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TRANSCONTINENTAL REALTY INVESTORS INC - Quarter Report: 2005 March (Form 10-Q)

For The Quarterly Period Ended March 31, 2005

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 


 

x QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005

 

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE TRANSITION PERIOD FROM              TO             

 

Commission File Number 001-09240

 


 

TRANSCONTINENTAL REALTY INVESTORS, INC.

(Exact Name of Registrant as Specified in Its Charter)

 


 

Nevada   94-6565852

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

1800 Valley View Lane, Suite 300, Dallas, Texas   75234
(Address of Principal Executive Office)   (Zip Code)

 

(469) 522-4200

(Registrant’s Telephone Number, Including Area Code)

 


 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x.    No  ¨.

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).     Yes  ¨.    No  x.

 

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   7,900,869
(Class)   (Outstanding at May 13, 2005)

 



PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

The accompanying Consolidated Financial Statements as of and for the three months ended March 31, 2005, have not been audited by independent certified public accountants, but in the opinion of the management of Transcontinental Realty Investors, Inc. (“TCI”), all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of TCI’s consolidated financial position, consolidated results of operations and consolidated cash flows at the dates and for the periods indicated, have been included.

 

TRANSCONTINENTAL REALTY INVESTORS, INC.

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

 

    

March 31,

2005


   

December 31,

2004


 
Assets                 

Real estate held for investment

   $ 740,703     $ 730,584  

Less—accumulated depreciation

     (72,517 )     (72,284 )
    


 


       668,186       658,300  

Real estate held for sale

     64,242       49,878  

Real estate subject to sales contract

     69,947       70,350  

Notes and interest receivable

                

Performing (including $37,228 in 2005 and $20,925 in 2004 from affiliates and related parties)

     52,751       56,630  

Non-performing, non-accruing

     —         —    
    


 


       52,751       56,630  

Less—allowance for estimated losses

     —         —    
    


 


       52,751       56,630  

Investment in real estate entities

     19,082       17,582  

Marketable equity securities, at market value

     7,249       6,580  

Cash and cash equivalents

     9,833       21,845  

Other assets (including $7,467 in 2005 and $1,706 in 2004 from affiliates and related parties)

     43,638       39,146  
    


 


     $ 934,928     $ 920,311  
    


 


 

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

2


TRANSCONTINENTAL REALTY INVESTORS, INC.

CONSOLIDATED BALANCE SHEETS—Continued

(Dollars in thousands)

 

    

March 31,

2005


   

December 31,

2004


 
Liabilities and Stockholders’ Equity                 

Liabilities:

                

Notes and interest payable

   $ 543,237     $ 524,670  

Liabilities related to assets held for sale

     51,555       59,424  

Liabilities related to assets subject to sales contract

     59,808       59,977  

Other liabilities (including $1,338 in 2005 and $2,282 in 2004 to related parties)

     33,063       34,840  
    


 


       687,663       678,911  

Commitments and contingencies

                

Minority interest

     1,075       881  

Stockholders’ equity:

                

Preferred Stock

                

Series C; $.01 par value; authorized, issued and outstanding 30,000 shares (liquidation preference $3,000)

     —         —    

Common stock, $.01 par value; authorized, 10,000,000 shares; issued and outstanding 7,900,869 shares in 2005 and 2004

     81       81  

Treasury stock

     (3,086 )     (3,086 )

Paid-in capital

     256,652       256,704  

Accumulated deficit

     (6,567 )     (10,915 )

Accumulated other comprehensive loss

     (890 )     (2,265 )
    


 


       246,190       240,519  
    


 


     $ 934,928     $ 920,311  
    


 


 

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

3


TRANSCONTINENTAL REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except per share)

 

    

For the Three Months

Ended March 31,


 
     2005

    2004

 
           As Restated  

Property revenue:

                

Rents

   $ 23,563     $ 21,086  

Property expense:

                

Property operations (including $1,240 for three months of 2005 and $803 for three months of 2004 to affiliates and related parties)

     15,155       13,530  
    


 


Operating income

     8,408       7,556  

Land Operations:

                

Sales

     1,003       29,950  

Cost of sales

     993       22,282  

Deferred gain on sale

     —         5,562  
    


 


Gain on Sales

     10       2,106  

Other income (loss):

                

Interest (including $550 for three months of 2005 and $201 for three months of 2004 from affiliates and related parties)

     845       398  

Equity in income (loss) of equity investees

     1,191       (570 )
    


 


       2,036       (172 )

Other expense:

                

Interest

     8,752       7,548  

Depreciation

     3,873       3,906  

Advisory fee to affiliate

     1,752       1,640  

Net income fee to affiliate

     325       79  

General and administrative (including $475 for three months of 2005 and $478 for three months of 2004 to affiliates and related parties)

     1,468       2,957  

Minority interest

     (155 )     324  
    


 


       16,015       16,454  
    


 


Net loss from continuing operations before taxes

     (5,561 )     (6,964 )

Income tax benefit

     1,946       —    
    


 


Net loss from continuing operations

     (3,615 )     (6,964 )

Discontinued operations (See Note 9)

     9,909       9,029  

Less: Income tax expense

     (1,946 )     —    
    


 


Net income from discontinued operations

     7,963       9,029  

Net income

     4,348       2,065  

Preferred dividend requirement

     (52 )     (53 )
    


 


Net income applicable to common shares

   $ 4,296     $ 2,012  
    


 


 

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

4


TRANSCONTINENTAL REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

 

    

For the Three Months

Ended March 31,


 
     2005

    2004

 
           As Restated  

Basic earnings per share:

                

Net loss from continuing operations

   $ (.46 )   $ (.93 )

Correction of accounting error in prior period

     —         .07  

Discontinued operations

     1.00       1.11  
    


 


Net income applicable to common shares

   $ .54     $ .25  
    


 


Diluted earnings per share:

                

Net loss from continuing operations

   $ (.46 )   $ (.93 )

Correction of accounting error in prior period

     —         .07  

Discontinued operations

     1.00       1.11  
    


 


Net income applicable to common shares

   $ .54     $ .25  
    


 


Weighted average common shares used in computing earnings per share:

                

Basic

     7,900,869       8,113,669  

Diluted

     7,900,869       8,113,669  

 

Convertible Series C Preferred stock (173,340 shares) and options to purchase 40,000 shares of TCI’s common stock were excluded from the computation of diluted earnings per share for the three months ended March 31, 2005, because the effect of their inclusion would be antidilutive.

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

5


TRANSCONTINENTAL REALTY INVESTORS, INC.

