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 JUNE 30, 1998 ------------- 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 3,872,505 - ---------------------------- ------------------------------ (Class) (Outstanding at July 31, 1998) 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. <TABLE> TRANSCONTINENTAL REALTY INVESTORS, INC. CONSOLIDATED BALANCE SHEETS <CAPTION> June 30, December 31, 1998 1997 Assets ----------- ----------- ------ (dollars in thousands) <S> <C> <C> Notes and interest receivable Performing ................................................ $ 4,370 $ 4,388 Nonperforming, nonaccruing ................................ 416 450 ------------ ------------ 4,786 4,838 Less - allowance for estimated losses ...................... (891) (891) ------------ ------------ 3,895 3,947 Foreclosed real estate held for sale ....................... 1,356 1,356 Real estate held for sale, net of accumulated depreciation ($4,790 in 1998 and $1,350 in 1997) ....................... 21,571 3,630 ------------ ------------ 22,927 4,986 Real estate held for investment, net of accumulated depreciation ($55,770 in 1998 and $55,487 in 1997) ........ 301,404 270,245 Investment in real estate entities ......................... 4,011 4,333 Cash and cash equivalents .................................. 7,093 24,733 Other assets (including $438 in 1998 and $497 in 1997 from affiliates) ............................................... 15,058 11,291 ------------ ------------ $ 354,388 $ 319,535 ============ ============ Liabilities and Stockholders' Equity ------------------------------------ Liabilities Notes and interest payable ................................. $ 261,440 $ 222,029 Other liabilities (including $115 in 1998 and $1,157 in 1997 to affiliates) .................................... 7,199 10,973 ------------ ------------ 268,639 233,002 Stockholders' equity Common stock, $.01 par value, authorized, 10,000,000 shares; issued and outstanding, 3,872,505 shares in 1998 and 3,889,200 shares in 1997 .................................. 39 39 Paid-in capital ............................................ 217,431 217,688 Accumulated distributions in excess of accumulated earnings .................................................. (131,721) (131,194) ------------ ------------ 85,749 86,533 ------------ ------------ $ 354,388 $ 319,535 ============ ============ </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 Six Months Ended June 30, Ended June 30, --------------------------- --------------------------- 1998 1997 1998 1997 ----------- ----------- ----------- ----------- (dollars in thousands, except per share) <S> <C> <C> <C> <C> Income Rents ........................................ $ 17,339 $ 13,310 $ 33,393 $ 25,424 Interest ..................................... 175 364 393 773 ----------- ----------- ----------- ----------- 17,514 13,674 33,786 26,197 Expenses Property operations .......................... 8,874 7,749 17,283 15,025 Interest ..................................... 5,609 3,938 10,944 7,762 Depreciation ................................. 2,606 2,350 5,129 4,605 Advisory and net income fee to affiliate ..... 689 491 1,303 956 General and administrative ................... 486 647 1,065 1,264 ----------- ----------- ----------- ----------- 18,264 15,175 35,724 29,612 ----------- ----------- ----------- ----------- (Loss) from operations ........................... (750) (1,501) (1,938) (3,415) Equity in income of investees .................... 450 429 432 777 Gain on sale of real estate ...................... 2,132 55 2,132 1,455 ----------- ----------- ----------- ----------- Net income (loss) ................................ $ 1,832 $ (1,017) $ 626 $ (1,183) =========== =========== =========== =========== Earnings Per Share Net income (loss) ................................ $ .47 $ (.26) $ .16 $ (.30) =========== =========== =========== =========== Weighted average Common shares used in computing earnings per share ............................. 3,871,436 3,907,344 3,879,080 3,916,838 =========== =========== =========== =========== </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 Six Months Ended June 30, 1998 <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, 1998 ............... 3,889,200 $ 39 $ 217,688 $ (131,194) $ 86,533 Repurchase of Common Stock ............. (21,950) -- (336) -- (336) Sale of Common Stock under dividend reinvestment plan ..................... 5,255 -- 79 -- 79 Dividends ($.30 per share) ............ -- -- -- (1,153) (1,153) Net income ............................. -- -- -- 626 626 ------------ ------------ ------------ ------------ ------------ Balance, June 30, 1998 ................. 3,872,505 $ 39 $ 217,431 $ (131,721) $ 85,749 ============ ============ ============ ============ ============ </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 Six Months Ended June 30, ---------------------------- 1998 1997 ------------ ------------ (dollars in thousands) <S> <C> <C> Cash Flows from Operating Activities Rents collected .................................................. $ 32,948 $ 27,936 Interest collected ............................................... 