (.83) $ (1.80) ============= =========== =========== ========= Weighted average Common shares used in computing earnings per share ......... 3,899,487 4,012,275 3,910,991 4,012,275 ============= =========== =========== ========= </TABLE> The accompanying notes are an integral part of these Consolidated Financial Statements. 3
4 TRANSCONTINENTAL REALTY INVESTORS, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY For the Nine Months Ended September 30, 1997 <TABLE> <CAPTION> Accumulated Distributions Common Stock in Excess of ------------ Paid-in Accumulated Stockholders' Shares Amount Capital Earnings Equity --------- -------- --------- --------- -------- (dollars in thousands, except per share) <S> <C> <C> <C> <C> <C> Balance, January 1, 1997 .... 3,926,445 $ 39 $ 218,133 $(138,813) $ 79,359 Fractional shares ........... (18) -- -- -- -- Repurchase of Common Stock .. (26,940) -- (302) -- (302) Dividends ($.21 per share) .. -- -- -- (819) (819) Net (loss) .................. -- -- -- (3,268) (3,268) --------- ----- --------- --------- -------- Balance, September 30, 1997 3,899,487 $ 39 $ 217,831 $(142,900) $ 74,970 ========= ===== ========= ========= ======== </TABLE> The accompanying notes are an integral part of these Consolidated Financial Statements. 4
5 TRANSCONTINENTAL REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS <TABLE> <CAPTION> For the Nine Months Ended September 30, ----------------------- 1997 1996 -------- -------- (dollars in thousands) <S> <C> <C> Cash Flows from Operating Activities Rents collected ................................ $ 41,841 $ 33,667 Interest collected ............................. 882 946 Interest paid .................................. (11,389) (10,535) Payments for property operations ............... (29,922) (22,033) Advisory fee paid to affiliate ................. (1,409) (1,414) General and administrative expenses paid ....... (2,062) (1,834) Distributions from operating cash flow of equity investees ................................... 1,695 419 Insurance settlement ........................... 9,633 -- Other .......................................... (580) (4,211) -------- -------- Net cash provided by (used in) operating activities ............................... 8,689 (4,995) Cash Flows from Investing Activities Acquisition of real estate ..................... (13,100) (4,787) Real estate improvements ....................... (4,408) (2,565) Proceeds from sale of real estate .............. 3,710 5,973 Collections on notes receivable ................ 5,028 887 Contributions to equity investees .............. (727) (152) -------- -------- Net cash (used in) investing activities ..... (9,497) (644) Cash Flows from Financing Activities Payments on notes payable ...................... (24,995) (11,020) Proceeds from notes payable .................... 32,181 11,550 Deferred borrowing costs ....................... (1,358) (633) Reimbursements to advisor ...................... (410) (309) Repurchase of Common Stock ..................... (302) -- Dividends to stockholders ...................... (819) (869) -------- -------- Net cash provided by (used in) financing activities ............................... 4,297 (1,281) Net increase (decrease) in cash and cash equivalents .................................... 3,489 (6,920) Cash and cash equivalents, beginning of period .... 960 9,620 -------- -------- Cash and cash equivalents, end of period .......... $ 4,449 $ 2,700 ======== ======== </TABLE> The accompanying notes are an integral part of these Consolidated Financial Statements. 5
6 TRANSCONTINENTAL REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS - Continued <TABLE> <CAPTION> For the Nine Months Ended September 30, ---------------------- 1997 1996 -------- ------- (dollars in thousands) <S> <C> <C> Reconciliation of net (loss) to net cash provided by (used in) operating activities Net (loss) ........................................ $ (3,268) $(7,227) Adjustments to reconcile net (loss) to net cash provided by (used in) operating activities Depreciation and amortization .................. 7,294 6,776 Provision for losses ........................... -- 1,579 Gain on sale of real estate .................... (1,455) (1,579) Extraordinary gain ............................. -- (256) Equity in (income) loss of equity investees .... (680) 102 Distributions from operating cash flow of equity investees ................................... 1,695 419 (Increase) in interest receivable .............. (244) (239) (Increase) decrease in other assets ............ (7,382) 470 Increase in interest payable ................... 211 196 Increase (decrease) in other liabilities ....... 12,518 (5,236) -------- ------- Net cash provided by (used in) operating activities ............................... $ 8,689 $(4,995) ======== ======= Schedule of noncash investing and financing activities Notes payable from purchase of real estate ........ $ 7,744 $ -- </TABLE> The accompanying notes are an integral part of these Consolidated Financial Statements. 6