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

For the Three Months Ended March 31, 2005

(Dollars in thousands)

 

     Common Stock

  

Treasury
Stock


   

Paid-in
Capital


   

Accumulated
Deficit


   

Accumulated
Other
Comprehensive
Income


   

Stockholders’
Equity


 
     Shares

   Amount

          

Balance, January 1, 2005

   7,900,869    $ 81    $ (3,086 )   $ 256,704     $ (10,915 )   $ (2,265 )   $ 240,519  

Comprehensive income

                                                    

Unrealized gain on foreign currency translation

   —        —        —         —         —         706       706  

Unrealized gain on marketable securities

   —        —        —         —         —         669       669  

Net income

   —        —        —         —         4,348       —         4,348  
                                                


                                                   5,723  

Series C Preferred Stock cash dividends ($7.00 per share)

   —        —        —         (52 )     —         —         (52 )
    
  

  


 


 


 


 


Balance, March 31, 2005

   7,900,869    $ 81    $ (3,086 )   $ 256,652     $ (6,567 )   $ (890 )   $ 246,190  
    
  

  


 


 


 


 


 

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

6


TRANSCONTINENTAL REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

 

    

For the Three Months

Ended March 31,


 
     2005

    2004

 
           As Restated  

Cash Flows from Operating Activities

                

Reconciliation of net income (loss) to net cash provided by (used in) operating activities

                

Net income

   $ 4,348     $ 2,065  

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities
     Depreciation and amortization

     3,909       5,507  

Amortization of deferred borrowing costs

     1,121       599  

Gain on sale of real estate

     (10,368 )     (11,906 )

Equity in (income) loss of equity investees

     (1,191 )     570  

Loss (income) allocated to minority interest

     (155 )     324  

Decrease (increase) in interest receivable

     37       (345 )

Decrease in other assets

     2,412       47  

Decrease in interest payable

     (818 )     (1,290 )

Increase in other liabilities

     1,089       15,995  
    


 


Net cash provided by operating activities

     384       11,566  

Cash Flows from Investing Activities

                

Collections on notes receivable

     1,374       39  

Funding of notes receivable

     (647 )     (55 )

Acquisition of real estate

     (7,806 )     (14,700 )

Real estate improvements

     (1,257 )     (1,785 )

Real estate construction

     (13,774 )     (53,279 )

Proceeds from sale of real estate

     13,638       51,844  

Distributions from equity investees, net

     406       4  

Deposits on pending purchases and financings

     (671 )     (2,594 )
    


 


Net cash used in investing activities

     (8,737 )     (20,526 )

Cash Flows from Financing Activities

                

Payments on notes payable

     (26,569 )     (106,861 )

Proceeds from notes payable

     31,688       117,137  

Payments from (to) advisor

     (8,470 )     1,070  

Deferred financing costs

     (308 )     (1,489 )
    


 


Net cash (used in) provided by financing activities

     (3,659 )     9,857  

Net increase (decrease) in cash and cash equivalents

     (12,012 )     897  

Cash and cash equivalents, beginning of period

     21,845       6,434  
    


 


Cash and cash equivalents, end of period

   $ 9,833     $ 7,331  
    


 


 

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

7


TRANSCONTINENTAL REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS—Continued

(Dollars in thousands)

 

    

For the Three Months

Ended March 31,


     2005

   2004

Supplemental Disclosures of Cash Flow Information:

             

Cash paid for interest

   $ 10,780    $ 10,202

Schedule of non-cash investing and financing activities:

             

Notes payable assumed on purchase of real estate

     7,430      —  

Notes payable assumed by buyer on sale of real estate

     738      2,825

Notes receivable provided on the sale of real estate

     —        9,925

Notes payable proceeds used by affiliate for the purchase of real estate

     —        1,000

Real estate purchased from affiliate decreasing affiliate receivable

     4,072      2,585

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

 

8


TRANSCONTINENTAL REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1. BASIS OF PRESENTATION

 

Transcontinental Realty Investors, Inc. (“TCI”) is a Nevada corporation and successor to a California business trust which was organized on September 6, 1983. TCI invests in real estate through direct ownership, leases and partnerships. TCI also invests in mortgage loans on real estate.

 

The accompanying Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America 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 accounting principles generally accepted in the United States of America for complete financial statements. Dollar amounts in tables are in thousands, except per share amounts. Certain balances for 2004 have been reclassified to conform to the 2005 presentation.

 

Operating results for the three month period ended March 31, 2005, are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. For further information, refer to the Consolidated Financial Statements and notes included in TCI’s Annual Report on Form 10-K for the year ended December 31, 2004 (the “2004 Form 10-K”).

 

Effective March 31, 2003, TCI financial results have been consolidated in the American Realty Investors, Inc. (“ARI”) Form 10-Q and related consolidated financial statements. As of March 31, 2005, ARI owned 82.2% of the outstanding TCI common shares.

 

Stock-based employee compensation. TCI provides stock options to certain directors. TCI accounts for these stock options using the intrinsic method pursuant to the Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), and related interpretations. In December 2002, the Financial Accounting Standards Board issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure” (“SFAS 148”), which amended SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”). The new standard provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. Additionally, the statement amends the disclosure requirements of SFAS 123 to require prominent disclosures in the annual and interim financial statements for fiscal years ending after December 15, 2002. In compliance with SFAS No. 148, TCI has elected to continue to follow the intrinsic value method in accounting for its stock-based employee compensation arrangement as defined by APB 25. If TCI had elected to recognize compensation cost for the issuance of options to directors of TCI based on the fair value at the grant dates for awards consistent with the fair value method prescribed by SFAS No. 123, net income (loss) and income (loss) per share would have been impacted as follows:

 

    

For the Three

Months

Ended March 31,


     2005

   2004

          As Restated

Net income (loss)

             

As reported

   $ 4,296    $ 2,012

Proforma compensation expense, net of tax

     154      137
    

  

Proforma

   $ 4,142    $ 1,875
    

  

Basic earnings (loss) per share:

             

As reported

   $ .54    $ .25

Proforma

   $ .52    $ .24

Diluted earnings (loss) per share:

             

As reported

   $ .54    $ .25

Proforma

   $ .52    $ .24

 

 

9


TRANSCONTINENTAL REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—Continued

 

NOTE 2. REAL ESTATE

 

In 2005, TCI purchased the following properties:

 

Property


   Location

   Units/
Sq. Ft./Acres


  

Purchase

Price


   Net Cash
Paid/(Received)


    Debt
Incurred


   

Interest

Rate


   

Maturity

Date


First Quarter

                                           

Office Buildings

                                           

Two Hickory(3)

   Farmers Branch, TX    96,127 Sq. Ft.    $ 11,502    $ —       $ 7,430 (1)   4.9 %(2)   05/06

Land

                                           

Mandahl Bay

   US Virgin Islands    50.8 Acres      7,000      4,101       3,500     7.0 %   07/05

Mandahl Bay (Gilmore)

   US Virgin Islands    1.02 Acres      96      104       —       —       —  

Mandahl Bay (Chung)

   US Virgin Islands    .75 Acres      95      101       —       —       —  

Second Quarter

                                           

Apartments

                                           

Foxwood(3)

   Memphis, TN    220 Units      6,988      —         5,609 (1)   6.54 %   01/08

Parc at Metro Center(4)

   Nashville, TN    144 Units      817      (378 )     817     5.65 %   09/46

Office Buildings

                                           

Park West

   Farmers Branch, TX    243,416 Sq. Ft.      10,000      4,715       6,500     7.5 %(2)   05/06

Land

                                           

Centurion

   Tarrant County, TX    12.724 Acres      850      892       —       —       —  

(1) Assumed debt.
(2) Variable rate.
(3) Property received from ARI, a related party, for payment of a note receivable. See NOTE 3. “NOTES AND INTEREST RECEIVABLE.”
(4) Initial construction loan funding to purchase land and begin apartment construction. Does not represent actual units purchased.