397 653 Interest paid .................................................... (9,984) (7,391) Payments for property operations ................................. (17,970) (20,351) Advisory fee paid to affiliate ................................... (2,094) (904) General and administrative expenses paid ......................... (1,245) (1,313) Distributions from operating cash flow of equity investees ....... 60 74 Insurance settlement ............................................. -- 9,529 Other ............................................................ (861) 507 ------------ ------------ Net cash provided by operating activities .................... 1,251 8,740 Cash Flows from Investing Activities Acquisition of real estate ....................................... (51,452) (15,617) Real estate improvements ......................................... (3,237) (2,991) Proceeds from sale of real estate ................................ 3,596 3,800 Deposits on pending purchases .................................... (505) (410) Collections on notes receivable .................................. 2,180 2,134 Distributions of equity investees' investing cash flow ........... 701 -- Contributions to equity investees ................................ (7) (389) ------------ ------------ Net cash (used in) investing activities ...................... (48,724) (13,473) Cash Flows from Financing Activities Payments on notes payable ........................................ (13,678) (24,563) Proceeds from notes payable ...................................... 49,654 35,880 Deferred borrowing costs ......................................... (876) (1,222) Reimbursements to advisor ........................................ (61) (501) Repurchase of Common Stock ....................................... (336) (302) Sale of Common Stock under dividend reinvestment plan ............ 79 -- Dividends to stockholders ........................................ (4,949) (546) ------------ ------------ Net cash provided by financing activities .................... 29,833 8,746 Net increase (decrease) in cash and cash equivalents ................. (17,640) 4,013 Cash and cash equivalents, beginning of period ....................... 24,733 960 ------------ ------------ Cash and cash equivalents, end of period ............................. $ 7,093 $ 4,973 ============ ============ </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 Six Months Ended June 30, ---------------------------- 1998 1997 ------------ ------------ (dollars in thousands) <S> <C> <C> Reconciliation of net income (loss) to net cash provided by operating activities Net income (loss) .................................................... $ 626 $ (1,183) Adjustments to reconcile net income (loss) to net cash provided by operating activities Depreciation and amortization ...................................... 5,525 4,755 Gain on sale of real estate ........................................ (2,132) (1,455) Equity in (income) of investees .................................... (432) (777) Distributions from operating cash flow of equity investees ......... 60 74 (Increase) decrease in interest receivable ......................... 4 (2) (Increase) decrease in other assets ................................ (2,262) 2,912 Increase in interest payable ....................................... 564 104 Increase (decrease) in other liabilities ........................... (702) 4,312 ------------ ------------ Net cash provided by operating activities ...................... $ 1,251 $ 8,740 ============ ============ Schedule of noncash investing and financing activities Notes payable from purchase of real estate ........................... $ 2,970 $ 5,169 </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 invests in mortgage loans on real estate, including first, wraparound and junior mortgage loans. 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 six month period ended June 30, 1998 are not necessarily indicative of the results that may be expected for the year ending December 31, 1998. 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, 1997 (the "1997 Form 10-K"). NOTE 2. REAL ESTATE In January 1998, the Company purchased the Mountain Plaza Apartments, a 188 unit apartment complex in El Paso, Texas, for $4.0 million. The Company paid $1.0 million in cash and obtained new mortgage financing of $3.0 million. The mortgage bears interest at 8.2% per annum, requires monthly payments of interest only and matures in January 2000. The Company paid a real estate brokerage commission of $139,000 to Carmel Realty, Inc. ("Carmel Realty"), an affiliate of Basic Capital Management, Inc. ("BCM"), the Company's advisor, and a real estate acquisition fee of $39,000 to BCM based on the $4.0 million purchase price of the property. Also in January 1998, the Company purchased the Hunters Glen Apartments, a 212 unit apartment complex in Midland, Texas, for $2.5 million. The Company paid $600,000 in cash and obtained seller financing of the remaining $1.9 million of the purchase price. The financing bears interest at a variable rate, currently 8.0% per annum, requires monthly payments of interest only for the first twenty-four months and thereafter requires monthly payments of principal and interest of $14,302 and matures in January 2003. The Company paid a real estate brokerage commission of $94,000 to Carmel Realty and a real estate acquisition fee of $25,000 to BCM based on the $2.5 million purchase price of the property. Further in January 1998, the Company purchased the Laws Street land, a 1.41 acre parcel of land in Dallas, Texas, for $1.9 million in cash. The Company paid a real estate brokerage commission of $39,000 to Carmel Realty and a real estate acquisition fee of $19,000 to BCM based on the $1.9 million purchase price of the property. 7