7 TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. BASIS OF PRESENTATION The Company, a Nevada corporation, is successor to a California business trust which was organized on September 6, 1983. The Company invests in real estate through direct equity ownership, leases and partnerships and also has invested in mortgage loans on real estate, including first, wraparound and junior mortgage loans. The Company is no longer seeking to fund or acquire new mortgage loans other than those which it may originate in conjunction with providing purchase money financing of a property sale. 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. Operating results for the nine month period ended September 30, 1997 are not necessarily indicative of the results that may be expected for the year ending December 31, 1997. For further information, refer to the Consolidated Financial Statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 1996 (the "1996 Form 10-K"). NOTE 2. REAL ESTATE In February 1997, the Company completed the sale of the Fiesta Mart, a 29,000 square foot shopping center in San Angelo, Texas, which was under contract for sale at December 31, 1996, for $544,000 in cash. The Company received net cash of $403,000 after the payoff of $90,000 in existing mortgage debt and the payment of various closing costs associated with the sale. The Company paid a real estate brokerage commission of $22,000 to Carmel Realty, Inc. ("Carmel Realty"), an affiliate of Basic Capital Management, Inc. ("BCM"), the Company's advisor, based on the $544,000 sales price of the property. The Company recognized no gain or loss on the sale. Also in February 1997, the Company completed the sale of a .9976 acre parcel of land in Dallas, Texas, which was under contract for sale at December 31, 1996, for $2.7 million in cash. The Company received net cash of $2.6 million after the payment of various closing costs associated with the sale. The Company paid a real estate brokerage commission of $103,000 to Carmel Realty based on the $2.7 million sales price of the property. The Company recognized a gain of $1.4 million on the sale. In March 1997, the Company purchased the Terrace Hills Apartments, a 310 unit apartment complex in El Paso, Texas, for $6.2 million. The Company paid $1.4 million in cash and obtained mortgage financing of $4.8 million. The mortgage bears interest at 8.07% per annum, requires monthly payments of principal and interest of $35,086 and matures in 7
8 TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 2. REAL ESTATE (Continued) April 2007. The Company paid a real estate brokerage commission of $193,000 to Carmel Realty and a real estate acquisition fee of $62,000 to BCM based on the $6.2 million purchase price of the property. In March 1997, the Company purchased the Crescent Place Apartments, a 120 unit apartment complex in Houston, Texas, for $2.3 million. The Company paid $500,000 in cash and obtained mortgage financing of $1.8 million. The mortgage bears interest at 8.5% per annum, requires monthly payments of principal and interest of $13,552 and matures in April 2004. The Company paid a real estate brokerage commission of $91,000 to Carmel Realty and a real estate acquisition fee of $24,000 to BCM based on the $2.3 million purchase price of the property. Also in March 1997, the Company purchased the Savings of America Building, a 68,634 square foot office building in Houston, Texas, for $1.6 million in cash. The Company paid a real estate brokerage commission of $64,000 to Carmel Realty and a real estate acquisition fee of $16,000 to BCM based on the $1.6 million purchase price of the property. In April 1997, the Company sold a foreclosed single family residence in Scottsdale, Arizona, for $778,000 in cash. The Company paid a real estate brokerage commission of $31,000 to Carmel Realty based on the $778,000 sales price of the property. The Company recognized a gain of $55,000 on the sale. In May 1997, the Company purchased the Treehouse Apartments, a 160 unit apartment complex in Irving, Texas, for $3.4 million in cash. The Company paid a real estate brokerage commission of $122,000 to Carmel Realty and a real estate acquisition fee of $34,000 to BCM based on the $3.4 million purchase price of the property. Also in May 1997, the Company purchased the Villas at Countryside Apartments, a 102 unit apartment complex in Sterling, Virginia, for $6.3 million. The Company paid $1.1 million in cash and assumed the existing mortgage of $5.2 million. The mortgage bears interest at a variable rate, currently 9.0% per annum, requires monthly payments of principal and interest of $38,768 and matures in December 1997. The Company paid a real estate brokerage commission of $183,000 to Carmel Realty and a real estate acquisition fee of $63,000 to BCM based on the $6.3 million purchase price of the property. In August 1997, the Company purchased an 8.844 acre parcel of undeveloped land in downtown Dallas, Texas, for $11.0 million. The Company paid $2.2 million in cash with the seller providing purchase money financing of the remaining $8.8 million of the purchase price. The financing bears interest at 8.5% per annum, requires monthly payments of principal and interest of $67,664 and matures in September 2002. The Company paid a real estate brokerage commission of $285,000 to Carmel Realty and a real estate acquisition fee of $110,000 to BCM based on the $11.0 million purchase price of the property. 8