 

In 2004, TCI purchased the following properties:

 

Property


   Location

   Units/Acres

  

Purchase

Price


   Net Cash
Paid/(Received)


    Debt
Incurred


  

Interest

Rate


    Maturity
Date


First Quarter

                                          

Apartments

                                          

288 City Park(1)

   Houston, TX    240 Units    $ 3,056    $ 612     $ 2,444    5.95 %   04/45

Blue Lake Villas II(1)

   Waxahachie, TX    70 Units      729      (164 )     729    5.80     04/45

Bridges on Kinsey(1)

   Tyler, TX    232 Units      2,291      596       1,687    5.74     08/45

Dakota Arms(1)

   Lubbock, TX    208 Units      2,472      681       1,791    5.85     06/45

Lake Forest(1)

   Houston, TX    240 Units      2,316      (470 )     2,316    5.60     03/45

Vistas of Vance Jackson(1)

   San Antonio, TX    240 Units      3,550      771       2,779    5.78     06/45

Land

                                          

Lubbock

   Lubbock, TX    2.866 Acres      224      224       —      —       —  

Railroad

   Dallas, TX    .293 Acres      708      704       —      —       —  

Vista Ridge(2)

   Lewisville, TX    14.216 Acres      2,585      —         —      —       —  

(1) Initial construction loan funding to purchase land and begin apartment construction. Does not represent actual units purchased.
(2) Property received from ARI for a decrease of $2.6 million to TCI’s affiliate receivable with Prime.

 

 

10


TRANSCONTINENTAL REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—Continued

 

In 2005, TCI sold the following properties:

 

Property


  

Location


   Acres/Sq.Ft.

  

Sales

Price


  

Net Cash

Received


  

Debt

Discharged


   

Gain

on Sale


First Quarter

                                      

Office Building

                                      

Institute Place

   Chicago, IL    144,915 Sq. Ft.    $ 14,460    $ 4,843    $ 7,792     $ 10,061

Industrial Warehouse

                                      

5700 Tulane

   Atlanta, GA    67,850 Sq. Ft.      816      738      —         294

Land

                                      

Granbury Station

   Fort Worth, TX    15.696 Acres      1,003      265      738 (1)     10

Second Quarter

                                      

Land

                                      

Alamo Springs/Lemmon Carlisle

   Dallas, TX    2.82 Acres      7,674      5,587      1,744       2,394

(1) Assumed debt.

 

In 2004, TCI sold the following properties:

 

Property


  

Location


   Acres/Sq.Ft.

  

Sales

Price


  

Net Cash

Received


  

Debt

Extinguished


   

Gain

on Sale


 

First Quarter

                                        

Office Building

                                        

Countryside Harmon

   Sterling, VA    72,062 Sq. Ft.    $ 2,650    $ 216    $ 2,200     $ 1,861  

Countryside Retail

   Sterling, VA    133,422 Sq. Ft.      27,100      3,408      22,800       5,475  

Industrial Warehouse

                                        

Kelly (Pinewood)

   Dallas, TX    100,000 Sq. Ft.      1,650      65      1,376       153  

Ogden Industrial

   Ogden, UT    107,112 Sq. Ft.      2,600      668      1,775       1,374  

Texstar Warehouse(2)

   Arlington, TX    97,846 Sq. Ft.      2,400      —        1,148 (1)     —   (3)

Shopping Center

                                        

K-Mart(2)

   Cary, NC    92,033 Sq. Ft.      3,200      —        1,677 (1)(5)     —   (4)

Land

                                        

Allen

   Collin County, TX    492.531 Acres      19,962      7,956      4,088       2,106 (6)

Marine Creek(7)

   Ft. Worth, TX    10.73 Acres      1,488      1,198      991       —   (8)

Red Cross

   Dallas, TX    2.89 Acres      8,500      2,842      4,450       —    

(1) Assumed debt.
(2) Property sold to Basic Capital Management (“BCM”), a related party, for assumption of debt and a note receivable. See Note 3. “NOTES AND INTEREST RECEIVABLE.”
(3) Excludes a $1.0 million deferred gain from a related party sale.
(4) Excludes $355,000 deferred gain from a related party sale.
(5) Failure to notify and receive approval from the lender for this transaction may constitute an even of default under the terms of the debt.
(6) Excludes a $5.0 million deferred gain due to a portion of the land sold on a contingent basis for a note receivable of $7.2 million. See Note 3. “NOTES AND INTEREST RECEIVABLE.”
(7) Property sold to Unified Housing Foundation, Inc. (“UHF”), a related party, for cash and a note receivable. See NOTE 6. “RELATED PARTY TRANSACTIONS.”
(8) Excludes a $581,000 deferred gain from a related party sale.

 

11


TRANSCONTINENTAL REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—Continued

 

At March 31, 2005, TCI had the following properties under construction:

 

Property


  

Location


  

Units


  

Amount

Expended


  

Additional

Amount

to Expend


  

Construction

Loan

Funding


Apartments

                              

Bluffs at Vista Ridge

   Lewisville, TX    272 Units    $ 19,458    $ 1,128    $ 15,500

Bridges on Kinsey

   Tyler, TX    232 Units      15,612      469      14,477

Dakota Arms

   Lubbock, TX    208 Units      12,970      967      12,549

Kingsland Ranch

   Houston, TX    398 Units      24,573      1,081      23,000

Laguna Vista

   Farmers Branch, TX    206 Units      3,790      17,315      17,741

Lake Forest

   Houston, TX    240 Units      14,137      300      12,815

Parc at Maumelle

   Maumelle, AR    240 Units      3,717      14,981      16,829

Stonebridge at City Park (formerly 288 City Park)

   Houston, TX    240 Units      15,528      1,158      15,005

Vistas of Vance Jackson

   San Antonio, TX    240 Units      16,761      1,341      16,056

Wildflower Villas

   Temple, TX    220 Units      11,806      3,790      14,073

 

For the three months ended March 31, 2005, TCI completed the 70 unit Blue Lake Villas II in Waxahachie, Texas.

 

NOTE 3. NOTES AND INTEREST RECEIVABLE

 

In March 2005, TCI entered into an agreement to advance a third party $3.2 million for development costs relating to land lots in Austin, Texas. These advances are secured by stock in the borrower and hold a second lien on the undeveloped land. The secured note bears interest at 10%, requires semi-annual payments and matures in March 2008. As of March 31, 2005, TCI had not advanced any funds to the borrower. TCI also guaranteed, with full recourse to TCI, an $18 million loan for the borrower which loan is secured by a first lien on the undeveloped land.

 

In October 2004, TCI sold the In The Pines apartments to a third party and provided $1.0 million of the purchase price as seller financing in the form of two notes. The first note bears interest at 7.0% per annum, requires monthly interest payments and matured in January 2005. The Purchaser extended this note to March 2005 by paying 1.0% of the outstanding principal balance as an extension fee and then extended the note an additional 30 days to April 2005 by paying an extension fee of 0.5% of the outstanding principal balance. In the event of a default, the note is also secured by membership rights in the purchaser’s entity. The second note is unsecured, bears interest at 8.5% per annum, requires monthly interest payments and matured in January 2005. The Purchaser extended this note to March 2005 by paying 1.0% of the outstanding principal balance as an extension fee and extended the note an additional 30 days to April 2005 by paying an extension fee of 0.5% of the outstanding principal balance. Both loans were extended to October 2005 with the payment to TCI of a 2.0% extension fee.

 

In March 2004, TCI sold 492.531 acres in Collin County, Texas to a third party for $20.0 million. TCI provided $7.2 million of the purchase price as seller financing for a portion of the land on a contingent basis. The secured note bore interest at 7% and matured in September 2004. The purchaser extended the note to December 2004 with a $1.1 million principal payment in September 2004. This note, including accrued but unpaid interest, was paid in December 2004.

 

In June 2003, TCI sold the 104 unit Willow Wick Apartments in North Augusta, South Carolina, for $2.7 million and provided $42,000 of the purchaser’s closing costs as seller financing. The note bore interest at a fixed rate of 5.0% and required all interest and principal payments be paid at maturity on December 2003. This loan was extended until February 2004 and $10,000 was received in March 2004. This note, including accrued but unpaid interest, was paid in June 2004. TCI discounted the note $2,000 and recognized a loss of $2,000.