8 TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 2. REAL ESTATE (Continued) In January 1998, the Company purchased the Bent Tree Garden Apartments, a 204 unit apartment complex in Addison, Texas, for $8.1 million. The Company paid $1.7 million in cash and obtained new mortgage financing of $6.4 million. The mortgage bears interest at 7.2% per annum, requires monthly payments of principal and interest of $46,054 and matures in February 2008. The Company paid a real estate brokerage commission of $232,000 to Carmel Realty and a real estate acquisition fee of $81,000 to BCM based on the $8.1 million purchase price of the property. In February 1998, the Company purchased Parkway North, a 71,041 square foot office building in Dallas, Texas, for $5.4 million. The Company paid $1.5 million in cash and obtained new mortgage financing of $3.9 million. The mortgage bears interest at a variable rate, currently 8.75% per annum, requires monthly payments of interest only and matures in March 2000. The Company paid a real estate brokerage commission of $179,000 to Carmel Realty and a real estate acquisition fee of $54,000 to BCM based on the $5.4 million purchase price of the property. Also in February 1998, the Company purchased the Lemmon Carlisle land, a 2.14 acre parcel of land in Dallas, Texas, for $3.4 million in cash. The Company paid a real estate brokerage commission of $54,000 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. In December 1997, the Company entered into a contract to sell Shaws Plaza, a 103,482 square foot shopping center in Sharon, Massachusetts, for $3.8 million. The agreed sales price was $1.4 million less than the property's carrying value. Accordingly, at December 31, 1997, the Company recognized a provision for loss of $1.4 million to reduce the property's carrying value to its sales price less estimated costs of sale. In March 1998, the Company completed the sale receiving net cash of $1.2 million after the payoff of $2.6 million in existing mortgage debt and the payment of various closing costs associated with the sale. The Company paid a real estate brokerage commission of $134,000 to Carmel Realty based on the $3.8 million sales price of the property. The Company incurred no gain or loss on the sale beyond the reserve previously established. In March 1998, the Company purchased the Plaza on Bachman Creek, a 80,278 square foot retail/office complex in Dallas, Texas, for $3.5 million. The Company paid $1.1 million in cash and obtained new mortgage financing of $2.4 million. The mortgage bears interest at a variable rate, currently 9% per annum, requires monthly payments of principal and interest of $21,593 and matures in March 2018. The Company paid a real estate brokerage commission of $124,000 to Carmel Realty and a real estate acquisition fee of $35,000 to BCM based on the $3.5 million purchase price of the property. In April 1998, the Company purchased in a single transaction Ashton Way, a 178 unit apartment complex in Midland, Texas, and the 4400 Apartments, 8
9 TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 2. REAL ESTATE (Continued) a 92 unit apartment complex also in Midland, Texas, and in May 1998, the Company purchased the Woodview Apartments, a 232 unit apartment complex in Odessa, Texas, for a total of $6.8 million. The Company paid a total of $1.5 million in cash and obtained new mortgage financing secured by all three properties totaling $5.3 million. The first mortgage of $4.5 million bears interest at 7.2% per annum and the second mortgage of $845,000 bears interest at a variable rate, currently 8.2% per annum. The mortgages require monthly payments of principal and interest totaling $38,003 and mature in October 1999 and May 2008, respectively. The Company paid a real estate brokerage commission of $244,000 to Carmel Realty and a real estate acquisition fee of $68,000 to BCM based on the $6.8 million purchase price of the properties. Also in May 1998, the Company purchased the Eagle Crest land, a 22.99 acre parcel of land in Farmers Branch, Texas, for $2.5 million in cash. The Company paid a real estate brokerage commission of $95,000 to Carmel Realty and a real estate acquisition fee of $25,000 to BCM based on the $2.5 million purchase price of the property. Further in May 1998, the Company purchased the Emerald Terrace Apartments, a 172 unit apartment complex in Midland, Texas, for $1.5 million. The Company paid $425,000 in cash, assumed the existing mortgage of $584,000 and obtained seller financing of the remaining $491,000 of the purchase price. The mortgages bear interest at variable rates, currently 7.5% and 9.5% per annum, respectively, require monthly payments of principal and interest totaling $10,643 and mature in November 1999 and June 2008. The Company paid a real