9 TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 2. REAL ESTATE (Continued) In September 1997, the Company purchased the Bonita Plaza, a 47,777 square foot office building in Bonita, California, for $5.7 million. The Company paid $1.7 million in cash and obtained mortgage financing of $4.0 million. The mortgage bears interest at a variable rate, currently 10.5% per annum, requires monthly payments of interest of $34,956 and matures in September 1998. The Company paid a real estate brokerage commission of $183,000 to Carmel Realty and a real estate acquisition fee of $57,000 to BCM based on the $5.7 million purchase price of the property. Also in September 1997, the Company purchased the Country Bend Apartments, a 166 unit apartment complex in Fort Worth, Texas, for $3.4 million. The Company paid $743,000 in cash and assumed the existing mortgage of $2.6 million. The mortgage bears interest at 8.82% per annum, requires monthly payments of principal and interest of $21,913 and matures in May 2005. The Company paid a real estate brokerage commission of $121,000 to Carmel Realty and a real estate acquisition fee of $34,000 to BCM based on the $3.4 million purchase price of the property. NOTE 3. INVESTMENTS IN EQUITY METHOD REAL ESTATE ENTITIES Set forth below is summarized results of operations for the real estate entities the Company accounts for using the equity method for the nine months ended September 30, 1997 (dollars in thousands): Rents and interest income............. $14,610 Depreciation ......................... 1,517 Property operations .................. 6,940 Interest expense ..................... 3,202 ------- Net income ........................... $ 2,951 The Company owns a 60% general partner interest in Nakash Income Associates, which in turn, owns a wraparound mortgage note receivable secured by a shopping center in Maulden, Missouri. The shopping center is owned by Mountain Home Associates ("MHA"). In August 1997, MHA refinanced the matured mortgage secured by the shopping center in the amount of $850,000. The new mortgage bears interest at a variable rate, currently 9.5% per annum, requires monthly payments of principal and interest of $13,000 and matures in May 2005. The Company contributed $271,000 to MHA to pay off the existing mortgage debt of $1.0 million. MHA also paid a mortgage brokerage and equity refinancing fee of $9,000 to BCM based on the $850,000 financing. The Company owns a combined 63.7% general and limited partner interest in Tri-City Limited Partnership ("Tri-City"), which owns five properties in Texas. 9
10 TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 3. INVESTMENTS IN EQUITY METHOD REAL ESTATE ENTITIES (Continued) In September 1997, Tri-City obtained first mortgage financing of $1.9 million secured by the previously unencumbered Oaks of Inwood and Inwood Green Apartments. The mortgage bears interest at 7.905% per annum, requires monthly payments of principal and interest of $14,415 and matures in September 2007. The Company received $1.1 million of the net financing proceeds. In conjunction with the financing, Tri-City paid a mortgage brokerage and equity refinancing fee of $19,000 to BCM, based on the $1.9 million financing. NOTE 4. NOTES AND INTEREST PAYABLE In January 1997, the Company refinanced the matured mortgage debt in the amount of $6.3 million secured by 74 New Montgomery, an office building in San Francisco, California. The Company received net cash of $1.0 million after the payoff of $5.2 million in existing mortgage debt. The remainder of the refinancing proceeds were used to fund a tax escrow and to pay various closing costs associated with the refinancing. The new mortgage bears interest at a variable rate, currently 9.25% per annum, requires monthly payments of principal and interest of $53,996 and matures in January 2004. The Company paid a mortgage brokerage and equity refinancing fee of $63,000 to BCM based on the $6.3 million refinancing. Also in January 1997, the Company refinanced the matured mortgage debt in the amount of $6.2 million secured by the Woods Edge Apartments in Rockville, Maryland. The Company received no net cash. The refinancing proceeds were used to payoff $5.9 million in existing mortgage debt, fund a tax escrow and pay various closing costs associated with the refinancing. The new mortgage bears interest at 8.125% per annum, requires monthly payments of principal and interest of $46,035 and matures in February 2007. The Company paid a mortgage brokerage and equity refinancing fee of $62,000 to BCM based on the $6.2 million refinancing. In February 1997, the Company refinanced the matured mortgage debt in the amount of $12.2 million secured by the Spa Cove Apartments in Annapolis, Maryland. The Company received net cash of $245,000 after the payoff of $11.6 million in existing mortgage debt. The remainder of the refinancing proceeds were used to fund a tax escrow and pay various closing costs associated with the refinancing. The new mortgage bears interest at 8.015% per annum, requires monthly payments of principal and interest of $89,529 and matures in March 2007. The Company paid a mortgage brokerage and equity refinancing fee of $122,000 to BCM based on the $12.2 million refinancing. In March 1997, the Company refinanced the mortgage debt in the amount of $1.9 million scheduled to mature in December 1997 and secured by President's Square, a shopping center in San Antonio, Texas. The Company received net cash of $600,000 after the payoff of $1.2 million 10