 

In August 2001, TCI agreed to fund up to $5.6 million secured by a second lien on an office building in Dallas, Texas. The note receivable bore interest at a variable rate (then 9.0% per annum), required monthly interest only payments and originally matured in January 2003. As of March 2004, TCI had funded a total of $4.3 million. On January 22, 2003, TCI agreed to extend the maturity date until May 1, 2003. The collateral used to secure TCI’s second lien was seized by the first lien holder. On March 11, 2004, TCI agreed to accept an assignment of claims in litigation as additional security for the note. In December 2004, TCI agreed to a Modification Agreement with the borrower, which was effective November 1, 2003. As of the modified effective date, accrued interest of $582,000 was added to the principal balance of the note, the interest rate fixed at 9.0% per annum and all principal and interest is due November 2005. TCI also received Pledge and Security Agreements in various partnership interests belonging to the borrower and received various Assignments of Proceeds from sales in certain entities owned by the borrower. TCI reduced accrued interest and principal by $1.5 million from the receipt of notes receivable assigned to TCI by borrower and by $605,000 from cash received. TCI also received $1.4 million in January 2005 that was applied to accrued interest and principal effective December 30, 2004.

 

12


TRANSCONTINENTAL REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—Continued

 

In March 2002, TCI sold the 174,513 sq.ft. Hartford Office Building in Dallas, Texas, for $4.0 million and provided the $4.0 million purchase price as seller financing and an additional $1.4 million line of credit for leasehold improvements in the form of a first lien mortgage note. The note bears interest at a variable interest rate, currently 7.5% per annum, requires monthly interest only payments and matures in March 2007. As of March 2005, TCI has funded $768,000 of the additional line of credit.

 

In July 2002, TCI entered into an agreement to fund up to $300,000 under a revolving line of credit secured by 100% interest in a partnership of the borrower. The line of credit bears interest at 12.0% per annum, requires monthly interest only payments, and matures in June 2005. As of March 2005, TCI has funded $300,000 of the line of credit.

 

Related Parties. In March 2004, TCI sold a K-Mart in Cary, North Carolina to BCM for $3.2 million, including the assumption of debt. TCI also provided $1.5 million of the purchase price as seller financing. The unsecured note bears interest at the prime rate plus 2% (which is currently 8.0%), and matured in April 2005. This note was extended to April 2008.

 

In March 2004, TCI sold the Texstar Warehouse in Arlington, Texas to BCM for $2.4 million, including the assumption of debt. TCI also provided $1.3 million of the purchase price as seller financing. The unsecured note bears interest at the prime rate plus 2% (which is currently 8.0%), and matured in April 2005. This note was extended to April 2008.

 

In January 2002, TCI purchased 100% of the outstanding common shares of ART Two Hickory Corporation (“Two Hickory”), a wholly-owned subsidiary of ARI for $4.4 million cash. Two Hickory owns the 96,217 sq. ft. Two Hickory Centre Office Building in Farmers Branch, Texas. ARI guaranteed that the asset shall produce at least a 12.0% annual return of the purchase price for a period of three years from the purchase date. If the asset fails to produce the 12.0% annual return, ARI shall pay TCI any shortfall. In addition, if the asset fails to produce the 12.0% return for a calendar year and ARI fails to pay the shortfall, TCI may require ARI to repurchase the shares of Two Hickory for the purchase price. Because ARI guaranteed the 12.0% return and TCI has the option of requiring ARI to repurchase the entities, management has classified this related party transaction as a note receivable from ARI. In June 2002, the asset was refinanced. TCI received $1.3 million of the proceeds as a principal reduction on its note receivable from ARI. In January 2005, TCI completed the purchase of Two Hickory by recording the asset and removing the note receivable from ARI.

 

In April 2002, TCI purchased 100% of the following entities: ART One Hickory Corporation (“One Hickory”), Garden Confederate Point, LP (“Confederate Point”), Garden Foxwood, LP (“Foxwood”), and Garden Woodsong, LP (“Woodsong”), all previously wholly-owned subsidiaries of ARI for $10.0 million. One Hickory owns the 120,615 sq. ft. One Hickory Centre Office Building in Farmers Branch, Texas. Confederate Point owns the 206 unit Confederate Apartments in Jacksonville, Florida. Foxwood owns the 220 unit Foxwood Apartments in Memphis, Tennessee. Woodsong owned the 190 unit Woodsong Apartments in Smyrna, Georgia. ARI guaranteed that these assets shall produce at least a 12.0% return annually of the purchase price for a period of three years from the purchase date. If the assets collectively fail to produce the 12.0% return, ARI shall pay TCI any shortfall. In addition, if the assets fail to produce the 12.0% return for a calendar year and ARI fails to pay the shortfall, TCI may require ARI to repurchase the entities for the purchase price. Because ARI guaranteed the 12.0% return and TCI has the option of requiring ARI to repurchase the entities, management has classified this related party transaction as a note receivable from ARI. In July 2002, the Woodsong Apartments were sold. TCI received $2.8 million from the proceeds as payment of principal and accrued but unpaid interest on the note receivable. In October 2003, TCI sold One Hickory to IORI for $12.2 million, less prorations, for a wraparound promissory note of $12.0 million. This note bears interest at 5.49% interest, requires monthly interest and principal payments and matures in June 2006. This transaction effectively discharged the note receivable TCI had from ARI for the financing of One Hickory. Also, in November 2003, Confederate Point sold the Confederate Apartments and paid $2.1 million to TCI to pay off the loan and accrued but unpaid interest. In April 2005, TCI completed the purchase of the Foxwood Apartments by recording the asset and removing the note receivable from ARI.

 

NOTE 4. INVESTMENT IN REAL ESTATE ENTITIES

 

Real estate entities. TCI’s investment in real estate entities at March 31, 2005 included equity securities of two publicly traded real estate entities, Income Opportunity Realty Investors, Inc. (“IORI”) and ARI, related parties, and interests in real estate joint venture partnerships. ARI is a related party that owns 82.2% of TCI’s common stock and consolidates TCI’s financial accounts and operations.

 

TCI accounts for its investment in IORI and ARI and the joint venture partnerships using the equity method. Garden Centura, L.P. is accounted for on the cost method.

 

13


TRANSCONTINENTAL REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—Continued

 

TCI’s investment in real estate entities at March 31, 2005, was as follows:

 

Investee


  

Percentage

of TCI’s

Ownership at

March 31, 2005


   

Carrying

Value of

Investment at

March 31, 2005


  

Market Value

of Investment at

March 31, 2005


IORI

   24.9 %   $ 5,825    $ 5,635

ARI

   6.4 %     11,005      6,723

Garden Centura, L.P.

   5.0 %     1,925      —  
          

  

             18,755    $ 12,358
                 

Other

           327       
          

      
           $ 19,082       
          

      

 

Management continues to believe that the market value of each of IORI and ARI undervalues their assets and, therefore, TCI may continue to increase its ownership in these entities.

 

Set forth below is summarized results of operations of equity method investees for the first three months of 2005 and 2004.