estate brokerage commission of $59,000 to Carmel Realty and a real estate acquisition fee of $15,000 to BCM based on the $1.5 million purchase price of the property. In May 1998, the Company purchased in a single transaction, Daley Plaza, a 62,425 square foot office building in San Diego, California and the View Ridge building, a 25,062 square foot office building, also in San Diego, California, for a total of $6.5 million. The Company paid $1.7 million in cash and obtained new mortgage financing totaling $4.8 million. The mortgages bear interest at a variable rate, currently 9.5% per annum, require monthly payments of principal and interest totaling $42,416 and mature in May 2005. The Company paid a real estate brokerage commission of $200,000 to Carmel Realty and a real estate acquisition fee of $65,000 to BCM based on the $6.5 million purchase price of the properties. In 1997, Montgomery Ward ("Ward"), a tenant at the Northtown Mall, a shopping center in Dallas, Texas, filed for bankruptcy protection. In an attempt to keep the Ward's lease from being sold, Northtown Mall was placed in administrative bankruptcy. The Northtown Mall lease, as well as other Ward leases, were sold for the benefit of the Ward bankruptcy 9
10 TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 2. REAL ESTATE (Continued) estate. The Company has agreed to buy back the lease in conjunction with the pending sale of the Northtown Mall. Such sale is scheduled to close in August 1998. In June 1998, the Company purchased the Atrium building, a 74,603 square foot office building in Palm Beach, Florida, for $5.4 million. The Company paid $1.3 million in cash and obtained new mortgage financing of $4.1 million. The mortgage bears interest at a variable rate, currently 7.93% per annum, requires monthly payments of principal and interest of $31,455 and matures in July 2001. The Company paid a real estate brokerage commission of $179,000 to Carmel Realty and a real estate acquisition fee of $54,000 to BCM based on the $5.4 million purchase price of the property. At June 30, 1998, the Company reclassified from real estate held for investment to real estate held for sale (i) Northtown Mall, a 354,174 square foot shopping center in Dallas, Texas; (ii) Denton Drive Warehouse, 123,800 square foot industrial warehouse in Dallas, Texas, and (iii) Chesapeake Ridge, a 100,484 square foot office building in San Diego, California. All three properties were under contract for sale at June 30, 1998. NOTE 3. NOTES AND INTEREST RECEIVABLE In February 1994, the Company provided $6.7 million of purchase money financing in conjunction with the sale of 1,406 acres of land in sixteen developed residential and commercial subdivisions located in Maumelle, Arkansas, secured by a first mortgage on the properties sold. The borrower did not make the scheduled February 1995 principal and interest payments. In September 1995, the Company reached a settlement with the borrower that provided for, among other things the payment by the borrower of $2.5 million in cash, and the Company's acceptance of a new $1.4 million note secured by 36.3 acres of commercial land. Such note matured in January 1996. In April 1998, the Company received $2.1 million in full settlement of its note and accrued but unpaid interest. The original sale had been recorded under the cost recovery method with gain being deferred until the note was collected. Accordingly, the Company recognized the previously deferred gain of $2.1 million on collection of its note receivable. At June 30, 1998, the Company held a wraparound mortgage note secured by a K-Mart in Wake County, North Carolina, with a principal balance of $2.5 million. In February 1998, the Company was informed that the first lien mortgage in the amount of $2.0 million was in default. In order to protect its interest, the Company has instituted foreclosure proceedings. The Company does not expect to incur a loss on foreclosure as the estimated fair value of the property exceeds the carrying value of its note receivable. Foreclosure is expected to be completed in August 1998. 10
11 TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 4. INVESTMENTS IN EQUITY METHOD REAL ESTATE ENTITIES Set forth below are summarized results of operations of the real estate entities the Company accounts for using the equity method for the six months ended June 30, 1998 (dollars in thousands): <TABLE> <S> <C> Rents and interest income............................. $ 9,132 Depreciation.......................................... 1,301 Property operations................................... 4,490 Interest expense...................................... 3,118 Gain on sale of real estate........................... 496 -------- Net income............................................ $ 719 ======== </TABLE> The Company owns a combined 63.7% general and limited partner interest in Tri-City Limited Partnership ("Tri-City"), which owned five properties in Texas. In May 1998, Tri-City sold two of its apartment complexes for $3.3 million in cash. Tri-City received net cash of $1.4 million after paying off $1.9 million in existing mortgage debt and the payment of various closing costs associated with the sale. The Company received a distribution of $701,000 of such net cash. Tri-City recognized a gain of $496,000 on the sale of which the Company's equity share was $316,000. Tri-City paid a real estate brokerage commission of $119,000 to Carmel Realty, based on the $3.3 million sales price of the properties. NOTE 5. NOTES AND INTEREST PAYABLE In December 1997, the Company extended the loan which was scheduled to mature December 31, 1997 and secured by the Northtown Mall Shopping Center in Dallas, Texas, by making a $100,000 principal paydown to extend the loan to March 31, 1998. The Company did not payoff the loan at maturity. Negotiations with the lender to again extend the loan's maturity date or the payoff of the loan are on hold pending the resolution of Northtown Malls' bankruptcy filing. See NOTE 2. "REAL ESTATE." The loan had a principal balance of $2.5 million at June 30, 1998. In March 1998, the Company refinanced the mortgage debt secured by the Tricon Warehouses in Atlanta, Georgia in the amount of $10.2 million. The Company received net cash of $5.4 million after paying off $4.8 million in existing mortgage debt, funding of required escrows and the payment of various closing costs associated with the financing. The new mortgage bears interest at a variable rate, currently 7.53% per annum, requires monthly payments of principal and interest of $75,576 and matures in April 2008. The Company paid a mortgage brokerage and equity refinancing fee of $102,000 to BCM based on the new $10.2 million mortgage. In May 1998, the Company obtained mortgage financing of $2.2 million secured by the previously unencumbered Lemmon Carlisle land in Dallas, Texas. The Company received net cash of $2.1 million after the payment 11
12 TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 5. NOTES AND INTEREST PAYABLE (Continued) of various closing costs associated with the financing. The mortgage bears interest at 9.25% per annum, requires monthly payment of interest only and matures in May 2000. The Company paid a mortgage brokerage and equity refinancing fee of $22,000 to BCM based on the $2.2 million financing. Also in May 1998, the Company refinanced the mortgage debt secured by the Plaza Office Building in St. Petersburg, Florida in the amount of $7.4 million. The Company received net cash of $2.6 million after paying off $4.8 million in existing mortgage debt, funding of required escrows and the payment of various closing costs associated with the refinancing. The new mortgage bears interest at a variable rate, currently 7.57% per annum, requires monthly payments of principal and interest of $55,023 and matures in June 2008. The Company paid a mortgage brokerage and equity refinancing fee of $74,000 to BCM based on the $7.4 million refinancing. NOTE 6. 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 7. SUBSEQUENT EVENTS In July 1998, the Company purchased the Valley Rim building, a 54,194 square foot office building in San Diego, California, for $5.1 million. The Company paid $1.4 million in cash and obtained new mortgage financing of $3.7 million. The mortgage bears interest at a variable rate, currently 9.5% per annum, requires monthly payments of principal and interest of $32,576 and matures in June 2005. The Company paid a real estate brokerage commission of $172,000 to Carmel Realty and an acquisition fee of $51,000 to BCM based on the $5.1 million purchase price of the property. Also in July 1998, the Company purchased the Limestone Canyon land, a 27 acre parcel of land in Austin, Texas, for $1.8 million in cash. In conjunction with the purchase, the Company obtained a mortgage financing commitment of $13.0 million for the construction of a 260 unit apartment complex on the site. The mortgage bears interest at a variable rate, currently 7.75% per annum, requires monthly payments of interest only and matures in July 2000. The Company paid a real estate brokerage commission of $70,000 to Carmel Realty and an acquisition fee of $18,000 to BCM based on the $1.8 million purchase price of the property. Further in July 1998, the Company refinanced the matured mortgage debt secured by Villas at Countryside Apartments in Sterling, Virginia in the amount of $5.4 million. The Company received net cash of $400,000 after paying off $5.0 million in existing mortgage debt, funding of 12
13 TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 7. SUBSEQUENT EVENTS (Continued) required escrows and the payment of various closing costs associated with the refinancing. The new mortgage bears interest at 6.85% per annum, requires monthly payments of principal and interest of $35,692 and matures in August 2005. The Company paid a mortgage brokerage and equity refinancing fee of $54,000 to BCM based on the $5.4 million refinancing. In July 1998, the Company collected a mortgage note receivable which had been written off in a prior year as uncollectible. The Company will recognize a gain of $671,000 on the collection of such note receivable. ---------- 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 invests in mortgage loans, including first, wraparound and junior mortgage loans. 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 $7.1 million at June 30, 1998 compared with $24.7 million at December 31, 1997. 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. The Company's cash flow from property operations (rents collected less payments for property operating expenses) increased from $7.6 million for the six months ended June 30, 1997 to $15.0 million for the six months ended June 30, 1998. This increase is primarily due to the Company having acquired twenty-six income producing properties in 1997 and 1998. The Company's management believes that this trend will continue for the remainder of 1998 as the Company continues to benefit from the acquired properties and increased rental rates and occupancy rates at both the Company's apartments and commercial properties. 13