11 TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 4. NOTES AND INTEREST PAYABLE (Continued) in existing debt and the payment of various closing costs associated with the refinancing. The new mortgage bears interest at 9.44% per annum, requires monthly payments of principal and interest of $16,521 and matures in March 2009. The Company paid a mortgage brokerage and equity refinancing fee of $19,000 to BCM based on the $1.9 million refinancing. In May 1997, the mortgage debt in the amount of $618,000 secured by the Sheboygan Shopping Center in Sheboygan, Wisconsin matured. The Company is in negotiations with the lender to extend the loan and expects to be successful in such negotiations, but if not successful, the Company intends to payoff the loan. In June 1997, the Company obtained mortgage financing of $2.8 million secured by the previously unencumbered Treehouse Apartments in Irving, Texas. The Company received net cash of $2.3 million after funding required tax and repair escrows and the payment of various closing costs associated with the financing. The mortgage bears interest at 8.28% per annum, requires monthly payments of principal and interest of $21,994 and matures in July 2007. The Company paid a mortgage brokerage and equity refinancing fee of $28,000 to BCM based on the $2.8 million financing. In August 1996, the Company modified and extended the matured mortgage debt secured by the Northtown Mall Shopping Center in Dallas, Texas. The Company paid $450,000 in principal paydowns to extend the loan's maturity date to March 31, 1997. In October 1997, the Company made a $200,000 principal paydown and extended the loan to December 31, 1997. In August 1997, the Company obtained mortgage financing of $1.3 million secured by the previously unencumbered Savings of America Office Building in Houston, Texas. The Company received net cash of $1.2 million after funding a required tax escrow and the payment of various closing costs associated with the financing. The mortgage bears interest at 8.49% per annum, requires monthly payments of principal and interest of $10,371 and matures in September 2007. The Company paid a mortgage brokerage and equity refinancing fee of $13,000 to BCM based on the $1.3 million refinancing. In August 1997, the mortgage debt in the amount of $2.6 million secured by the Shaws Plaza in Sharon, Massachusetts matured. The Company is in negotiations with the lender to extend the loan and expects to be successful in such negotiations, but if not successful, the Company intends to payoff the loan. In September 1997, the Company obtained mortgage financing of $1.5 million secured by the previously unencumbered Carseka Apartments in Los Angeles, California. The Company received net cash of $1.5 million after funding required tax and insurance escrows and the payment of 11
12 TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 4. NOTES AND INTEREST PAYABLE (Continued) various closing costs associated with the financing. The mortgage bears interest at 7.6% per annum, requires monthly payments of principal and interest of $10,768 and matures in October 2007. The Company paid a mortgage brokerage and equity refinancing fee of $15,250 to BCM based on the $1.5 million financing. NOTE 5. COMMITMENTS AND CONTINGENCIES The Company is involved in various lawsuits arising in the ordinary course of business. The Company's management is of the opinion that the outcome of these lawsuits will have no material impact on the Company's financial condition. NOTE 6. SUBSEQUENT EVENTS In October 1997, the Company purchased the Sandstone Apartments, a 238 unit apartment complex in Mesa, Arizona, for $7.9 million. The Company paid $2.0 million in cash and assumed the existing mortgage of $5.9 million. The mortgage bears interest at a variable rate, currently 8.25% per annum, requires monthly payments of principal and interest of $45,087 for the first sixty months and thereafter requires monthly payments of principal and interest of $49,962 and matures in August 2004. The Company paid a real estate brokerage commission of $228,000 to Carmel Realty and an acquisition fee of $79,000 to BCM based on the $7.9 million purchase price of the property. In October 1997, the Company purchased the Encon Warehouse, a 279,290 square foot warehouse facility in Fort Worth, Texas, for $4.7 million. The Company paid $1.2 million in cash and obtained mortgage financing of $3.5 million. The mortgage bears interest at 8.5% per annum, requires monthly payments of interest only of $24,972 for the first thirty-six months and thereafter requires monthly payments of principal and interest of $26,912 and matures in October 2007. The Company paid a real estate brokerage commission of $161,000 to Carmel Realty and a real estate acquisition fee of $47,000 to BCM based on the $4.7 million purchase price of the property. In October 1997, the Company purchased the Sunchase Apartments, a 300 unit apartment complex in Odessa, Texas, for $3.6 million. The Company paid $1.5 million in cash and assumed the existing mortgage of $2.1 million. The mortgage bears interest at 9.0% per annum, requires monthly payments of principal and interest of $17,621 and matures in June 2001. The Company paid a real estate brokerage commission of $127,000 to Carmel Realty and an acquisition fee of $36,000 to BCM based on the $3.6 million purchase price of the property. Also in October 1997, the Company refinanced the mortgage debt in the amount of $2.0 million secured by the South Cochran Apartments in Los Angeles, California. The Company received net cash of $921,000 after the payoff of $902,000 in existing mortgage debt, funding of tax and 12