 

     2005

    2004

 

Revenues

   $ 53,372     $ 32,264  

Equity in loss of partnerships

     (9 )     (1 )

Property operating expenses

     (25,404 )     (26,299 )

Depreciation

     (2,139 )     (2,633 )

Interest expense

     (7,991 )     (10,403 )

Income/(loss) before gains on sale of real estate

     17,829       (7,072 )

Gain on sale of real estate

     99       6,987  
    


 


Net income (loss)

   $ 17,928     $ (85 )
    


 


 

NOTE 5. MARKETABLE EQUITY SECURITIES

 

TCI owns equity securities of Realty Korea CR-REIT Co., Ltd. No. 1 representing approximately a 9.2% ownership interest. This investment is considered an available-for-sale security. TCI recognized an unrealized gain of $669,000 for the period ending March 31, 2005 due to an increase in market price.

 

NOTE 6. RELATED PARTIES

 

On September 19, 2002, TCI’s Board of Directors authorized the Chief Financial Officer of TCI to advance funds either to or from TCI, through the advisor, in an amount up to $15.0 million on the condition that such advances shall be repaid in cash or transfers of assets within 90 days. These advances are unsecured and bear no interest and generally have not had specific repayment terms and have been reflected in TCI’s financial statements as other assets and other liabilities.

 

In February 2004, TCI received a loan for $1.0 million used for the purchase of land by ARI, increasing the affiliate receivable balance by $1.0 million.

 

In February 2004, TCI recorded the sale of a tract of Marine Creek land originally sold to a related party in December 2003. This transaction was not recorded as a sale for accounting purposes in December 2003 and was recorded as a TCI refinancing transaction in February 2004. TCI received $1.2 million in cash from the related party in February 2004 as payment on the land. TCI still has a note receivable balance of $270,000 that bears interest at 12.0% and matures in April 2009. TCI recorded the sale of the Marine Creek land tract due to the payment received on the note receivable.

 

In January 2004, TCI purchased 14.216 acres of land from an affiliate with a net purchase price of $2.6 million, decreasing the affiliate receivable balance by $2.6 million.

 

14


TRANSCONTINENTAL REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—Continued

 

The following table reconciles the beginning and ending Affiliates receivable (payable) balances as of March 31, 2005.

 

     PRIME

    IORI

 

Balance, December 31, 2004

   $ (829 )   $ (260 )

Cash transfers

     13,650       —    

Cash repayments

     (5,180 )     —    

Repayments through property transfers

     (1,370 )     —    

Fees payable to affiliate

     (416 )     —    

Payables clearing through Prime

     330       —    
    


 


Balance, March 31, 2005

   $ 6,185     $ (260 )
    


 


 

Returns on Metra Properties. In April 2002, TCI sold 12 apartment properties to partnerships controlled by Metra Capital, LLC (“Metra”). Innovo Group, Inc. (“Innovo”) is a limited partner in the partnerships that purchased the properties. Joseph Mizrachi, then a Director of ARI, a related party, controlled approximately 11.67% of the outstanding common stock of Innovo. Management determined to treat the sales as financing transactions, and TCI continues to report the assets and the new debt incurred by Metra on its financial statements. The partnership agreements for each of these partnerships state that the Metra Partners, as defined, receive cash flow distributions at least quarterly in an amount sufficient to provide them with a 15% cumulative compounded annual rate of return on their invested capital, as well as a cumulative compounded annual amount of 0.50% of the average outstanding balance of the mortgage indebtedness secured by any of these properties. These distributions to the Metra Partners have priority over distributions to any other partners. At March 31, 2005, 12 of the properties remained on TCI’s balance sheet. During April 2005, resolution of the litigation occurred, settling all liabilities remaining from the original partnership arrangements which included a return of investor equity, prospective asset management fees and miscellaneous fees and transactions costs from the Plaintiffs as a prepayment of a preferred return, along with a delegation of management to another entity, and a motion to dismiss the action as a part of the resolution. Of the prepayment, the Company will recognize expenses of $462,000 and a reduction in liabilities of $2.1 million during the second quarter of 2005.

 

NOTE 7. NOTES AND INTEREST PAYABLE

 

In February 2005, TCI received a loan in the amount of $5.0 million. The note bears interest at 8.0% per annum, requires semi-annual interest payments and matures in July 2006. The loan is collateralized by certain partnership interests that hold apartments owned by TCI. At maturity, the lender has the option to convert the outstanding loan balance into general and limited partnership units in each of the partnerships, subject to HUD approval.

 

In February 2004, TCI received a loan for $1.0 million that is cross defaulted and cross collateralized with ARI’s purchase of land in Portage County, Ohio. The loan bears interest at the prime rate plus .5%, which is currently 6.5%, requires monthly principal and interest payments, and matured in February 2005. This loan was extended to August 2005.

 

15


TRANSCONTINENTAL REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—Continued

 

In 2005, TCI refinanced or financed the following properties:

 

Property


   Location

   Sq.Ft./Units

  

Debt

Incurred


  

Debt

Discharged


  

Net Cash

Received


  

Interest

Rate


   

Maturity

Date


First Quarter

                                         

Office Buildings

                                         

Bridgeview Plaza

   LaCrosse, WI    116,008 Sq. Ft.    $ 7,197    $ 6,304    $ 649    7.25 %(1)   03/10

Shopping Centers

                                         

Dunes Plaza

   Michigan City, IN    223,869 Sq. Ft.      3,750      2,685      658    7.50 (1)   01/10

Second Quarter

                                         

Apartments

                                         

Autumn Chase

   Midland, TX    64 Units      1,166      797      317    5.88 (1)   05/35

Courtyard

   Midland, TX    133 Units      1,342      966      266    5.88 (1)   05/35

Southgate

   Odessa, TX    180 Units      1,879      1,712      61    5.88 (1)   05/35

(1) Variable rate.

 

In 2004, TCI refinanced or financed the following properties:

 

Property


   Location

   Sq. Ft./Acres

  

Debt

Incurred


  

Debt

Discharged


  

Net Cash

Received/(Paid)


   

Interest

Rate


   

Maturity

Date


 

First Quarter

                                            

Office Building

                                            

Centura Tower

   Farmers Branch, TX    410,901 Sq. Ft.    $ 34,000    $ 36,889    $ (4,588 )   5.50 %(1)   04/06  

Land

                                            

Centura Land

   Farmers Branch, TX    8.753 Acres      4,485      4,400      (183 )   7.00 (1)   11/04 (3)

Hollywood, Dominion & Mira Lago(2)

   Farmers Branch, TX    66.085 Acres      6,985      6,222      (67 )   7.00 (1)   02/05 (4)

(1) Variable rate
(2) The Hollywood Casino, Dominion and Mira Lago tracts are cross collateralized.
(3) Repaid in February 2005.
(4) Maturity extended to February 2006.

 

NOTE 8. OPERATING SEGMENTS

 

Significant differences among the accounting policies of the operating segments as compared to the Consolidated Financial Statements principally involve the calculation and allocation of administrative expenses. Management evaluates the performance of each of the operating segments and allocates resources to them based on their operating income and cash flow. Items of income that are not reflected in the segments are interest, equity in loss of equity investees and equity in investees gains on sales of real estate which totaled $2.0 million and $856,000 for the three months ended March 31, 2005 and 2004, respectively. Expenses that are not reflected in the segments are general and administrative expenses, minority interest, advisory and net income fees which totaled $3.4 million and $5.0 million for the three months ended March 31, 2005 and 2004, respectively. Also excluded from segment assets are assets of $132.6 million at March 31, 2005, and $105.5 million at March 31, 2004, which are not identifiable with an operating segment. There are no intersegment revenues and expenses.

 

 

16


TRANSCONTINENTAL REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—Continued

 

Presented below is the operating income of each operating segment for the three months ended March 31, 2005 and 2004, and each segment’s assets at March 31.