14 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Liquidity and Capital Resources (Continued) In the first six months of 1998, the Company paid dividends of $.30 per share, or a total of $1.2 million. In January 1998, the Company also paid a special dividend of $1.00 per share which was declared in December 1997. The Company's Board of Directors has approved the Company's repurchase of a total of 687,000 shares of its Common Stock. Through July 31, 1998, the Company had purchased a total of 398,315 shares, for an aggregate purchase price of $3.3 million. The Company repurchased 21,950 shares at a total cost of $336,000 in the first six months of 1998. In the first six months of 1998, the Company sold 5,255 shares of its Common Stock, through its dividend reinvestment program for a total of $79,000. In January 1998, the Company purchased (i) the Mountain Plaza Apartments in El Paso, Texas, for $4.0 million, consisting of $1.0 million in cash and mortgage financing $3.0 million, (ii) the Hunters Glen Apartments in Midland, Texas, for $2.5 million, consisting of $600,000 in cash and seller financing of $1.9 million, (iii) a 1.41 acre parcel of land in Dallas, Texas, for $1.9 million in cash, and (iv) the Bent Tree Garden Apartments in Addison, Texas, for $8.1 million, consisting of $1.7 million in cash and mortgage financing of $6.4 million. In February 1998, the Company purchased (i) the Parkway North Office Building in Dallas, Texas, for $5.4 million, consisting of $1.5 million in cash and mortgage financing of $3.9 million, and (ii) a 2.14 acre parcel of land in Dallas, Texas, for $3.4 million in cash. In March 1998, the Company refinanced the mortgage debt secured by Tricon Warehouses in Atlanta, Georgia. The Company received net cash of $5.4 million after paying off $4.8 million in mortgage debt. Also in March 1998, the Company completed the sale of the Shaws Plaza Shopping Center in Sharon, Massachusetts. The Company received net cash of $1.2 million after paying off $2.6 million in mortgage debt. Further in March 1998, the Company purchased the Plaza on Bachman Creek, a retail/office complex in Dallas, Texas, for $3.5 million, consisting of $1.1 million in cash and mortgage financing of $2.4 million. In April 1998, the Company purchased in a single transaction, the Ashton Way and 4400 Apartments in Midland, Texas, for $3.4 million, consisting of $700,000 in cash and mortgage financing of $2.7 million. Also in April 1998, the Company received $2.1 million in cash in settlement of a mortgage note receivable which had been in default. 14
15 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Liquidity and Capital Resources (Continued) In May 1998, the Company purchased (i) the Woodview Apartments in Odessa, Texas, for $3.4 million, consisting of $800,000 in cash and mortgage financing of $2.6 million, (ii) Eagle Crest land, a 22.99 acre parcel of land in Farmers Branch, Texas, for $2.5 million in cash, (iii) Emerald Terrace Apartments in Midland, Texas, for $1.5 million, consisting of $425,000 in cash and mortgage financing of $1.1 million, (iv) Daley Plaza in San Diego, California, for $4.6 million, consisting of $1.1 million in cash and $3.5 million in mortgage financing, and (v) View Ridge Building in San Diego, California, for $1.9 million, consisting of $600,000 in cash and $1.3 million in mortgage financing. Also in May 1998, the Company obtained mortgage financing in the amount of $2.2 million secured by the previously unencumbered Lemmon Carlisle land. The Company received net cash of $2.1 million. Further in May 1998, the Company refinanced the mortgage debt secured by the Plaza Office Building in St. Petersburg, Florida. The Company received net cash of $2.6 million after paying off $4.8 million in mortgage debt. In June 1998, the Company purchased the Atrium Office Building in Palm Beach, Florida, for $5.4 million, consisting of $1.3 million in cash and mortgage financing of $4.1 million. In July 1998, the Company purchased the Valley Rim building in San Diego, California, for $5.1 million, consisting of $1.4 million in cash and mortgage financing of $3.7 million. Also in July 1998, the Company purchased the Limestone Canyon land in Austin, Texas, for $1.8 million in cash. Further in July 1998, the Company refinanced the matured mortgage debt secured by the Villas at Countryside Apartments in Sterling, Virginia. The Company received net cash of $400,000 after paying off $5.0 million in mortgage debt. In July 1998, the Company received $671,000 in settlement of a mortgage note receivable which had been written off in a prior year. 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 15