13 TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 6. SUBSEQUENT EVENTS (Continued) insurance escrows and the payment of various closing costs associated with the refinancing. The new mortgage bears interest at 7.62% per annum, requires monthly payments of principal and interest of $13,795 and matures in November 2007. The Company paid a mortgage brokerage and equity refinancing fee of $20,000 to BCM based on the $2.0 million refinancing. ----------------------- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Introduction Transcontinental Realty Investors, Inc. (the "Company") invests in real estate through direct ownership, leases and partnerships and has invested in mortgage loans, including first, wraparound and junior mortgage loans. The Company is no longer seeking to fund or acquire new mortgage loans other than those which it may originate in conjunction with providing purchase money financing of a property sale. The Company is the successor to a business trust which was organized on September 6, 1983 and commenced operations on January 31, 1984. Liquidity and Capital Resources Cash and cash equivalents aggregated $4.4 million at September 30, 1997 compared with $960,000 at December 31, 1996. The Company'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. The Company anticipates that its cash on hand, as well as cash generated from the collection of mortgage notes receivable, sales of properties, borrowings against certain of the Company's unencumbered properties and refinancing or extensions of certain of its mortgage debt will be sufficient to meet all of the Company's cash requirements including debt service obligations and expenditures for property maintenance and improvements. In the first nine months of 1997, the Company paid dividends of $.21 per share, or a total of $819,000. The Company's Board of Directors has approved the Company's repurchase of a total of 458,000 shares of its Common Stock. Through September 30, 1997, the Company had purchased a total of 377,528 shares, for an aggregate purchase price of $2.0 million. The Company repurchased 26,940 shares at a total cost of $302,000 during 1997. In January 1997, the Company received a $9.6 million final payment on an insurance settlement from the 1995 hail storm and flood damage to the 13
14 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Liquidity and Capital Resources (Continued) Republic Towers Office Building in Dallas, Texas. The Company is not currently able to estimate the amount of such proceeds that will be expended to complete repairs to the building. In January 1997, the Company refinanced the mortgage debt in the amount of $6.3 million secured by 74 New Montgomery, an office building in San Francisco, California. The Company received net cash of $1.0 million after the payoff of $5.2 million in existing mortgage debt and the payment of various closing costs associated with the refinancing. Also in January 1997, the Company refinanced the mortgage debt in the amount of $6.2 million secured by the Woods Edge Apartments in Rockville, Maryland. The Company received no net cash. The refinancing proceeds were used to payoff $5.9 million in existing mortgage debt, fund a tax escrow and to pay various closing costs associated with the refinancing. In February 1997, the Company refinanced the mortgage debt in the amount of $12.2 million secured by the Spa Cove Apartments in Annapolis, Maryland. The Company received net cash of $245,000 after the payoff of $11.6 million in existing mortgage debt, funding a tax escrow and the payment of various closing costs associated with the refinancing. In February 1997, the Company completed the sale of two properties which were under contract for sale at December 31, 1996, (i) the Fiesta Mart, a shopping center in San Angelo, Texas, and (ii) a .9976 acre parcel of land in the central business district of Dallas, Texas. The Company received net cash of $3.0 million after the payoff of $90,000 in existing mortgage debt secured by the Fiesta Mart and the payment of various closing costs associated with the sales. In March 1997, the Company purchased (i) the Crescent Place, an apartment complex in Houston, Texas, for $2.3 million, consisting of $500,000 in cash and mortgage financing of $1.8 million, (ii) the Savings of America Building, an office building in Houston, Texas, for $1.6 million in cash and (iii) Terrace Hills, an apartment complex in El Paso, Texas, for $6.2 million consisting of $1.4 million in cash and mortgage financing of $4.8 million. Also in March 1997, the Company refinanced the mortgage debt secured by President's Square, a shopping center in San Antonio, Texas. The Company received net cash of $600,000 after the payoff of $1.2 million in existing mortgage debt and the payment of various closing costs associated with the refinancing. In April 1997, the Company sold a foreclosed single family residence in Scottsdale, Arizona, for $778,000 in cash. In May 1997, the Company purchased (i) the Treehouse Apartments, an apartment complex in Irving, Texas, for $3.4 million in cash and (ii) the Villas at Countryside, an apartment complex in Sterling, Virginia, 14