 

Three Months Ended March 31, 2005


   Land

   

Commercial

Properties


   Apartments

   Hotels

   Total

Rents

   $ 134     $ 5,921    $ 16,035    $ 1,473    $ 23,563

Property operating expenses

     762       3,595      9,555      1,243      15,155
    


 

  

  

  

Operating income (loss)

   $ (628 )   $ 2,326    $ 6,480    $ 230    $ 8,408
    


 

  

  

  

Interest

   $ 889     $ 1,955    $ 5,566    $ 342    $ 8,752

Depreciation

     11       1,769      1,913      180      3,873

Real estate improvements

     148       1,099      —        10      1,257

Real estate construction

     —         —        13,774      —        13,774

Assets

     150,277       142,116      475,539      34,443      802,375

Property Sales:

 

   Land

   

Commercial

Properties


   Apartments

   Hotels

   Total

Sales price

   $ 1,003     $ 15,276    $ —      $ —      $ 16,279

Cost of sales

     993       4,922      —        —        5,915
    


 

  

  

  

Gain on sale

   $ 10     $ 10,354    $ —      $ —      $ 10,364
    


 

  

  

  

Three Months Ended March 31, 2004 (As Restated)


   Land

   

Commercial

Properties


   Apartments

   Hotels

   Total

Rents

   $ 142     $ 6,873    $ 12,909    $ 1,162    $ 21,086

Property operating expenses

     428       4,174      7,896      1,032      13,530
    


 

  

  

  

Operating income (loss)

   $ (286 )   $ 2,699    $ 5,013    $ 130    $ 7,556
    


 

  

  

  

Interest

   $ 621     $ 1,568    $ 4,805    $ 554    $ 7,548

Depreciation

     19       2,005      1,545      337      3,906

Real estate improvements

     100       1,445      222      18      1,785

Real estate construction

     —         —        53,279      —        53,279

Assets

     84,861       244,281      426,208      33,222      788,572

Property Sales:

 

   Land

   

Commercial

Properties


   Apartments

   Hotels

   Total

Sales price

   $ 29,950     $ 39,600    $ —      $ —      $ 69,550

Cost of sales

     22,282       29,434      —        —        51,716

Deferred current gain

     5,562       1,394      —        —        6,956
    


 

  

  

  

Gain on sale

   $ 2,106     $ 8,772    $ —      $ —      $ 10,878
    


 

  

  

  

 

 

17


TRANSCONTINENTAL REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—Continued

 

NOTE 9. DISCONTINUED OPERATIONS

 

For the three months ended March 31, 2005 and 2004, income from discontinued operations relates to 9 properties that TCI sold or are to be sold in 2005 and 22 properties that TCI sold during 2004. The following table summarizes revenue and expense information for these properties sold and held-for-sale.

 

    

For the

Three Months

Ended March 31,


 
     2005

    2004

 

Revenue

                

Rental

   $ 2,961     $ 9,803  

Property operations

     2,091       5,224  
    


 


       870       4,579  

Expenses

                

Interest

     1,283       3,748  

Depreciation

     36       1,602  
    


 


       1,319       5,350  
    


 


Net loss from discontinued operations before gains on sale of real estate

     (449 )     (771 )

Gain on sale of operations

     10,354       8,772  

Equity in investees gain on sale of real estate

     4       1,028  
    


 


Net income from discontinued operations

   $ 9,909     $ 9,029  
    


 


 

Discontinued operations have not been segregated in the consolidated statements of cash flows. Therefore, amounts for certain captions will not agree with respective consolidated statements of operations.

 

NOTE 10. CORRECTION OF ACCOUNTING ERROR IN PRIOR PERIOD

 

During the second quarter of 2004, TCI discovered an error in the depreciation calculation for a shopping center TCI had purchased in March 2003 for $8.7 million. The amount subject to depreciation was $7.8 million and was to be depreciated straight-line over 40 years or 480 months. Instead, the property was depreciated over 40 months instead of 480 months, resulting in depreciation expense being overstated since March 2003. The unaudited Consolidated Statements of Operations for the three months ended March 31, 2004, reflect the correction of the impact of this error on depreciation expense of $538,000. TCI does not intend to restate any previously issued Form 10-Q’s or Form 10-K’s for previous periods because, in the opinion of management, the effect is not material to the results of operations for any period previously reported.

 

NOTE 11. COMMITMENTS AND CONTINGENCIES

 

Partnership Obligations. TCI is the limited partner in 11 partnerships that are currently constructing residential properties. As permitted in the respective partnership agreements, TCI intends to purchase the interests of the general and any other limited partners in these partnerships subsequent to the completion of these projects. The amounts paid to buyout the non-affiliated partners are limited to development fees earned by the non-affiliated partners, and are set forth in the respective partnership agreements. The total amount of the expected buyouts as of March 31, 2005 is approximately $2.1 million. TCI is a non-controlling general and limited partner in a real estate partnership and is obligated to fund approximately $2.3 million through March 31, 2006 for certain partnership obligations.

 

Liquidity. Although management anticipates that TCI will generate excess cash from operations in 2005, such excess, however, will not be sufficient to discharge all of TCI’s debt obligations as they mature. Management intends to selectively sell income producing real estate, refinance real estate and incur additional borrowings against real estate to meet its cash requirements.

 

Litigation. TCI is involved in various lawsuits arising in the ordinary course of business. Management is of the opinion that the outcome of these lawsuits will have no material impact on TCI’s financial condition, results of operations or liquidity.

 

Guarantees. In February 2004, various subsidiaries of TCI guaranteed a $10 million line of credit for its parent, ARI. The subsidiaries of TCI also pledged and assigned assets, in the form of securities and partnership interests in construction properties, as additional collateral for this line of credit.

 

 

18


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

WARNING CONCERNING FORWARD LOOKING STATEMENTS

 

This quarterly report on Form 10-Q and TCI’s 2004 Form 10-K, referred to herein, contain forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and federal securities laws. These statements concern the intent, belief or expectations of TCI’s officers with respect to TCI’s ability to lease its properties, tenant’s ability to pay rents, purchase of additional properties, ability to pay interest and debt principal and make distributions, policies and plans regarding investments and financings, and other matters. Also, words such as “believe”, “expect”, “anticipate”, “intend”, “plan”, “estimate”, or similar expressions identify forward looking statements. Actual results may differ materially from those contained in or implied by the forward looking statements as a result of various factors. Such factors include, without limitation, the impact of changes in the economy and the capital markets on TCI and its tenants, competition within the real estate industry or those industries in which its tenants operate, and changes in federal, state and local legislation. For example: Some of TCI’s tenants may not renew expiring leases and TCI may be unable to locate new tenants to maintain the historical occupancy rates of the properties; rents which TCI can achieve at its properties may decline; tenants may experience losses and become unable to pay rents; and TCI may be unable to identify or to negotiate acceptable purchase prices for new properties. These results could occur due to many different circumstances, some of which, such as changes in TCI’s tenants’ financial conditions or needs for leased space, or changes in the capital markets or the economy, generally, are beyond TCI’s control. Forward looking statements are only expressions of TCI’s present expectations and intentions. Forward looking statements are not guaranteed to occur, and they may not occur. You should not place undue reliance upon forward looking statements.

 

Introduction

 

TCI invests in real estate through acquisitions, leases and partnerships. TCI also invests in mortgage loans. TCI is the successor to a business trust organized on September 6, 1983, and commenced operations on January 31, 1984.