16 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Liquidity and Capital Resources (Continued) 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 income for the three and six months ended June 30, 1998 was $1.8 million and $626,000 as compared to a net loss of $1.0 million and $1.2 million in the corresponding periods in 1997. The net income for the three and six months ended June 30, 1998 includes $2.1 million of gains on the sale of real estate. The net loss for the three and six months ended June 30, 1997 includes gains on sale of real estate of $55,000 and $1.5 million, respectively. Fluctuations in this and other components of the Company's revenues and expenses between the 1997 and 1998 periods are discussed below. Rents in the three and six months ended June 30, 1998 were $17.3 million and $33.4 million compared to $13.3 million and $25.4 million in the corresponding periods in 1997. Of the increase, $268,000 and $845,000 relates to an increase in rental rates and common area maintenance income at the Company's commercial properties and $3.8 million and $7.6 million is due to the acquisition of thirty properties in 1997 and 1998. These increases were partially offset by decreases of $376,000 and $703,000 due to the sale of six properties during 1997 and 1998. Rents are expected to continue to increase due to properties acquired in 1997 and 1998. Interest income decreased to $175,000 and $393,000 in the three and six months ended June 30, 1998 compared to $364,000 and $773,000 in the corresponding periods in 1997. This decrease is due to four mortgage notes receivable being paid in full in 1997. Interest income for the remainder of 1998 is expected to approximate that of the first and second quarters of 1998. Property operations expense in the three and six months ended June 30, 1998 was $8.9 million and $17.3 million compared to $7.7 million and $15.0 million in the corresponding periods in 1997. Of the increases, $2.1 million and $4.2 million for the three and six months ended June 30, 1998 is due to the acquisition of thirty properties in 1997 and 1998. This increase is partially offset by decreases of $919,000 and $1.7 million for the three and six months ended June 30, 1998 due to the sale of six properties during 1997 and 1998 and $57,000 and $219,000 for the three and six months ended June 30, 1998 due to a decrease in property replacement and personnel expenses at the Company's commercial properties. Property operating expenses are expected to continue to increase due to properties acquired in 1997 and 1998. 16
17 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Results of Operations (Continued) Interest expense increased to $5.6 million and $10.9 million in the three and six months ended June 30, 1998 compared to $3.9 million and $7.8 million in the corresponding periods in 1997. Of the increase, $1.5 million and $2.9 million for the three and six months ended June 30, 1998 is due to the debt incurred or assumed on twenty-eight of thirty properties acquired in 1997 and 1998 and $300,000 and $482,000 is due to refinancings and financing obtained on unencumbered properties. These increases are partially offset by decreases of $84,000 and $126,000 for the three and six months ended June 30, 1998 due to properties sold in 1997 and 1998. Interest expense for the remainder of 1998 is expected to be comparable to that of the first and second quarters of 1998. Depreciation expense increased to $2.6 million and $5.1 million for the three and six months ended June 30, 1998 compared to $2.4 million and $4.6 million in the corresponding periods in 1997. Of this increase, $438,000 and $862,000 for the three and six months ended June 30, 1998 is due to the acquisition of thirty properties in 1997 and 1998 with fifteen of the properties being acquired in the first six months of 1998 and $145,000 and $271,000 is due to capital improvements. These increases are partially offset by a decrease of $327,000 and $609,000 for the three and six months ended June 30, 1998 due to six properties being sold during 1997 and 1998. Depreciation is expected to continue to increase during the remainder of 1998 as a result of depreciation on the properties acquired in 1997 and in 1998. Advisory and net income fee increased to $689,000 and $1.3 million for the three and six months ended June 30, 1998 compared to $491,000 and $956,000 in the corresponding periods in 1997. 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 decreased to $486,000 and $1.1 million for the three and six months ended June 30, 1998 compared to $647,000 and $1.3 million in the corresponding periods in 1997. The decrease for the three and six months ended June 30, 1998 is mainly due to a decrease in legal fees relating to Republic Towers and Olive litigation. Equity in earnings of investees was income of $414,000 and $432,000 for the three and six months ended June 30, 1998 compared to income of $429,000 and $777,000 for the corresponding periods in 1997. Included in equity earnings of investees for the six months ended June 30, 1998 is a gain on the sale of real estate of $316,000 which is the Company's equity share of the gain recognized by Tri-City Limited Partnership ("Tri-City") on the sale of its two apartment complexes. Included in equity earnings of investees for the six months ended June 30, 1997 is a gain on sale of real estate of $416,000, which is the Company's equity share of the gain recognized by Income Opportunity Realty Investors, 17