15 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Liquidity and Capital Resources (Continued) for $6.3 million, consisting of $1.1 million in cash and the assumption of the existing mortgage of $5.2 million. Also in May 1997, the Company accepted a discounted early payoff of $2,075,000 in settlement of a mortgage note receivable with a principal balance of $2,110,000. In June 1997, the Company obtained mortgage financing in the amount of $2.8 million secured by the previously unencumbered Treehouse Apartments. The Company received net cash of $2.3 million after funding required tax, insurance and repair escrows and the payment of various closing costs associated with the financing. In August 1997, the Company obtained mortgage financing in the amount of $1.3 million secured by the previously unencumbered Savings of America Office Building. The Company received net cash of $1.2 million after funding a required tax escrow and the payment of various closing costs associated with the financing. In August 1997, the Company purchased an 8.844 acre parcel of undeveloped land in downtown Dallas, Texas, for $11.0 million. The Company paid $2.2 million in cash and the seller provided purchase money financing of $8.8 million. In August 1997, the Company received cash of $72,000 from the early payoff of two mortgage notes receivable. Also in August 1997, Mountain Home Associates, an equity investee refinanced the matured mortgage debt secured by a shopping center in Maulden, Missouri in the amount of $850,000. The Company contributed $271,000 to the partnership to pay off the existing mortgage debt. In September 1997, Tri-City Limited Partnership, an equity investee, obtained mortgage financing of $1.9 million on the previously unencumbered Oaks of Inwood and Inwood Green Apartments. The Company received $1.1 million of the net financing proceeds. Also in September 1997, the Company purchased (i) the Bonita Plaza, an office building in Bonita, California, for $5.7 million, consisting of $1.7 million in cash and mortgage financing of $4.0 million and (ii) Country Bend Apartments, an apartment complex in Fort Worth, Texas, for $3.4 million, consisting of $743,000 in cash and an assumed mortgage of $2.6 million. Further in September 1997, the Company received $2.8 million in payment of a wraparound mortgage note receivable, prior to maturity. Included in interest income in the accompanying Consolidated Statement of Operations is $248,000 of an unamortized discount on such note receivable. In October 1997, the Company purchased (i) Sandstone Apartments, an apartment complex in Mesa, Arizona, for $7.9 million, consisting of $2.0 million in cash and assumed financing of $5.9 million; (ii) Encon 15
16 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Liquidity and Capital Resources (Continued) Warehouse, a warehouse facility in Fort Worth, Texas, for $4.7 million, consisting of $1.2 million in cash and mortgage financing of $3.5 million; and (iii) Sunchase Apartments, an apartment complex in Odessa, Texas, for $3.6 million, consisting of $1.5 million in cash and assumed financing of $2.1 million. Also in October 1997, the Company refinanced the mortgage debt secured by the South Cochran Apartments in Los Angeles, California. The Company received net cash of $933,000 after the payoff of $902,000 in existing mortgage debt, funding of tax and insurance escrows and the payment of various closing costs associated with the refinancing. The Company's management reviews the carrying values of the Company'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. In those instances where impairment is found to exist, a provision for loss is recorded by a charge against earnings. The Company's mortgage note receivable review includes an evaluation of the collateral property securing such note. The property review generally includes selective property inspections, a review of the property's current rents compared to market rents, a review of the property's expenses, a review of maintenance requirements, a review of the property's cash flow, discussions with the manager of the property and a review of properties in the surrounding area. Results of Operations The Company's net loss for the three and nine months ended September 30, 1997 was $2.1 million and $3.3 million as compared to a net loss of $2.2 million and $7.2 million in the corresponding periods in 1996. Net loss for the nine months ended September 30, 1997 includes gains on sale of real estate of $1.5 million. The 1996 net loss includes an extraordinary gain of $256,000, gains on sales of real estate of $1.6 million and a provision for loss of $1.6 million. Fluctuations in these and other components of the Company's revenues and expenses between the 1996 and 1997 periods are discussed below. Rents in the three and nine months ended September 30, 1997 were $13.8 million and $39.2 million compared to $11.4 million and $33.6 million in the corresponding periods in 1996. Of the increases, $531,000 and $1.6 million for the three and nine months ended September 30, 1997 relates to an increase in rental rates at the Company's properties, $20,000 and $516,000 relates to a decrease in discounts and concessions primarily at the Company's office buildings, and $1.8 million and $4.0 million is due to the acquisition of thirteen properties in 1996 and 1997. These increases are partially offset by decreases of $10,000 and $705,000 for 16