 

Critical Accounting Policies

 

Critical accounting policies are those that are both important to the presentation of TCI’s financial condition and results of operations and require management’s most difficult, complex or subjective judgments. TCI’s critical accounting policies relate to the evaluation of impairment of long-lived assets and the evaluation of the collectibility of accounts and notes receivable.

 

If events or changes in circumstances indicate that the carrying value of a rental property to be held and used or land held for development may be impaired, management performs a recoverability analysis based on estimated undiscounted cash flows to be generated from the property in the future. If the analysis indicates that the carrying value is not recoverable from future cash flows, the property is written down to estimated fair value and an impairment loss is recognized. If management decides to sell rental properties or land held for development, management evaluates the recoverability of the carrying amounts of the assets. If the evaluation indicates that the carrying value is not recoverable from estimated net sales proceeds, the property is written down to estimated fair value less costs to sell and an impairment loss is recognized within income from continuing operations. TCI’s estimates of cash flow and fair values of the properties are based on current market conditions and consider matters such as rental rates and occupancies for comparable properties, recent sales data for comparable properties and, where applicable, contracts or the results of negotiations with purchasers or prospective purchasers. TCI’s estimates are subject to revision as market conditions and TCI’s assessments of them change.

 

TCI’s allowance for doubtful accounts receivable and notes receivable is established based on analysis of the risk of loss on specific accounts. The analysis places particular emphasis on past due accounts. Management considers such information as the nature and age of the receivable, the payment history of the tenant or other debtor, the financial condition of the tenant or other debtor and TCI’s assessment of its ability to meet its lease or interest obligations. TCI’s estimate of the required allowance, which is reviewed on a quarterly basis, is subject to revision as these factors change and is sensitive to the effects of economic and market conditions.

 

TCI’s management periodically discusses criteria for estimates and disclosures of its estimates with the Audit Committee of its Board of Directors.

 

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

Liquidity and Capital Resources

 

TCI reported net income of $4.3 million for the three months ended March 31, 2005, which included the following non-cash charges: depreciation and amortization of $5.0 million, equity income of equity investees of $1.2 million, and gain on sale of real estate of $10.4 million. For the three months ended March 31, 2004, TCI reported net income of $2.1 million, which included the following non-cash charges: depreciation and amortization of $6.1 million, equity loss of equity investees of $570,000 and gain on sale of real estate of $11.9 million.

 

For the three months ended March 31, 2005, net cash provided by operating activities amounted to $384,000, due to other assets increased by $2.4 million primarily due to a reduction in escrows and deposits, interest payable decreased by $818,000 and other liabilities increased by $1.1 million due to an increase in accrued expenses.

 

Also for the three months ended March 31, 2005, net cash used in investing activities was $8.7 million primarily due to real estate construction and improvements of $15.0 million, payments for real estate acquisitions of $7.8 million, deposits on pending purchases of $671,000 and additional fundings on notes receivable of $647,000. These outflows for investing activities were offset by the collection of $1.4 million on notes receivable and proceeds from sale of real estate of $13.6 million.

 

Net cash used in financing activities of $3.7 million was due to proceeds received from the funding or refinancing of notes payable of $31.7 million; offset by cash payments of $26.6 million to paydown existing notes payable, $308,000 for financing costs and $8.5 million in payments made to the advisor.

 

In the first three months of 2005, TCI sold one office building, one industrial warehouse and one land parcel for a total of $16.3 million, receiving $5.8 million in cash and discharging debt of $8.5 million after the payment of various closing costs.

 

Also in the first three months of 2005, TCI financed or refinanced two shopping centers for a total of $10.9 million, discharging $9.0 million in debt and receiving $1.3 million in cash.

 

Further in the first three months of 2005, TCI purchased three parcels of unimproved land and one office building for $18.7 million. TCI paid $4.3 million in cash, including various closing costs and incurred or assumed $10.9 million in debt. TCI also incurred $13.8 million on property construction, of which $12.3 million was funded by debt. For the remainder of 2005 and the first half of 2006, TCI expects to spend an additional $42.5 million on property construction projects, of which $42.1 million will be funded by debt.

 

Management reviews the carrying values of TCI’s properties and mortgage notes receivable at least annually and whenever events or a change in circumstances indicate that impairment may exist. Impairment is considered to exist if, in the case of a property, the future cash flow from the property (undiscounted and without interest) is less than the carrying amount of the property. For notes receivable, impairment is considered to exist if it is probable that all amounts due under the terms of the note will not be collected. If impairment is found to exist, a provision for loss is recorded by a charge against earnings. The mortgage note receivable review includes an evaluation of the collateral property securing each note. The property review generally includes: (1) selective property inspections; (2) a review of the property’s current rents compared to market rents; (3) a review of the property’s expenses; (4) a review of maintenance requirements; (5) a review of the property’s cash flow; (6) discussions with the manager of the property; and (7) a review of properties in the surrounding area.

 

Related Party Transactions

 

In February 2004, TCI received a loan for $1.0 million used for the purchase of land by ARI, increasing the affiliate receivable balance by $1.0 million.

 

In February 2004, TCI recorded the sale of a tract of Marine Creek land originally sold to a related party in December 2003. This transaction was not recorded as a sale for accounting purposes in December 2003 and was recorded as a TCI refinancing transaction in February 2004. TCI received $1.2 million in cash from the related party in February 2004 as payment on the land. TCI still has a note receivable balance of $270,000 remaining that bears interest at 12.0% and matures in April 2009. TCI recorded the sale of the Marine Creek land tract due to the payment received on the note receivable.

 

In January 2004, TCI purchased 14.216 acres of land from an affiliate with a net purchase price of $2.6 million, decreasing the affiliate receivable balance by $2.6 million.

 

20


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

In April 2002, TCI sold 12 apartment properties to partnerships controlled by Metra Capital, LLC (“Metra”). Innovo Group, Inc. (“Innovo”) is a limited partner in the partnerships that purchased the properties. Joseph Mizrachi, then a Director of ARI, a related party, controlled approximately 11.67% of the outstanding common stock of Innovo. Management determined to treat the sales as financing transactions, and TCI continues to report the assets and the new debt incurred by Metra on its financial statements. The partnership agreements for each of these partnerships state that the Metra Partners, as defined, receive cash flow distributions at least quarterly in an amount sufficient to provide them with a 15% cumulative compounded annual rate of return on their invested capital, as well as a cumulative compounded annual amount of 0.50% of the average outstanding balance of the mortgage indebtedness secured by any of these properties. These distributions to the Metra Partners have priority over distributions to any other partners. At March 31, 2005, 12 of the properties remained on TCI’s balance sheet.

 

Results of Operations

 

TCI had net income of $4.3 million in the period ended March 31, 2005, including gains on the sale of real estate totaling $10.4 million and a loss from discontinued operations of $449,000, compared to net income of $2.0 million in the corresponding period in 2004, including gains on real estate of $10.9 million, a loss from discontinued operations of $771,000 and $1.0 million gain on sale of real estate by equity investees. Fluctuations in this and other components of revenues and expense between the 2005 and 2004 periods are discussed below.

 

Rents in the period ended March 31, 2005, increased to $23.6 million compared to $21.1 million in 2004. This increase is mainly due to additional rental income from the completion of apartment construction projects over the past four years and from slightly higher room revenues from TCI’s hotels. These gains were offset by a decrease in commercial revenues due to lower occupancies.

 

Property operations expense increased to $15.2 million in the period ended March 31, 2005, compared to $13.5 million in 2004. This increase is mainly due to the completion of apartment construction projects over the past four years, offset by lower commercial expenses due to lower occupancies. Property operations expenses for the remaining quarters of 2005 may continue to increase as TCI continues to finish construction of new apartment projects.