18 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Results of Operations (Continued) Inc. on the sale of one of its apartment complexes. At July 31, 1998, the Company owned approximately 22.8% of IORI's outstanding shares of common stock. In the three and six months ended June 30, 1998, the Company recognized a gain on sale of real estate of $2.1 million. Such gain had been deferred on a prior years sale of one of the Company's properties until the financing provided by the Company was collected. Such note was collected in April 1998. See NOTE 3. "NOTES AND INTEREST RECEIVABLE." In the six months ended June 30, 1997, the Company recognized gains totaling $1.5 million on the sale of (i) the Fiesta Mart, a shopping center, (ii) a parcel of land in the Dallas central business district, and (iii) a foreclosed single family residence. Tax Matters As more fully discussed in the Company's 1997 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 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 18
19 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Environmental Matters (Continued) 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. YEAR 2000 The Company's advisor has advised the Company that its current computer software has been certified by the Information Technology Association of America ("ITAA") as year 2000 compliant. The Company's advisor has also advised the Company that it has recently received and plans to install in the third quarter of 1998 the ITAA certified year 2000 compliant operating system for its computer hardware. ---------- 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 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 Olive Modification, and during August and September 1996, the Court held evidentiary hearings to assess compliance with the terms of the Olive Modification by various parties. The Court issued no ruling or order with respect to the matters addressed at the hearings. 19
20 ITEM 1. LEGAL PROCEEDINGS (Continued) 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 Olive Modification. On January 27, 1997, the parties entered into an Amendment to the Olive Modification effective January 9, 1997 (the "Olive Amendment"), which was submitted to the Court for approval on January 29, 1997. The Olive 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 Olive Amendment. As a result of the hearing, the parties entered into a revised Amendment. The Court issued an order approving the Olive Amendment on July 3, 1997. The Olive 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 Olive Modification shall be settled by mutual agreement of the parties or, lacking such agreement, by an arbitration proceeding. Under the Olive Amendment, all shares of the Company owned by Gene E. Phillips or any of his affiliates shall be voted at all stockholder meetings of the Company held until April 28, 1999 in favor of all new Board members added under the Olive Amendment. The Olive 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. In accordance with the Olive Amendment, Richard W. Douglas, Larry E. Harley and R. Douglas Leonhard were added to the Company's Board of Directors in January 1998 and Murray Shaw was added to the Company's Board of Directors in February 1998. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: <TABLE> <CAPTION> Exhibit Number Description - ------- ----------- <S> <C> 27.0 Financial Data Schedule </TABLE> 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 December 22, 1997, was filed January 9, 1998, with respect to Item 2. "Acquisition or Disposition of Assets," and Item 7. "Financial Statements and Exhibits," which reports the acquisition of the Fairpark Apartments, Villa Piedra Apartments, Timbers Apartments and Lexington Center, and as amended on Form 8-K/A, filed June 29, 1998. A Current Report on Form 8-K, dated May 29, 1998, was filed July 2, 1998, with respect to Item 2. "Acquisition or Disposition of Assets," and Item 7. "Financial Statements and Exhibits," which reports the acquisition of the Mountain Plaza Apartments, Hunters Glen Apartments, Bent Tree Garden Apartments, Parkway North, Plaza on Bachman Creek, Ashton Way Apartments, 4400 Apartments, Woodview Apartments, Emerald Terrace Apartments, Daley Office Building and Viewridge Office Building. A Current Report on Form 8-K, dated June 26, 1998, was filed July 21, 1998, with respect to Item 2. "Acquisition or Disposition of Assets," and Item 7. "Financial Statements and Exhibits," which reports the acquisition of the Atrium Office Building and Valley Rim Office Building. 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: August 11, 1998 By: /s/ Randall M. Paulson ------------------------ ------------------------------ Randall M. Paulson President Date: August 11, 1998 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 Six Months ended June 30, 1998 <TABLE> <CAPTION> Exhibit Page Number Description Number - ------- --------------------------------------- ------ <S> <C> <C> 27.0 Financial Data Schedule 24 </TABLE> 23