17 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Results of Operations (Continued) the three and nine months ended September 30, 1997 due to the sale of three properties subsequent to September 30, 1996. Rents are expected to continue to increase due to properties acquired in 1996 and 1997. Interest income increased from $361,000 and $1.1 million in the three and nine months ended September 30, 1996 to $510,000 and $1.3 million in the three and nine months ended September 30, 1997. Of the increases, $248,000 for the three and nine months ended September 30, 1997 is due to a writeoff of unamortized discount from the early payoff of a mortgage note receivable and an increase in interest earned on the short-term investment of the Company's excess cash. These increases are partially offset by decreases of $101,000 and $132,000 for the three and nine months ended September 30, 1997 due to two mortgage notes receivable paid in full in 1997. Interest income for the remainder of 1997 is expected to approximate that of the third quarter of 1997, excluding the unamortized discount discussed above. Property operations expense in the three and nine months ended September 30, 1997 was $8.4 million and $23.4 million as compared to $7.0 million and $21.4 million in the corresponding periods in 1996. Of the increases, $1.4 million and $3.0 million is due to the acquisition of thirteen properties in 1996 and 1997. These increases are partially offset by decreases of $39,000 and $526,000 due to the sale of three properties subsequent to September 30, 1996 and $153,000 and $715,000 due to a decrease in operating expenses at Republic Towers. Property operating expenses are expected to continue to increase due to properties acquired in 1996 and 1997. Interest expense increased from $3.8 million and $11.2 million in the three and nine months ended September 30, 1996 to $4.2 million and $12.0 million in the three and nine months ended September 30, 1997. Of the increases, $280,000 and $622,000 is due to the debt incurred or assumed on five of thirteen properties acquired in 1996 and 1997 and $115,000 and $380,000 is due to refinancings and financing obtained on previously unencumbered properties. Interest expense for the remainder of 1997 is expected to be comparable to that of the third quarter of 1997. Depreciation expense increased to $2.4 million and $7.0 million for the three and nine months ended September 30, 1997 compared to $2.1 million and $6.3 million in the corresponding periods in 1996. The increases are due to the acquisition of thirteen properties in 1996 and 1997 with seven of the properties being acquired in the first nine months of 1997. The increases are partially offset by the sale of three properties in 1997. Depreciation is expected to continue to increase during the remainder of 1997 as a result of depreciation on the properties acquired in 1996 and in 1997. Advisory fees increased to $503,000 and $1.5 million for the three and nine months ended September 30, 1997 compared to $464,000 and $1.4 17
18 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Results of Operations (Continued) million in the corresponding periods in 1996. Advisory fees are expected to continue to increase with increases in the Company's gross assets, the basis for such fee. General and administrative expenses increased to $713,000 and $2.0 million for the three and nine months ended September 30, 1997 compared to $632,000 and $1.8 million in the corresponding periods in 1996. The increases are mainly due to legal fees related to Republic Towers litigation and an increase in other professional fees. Equity in earnings of investees was a loss of $97,000 and income of $680,000 for the three and nine months ended September 30, 1997 compared to losses of $56,000 and $102,000 for the corresponding periods in 1996. Included in equity earnings of investees for the nine months ended September 30, 1997 are gains on sale of real estate of $747,000, which is the Company's equity share of the gains recognized by Income Opportunity Realty Investors, Inc. ("IORI") on the sale of two of its apartment complexes. At October 31, 1997, the Company owned approximately 22.5% of IORI's outstanding shares of common stock. In the nine months ended September 30, 1997, the Company recognized gains totaling $1.5 million from the sale of (i) the Fiesta Mart, a shopping center, (ii) a parcel of land in the Dallas central business district, both of which were under contract for sale at December 31, 1996 and (iii) a foreclosed single family residence. In the nine months ended September 30, 1996, the Company recognized gains totaling $1.6 million from the sales of Cheyenne Mountain land and Park Forest Apartments. In the three and nine months ended September 30, 1996, the Company recognized an extraordinary gain of $208,000 and $256,000 on the paydown of the mortgage debt secured by the Dunes Plaza, a shopping center. No such gain was recognized in 1997. Tax Matters As more fully discussed in the Company's 1996 Form 10-K, the Company has elected and, in the opinion of the Company's management, qualified to be taxed as a Real Estate Investment Trust ("REIT"), as defined under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended, (the "Code"). To continue to qualify for federal taxation as a REIT under the Code, the Company is required to hold at least 75% of the value of its total assets in real estate assets, government securities, cash and cash equivalents at the close of each quarter of each taxable year. The Code also requires a REIT to distribute at least 95% of its REIT taxable income, plus 95% of its net income from foreclosure property, all as defined in Section 857 of the Code, on an annual basis to stockholders. Inflation The effects of inflation on the Company's operations are not quantifiable. Revenues from property operations generally fluctuate 18
19 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Inflation (Continued) proportionately with inflationary increases and decreases in housing costs. Fluctuations in the rate of inflation also affect the sales values of properties, and correspondingly, the ultimate gains to be realized by the Company from property sales. To the effect that inflation affects interest rates, the Company's earnings from short-term investments and the cost of new financings as well as the cost of its variable note financing will be affected. Environmental Matters Under various federal, state and local environmental laws, ordinances and regulations, the Company 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 from the Company for personal injury associated with such materials. The Company's management is not aware of any environmental liability relating to the above matters that would have a material adverse effect on the Company's business, assets or results of operations. ------------------------ PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Olive Litigation. In February 1990, the Company, together with Continental Mortgage and Equity Trust ("CMET"), Income Opportunity Realty Investors, Inc. ("IORI") and National Income Realty Trust, three real estate entities with, at the time, the same officers, directors or trustees and advisor as the Company, entered into a settlement of a class and derivative action entitled Olive et al. v. National Income Realty Trust et al. pending before the United States District Court for the Northern District of California and relating to the operation and management of each of the entities (the "Olive Litigation"). On April 23, 1990, the Court granted final approval of the terms of a Stipulation of Settlement. On May 4, 1994, the parties entered into a Modification of Stipulation of Settlement dated April 27, 1994 (the "Olive Modification") that settled subsequent claims of breaches of the settlement that were asserted by the plaintiffs and that modified certain provisions of the April 1990 settlement. The Olive Modification was preliminarily 19
20 ITEM 1. LEGAL PROCEEDINGS (Continued) approved by the Court on July 1, 1994, and final Court approval was entered on December 12, 1994. The effective date of the Olive Modification was January 11, 1995. The Court retained jurisdiction to enforce the Modification, and during August and September 1996, the Court held evidentiary hearings to assess compliance with the terms of the Modification by various parties. The Court issued no ruling or order with respect to the matters addressed at the hearings. Separately in 1996, legal counsel for the plaintiffs notified the Company's Board of Directors that he intended to assert that certain actions taken by the Board of Directors breached the terms of the Modification. On January 27, 1997, the parties entered into an Amendment to the Modification effective January 9, 1997 (the "Amendment"), which was submitted to the Court for approval on January 29, 1997. The Amendment provides for the settlement of all matters raised at the evidentiary hearings and by plaintiffs' counsel in his notices to the Company's Board of Directors. On May 2, 1997, a hearing was held for the Court to consider approval of the Amendment. As a result of the hearing, the parties entered into a revised Amendment. The Court issued an order approving the Amendment on July 3, 1997. The Amendment provides for the addition of four new unaffiliated members to the Company's Board of Directors and sets forth new requirements for the approval of any transactions with certain affiliates until April 28, 1999. In addition, the Company, CMET, IORI and their shareholders released the defendants from any claims relating to the plaintiffs' allegations and matters which were the subject of the evidentiary hearings. The plaintiffs' allegations of any breaches of the Modification shall be settled by mutual agreement of the parties or, lacking such agreement, by an arbitration proceeding. Under the Amendment, all shares of the Company owned by Gene E. Phillips or any of his affiliates shall be voted at all stockholders' meetings held until April 28, 1999 in favor of all new Board members added under the Amendment. The Amendment also requires that, until April 28, 1999, all shares of the Company owned by Gene E. Phillips or his affiliates in excess of forty percent (40%) of the Company's outstanding shares shall be voted in proportion to the votes cast by all non-affiliated shareholders of the Company. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a)Exhibits: Exhibit Number Description 27.0 Financial Data Schedule 20
21 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (Continued) (b) Reports on Form 8-K as follows: A Current Report on Form 8-K, dated September 16, 1997, was filed with respect to Item 2. "Acquisition or Disposition of Assets," and Item 7. "Financial Statements and Exhibits," which reports the acquisition of the Terrace Hills Apartments, the Crescent Place Apartments, the Savings of America Building, the Treehouse Apartments, the Villas at Countryside Apartments, the Bonita Plaza Office Building, the Country Bend Apartments, the Encon Warehouse, the Sandstone Apartments and the Sunchase Apartments. 21
22 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 7, 1997 By: /s/ Randall M. Paulson ------------------------ ---------------------------------- Randall M. Paulson President Date: November 7, 1997 By: /s/ Thomas A. Holland ------------------------ ---------------------------------- Thomas A. Holland Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) 22
23 TRANSCONTINENTAL REALTY INVESTORS, INC. EXHIBITS TO QUARTERLY REPORT ON FORM 10-Q For the Nine Months ended September 30, 1997 <TABLE> <CAPTION> Exhibit Page Number Description Number ----- ----------- ------ <S> <C> 27.0 Financial Data Schedule 24 </TABLE> 23