 

Interest income increased to $845,000 in the period ended March 31, 2005, compared to $398,000 in 2004. The increase is primarily due to additional interest from an increase in the outstanding notes receivable balances from March 2004 and from additional interest on variable rate notes due to increases in the prime rate during 2004 and 2005.

 

Equity income of investees was $1.2 million in the period ended March 31, 2005, compared to equity in loss of equity investees of $570,000 in 2004. ARI and IORI both recognized income from operations in the first quarter of 2005 compared to losses in the first quarter of 2004.

 

Interest expense increased to $8.8 million in the period ended March 31, 2005, from $7.5 million in 2004. This increase is mainly due to the completion of apartment construction projects over the past four years, plus additional interest from land loans due to new land purchases in 2004 and 2005.

 

Net income fee due to affiliate in the period ended March 31, 2005 was $325,000, as compared to $79,000 in 2004. The net income fee is payable to TCI’s advisor based on 7.5% of TCI’s net income. TCI had higher net income for the three months ended March 31, 2005 compared to the same period in 2004.

 

General and administrative expenses decreased to $1.5 million in the period ended March 31, 2005, from $3.0 million in 2004. The decrease was mainly due to lower spending on legal fees, lower state and franchise income taxes and lower cost reimbursements to Prime.

 

In the three months of 2005, gains on sale of real estate totaling $10.4 million were recognized, including $10.1 million on the sale of Institute Place, $294,000 on the sale of the 5700 Tulane industrial warehouse and $10,000 on the sale of Granbury Station land.

 

Tax Matters

 

Financial statement income varies from taxable income principally due to the accounting for income and losses of investees, gains and losses from asset sales, depreciation on owned properties, amortization of discounts on notes receivable and payable and the difference in the allowance for estimated losses. TCI had a loss for federal income tax purposes, after the use of net operating loss carryforwards, in the first three months of 2005 and the first three months of 2004; therefore, it recorded no provision for income taxes.

 

21


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

At March 31, 2005, TCI had a net deferred tax asset of $45.7 million due to tax deductions available to it in future years. However, as management cannot determine that it is more likely than not that TCI will realize the benefit of the deferred tax assets, a 100% valuation allowance has been established.

 

Inflation

 

The effects of inflation on TCI’s operations are not quantifiable. Revenues from property operations tend to fluctuate proportionately with inflationary increases and decreases in housing costs. Fluctuations in the rate of inflation also affect sales values of properties and the ultimate gain to be realized from property sales. To the extent that inflation affects interest rates, TCI’s earnings from short-term investments and the cost of new financings as well as the cost of variable interest rate debt, will be affected.

 

Environmental Matters

 

Under various federal, state and local environmental laws, ordinances and regulations, TCI may be potentially liable for removal or remediation costs, as well as certain other potential costs, relating to hazardous or toxic substances (including governmental fines and injuries to persons and property) where property-level managers have arranged for the removal, disposal or treatment of hazardous or toxic substances. In addition, certain environmental laws impose liability for release of asbestos-containing materials into the air, and third parties may seek recovery for personal injury associated with such materials.

 

Management is not aware of any environmental liability relating to the above matters that would have a material adverse effect on TCI’s business, assets or results of operations.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

 

At March 31, 2005, TCI’s exposure to a change in interest rates on its debt is as follows:

 

     Balance

  

Weighted Average

Interest Rate


   

Effect of 1%

Increase In

Base Rates


Notes payable:

                   

Variable rate

   $ 148,034    6.26 %   $ 1,480
    

        

Total decrease in TCI’s annual net income

                $ 1,480
                 

Per share

                $ .19
                 

 

ITEM 4. CONTROLS AND PROCEDURES

 

As of the end of the period covered by this report, TCI carried out an evaluation, under the supervision and with the participation of TCI’s Acting Principal Executive Officer and principal accounting officer, of TCI’s disclosure controls and procedures pursuant to Exchange Act Rules 13a-15 and 15d-15. Based upon that evaluation, TCI’s Acting Principal Executive Officer and principal accounting officer concluded that TCI’s disclosure controls and procedures are effective.

 

There have been no significant changes in TCI’s internal controls over financial reporting during the quarter ending March 31, 2005, that have materially affected, or are reasonably likely to materially affect, TCI’s internal control over financial reporting.

 

 

22


PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

Innovo Realty, Inc. On August 10, 2004, three entities, including Transcontinental Realty Investors, Inc. (the “Company”), instituted an action in Texas State District Court as Cause No. 2004-60231-393 styled American Realty Investors, Inc., Transcontinental Realty Investors, Inc. and Income Opportunity Realty Investors, Inc., Plaintiffs v. Innovo Realty, Inc. and Innovo Group, Inc., Involuntary Plaintiffs v. Innovo Realty, Inc., Metra Capital LLC, Innovo Group, Inc., Joseph Mizrachi, Simon Mizrachi, Herbert Guez, Third Millennium Partners LLC, Third Millennium Partners, Inc., Third Millennium Group LLC and Sunridge Management, Inc., Defendants. The Plaintiffs’ complaint alleges that a former director of American Realty Investors, Inc. (“ARI”), and others, offered a plan to the Plaintiffs to create one or more joint venture arrangements with one or more of the Plaintiffs to pursue alternative forms of financing or refinancing portions of Plaintiffs’ real estate portfolios, which entailed the creation of 22 separate limited partnerships to acquire 28 separate apartment complexes in three states (Texas, Florida and Louisiana), the general partners of which were affiliates of, or are controlled by, the former director of the Company. During April 2005, resolution of the litigation occurred, settling all liabilities remaining from the original partnership arrangements which included a return of investor equity, prospective asset management fees and miscellaneous fees and transactions costs from the Plaintiffs as a prepayment of a preferred return, along with a delegation of management to another entity, and a motion to dismiss the action as a part of the resolution. Of the prepayment, the Company will recognize expenses of $462,000 and a reduction in liabilities of $2.1 million during the second quarter of 2005.

 

Sunset Management LLC. On October 5, 2004, Sunset Management LLC (“Sunset”) filed a complaint as a purported stockholder’s derivative action on behalf of Transcontinental Realty Investors, Inc. in the United States District Court for the Northern District of Texas, Dallas Division, against American Realty Investors, Inc., Basic Capital Management, Inc., Prime Income Asset Management, Inc., Prime Income Asset Management LLC, Income Opportunity Realty Investors, Inc., United Housing Foundation (“United”), Inc., Regis Realty, Inc., the Company, the Company’s current directors and officers and others. Sunset’s complaint filed as Case No. 304CV02162-B styled Sunset Management LLC, derivatively on behalf of Transcontinental Realty Investors, Inc. v. American Realty Investors, Inc., et al., raises a number of allegations previously raised by Sunset in four other cases which, as rulings have occurred, have resulted in a denial of Sunset’s requested relief. The Defendants on November 8, 2004 filed a Motion to Dismiss pursuant to Rules 12 and 23.1 of the Federal Rules of Civil Procedure on the basis that Sunset’s allegations are insufficient to evade the stringent demand requirement under the futility exceptions for stockholder derivative actions, and that Sunset cannot fairly and adequately represent the interests of other stockholders. One of the individual Defendants also filed on January 4, 2005 a Motion to Disqualify Sunset’s Counsel. On January 4, 2005, the Defendants filed a Motion to Stay Discovery and for Protective Order, which Motion was granted on March 30, 2005 by the issuance of an Order of the Court granting the Motion for Protective Order and staying all discovery in the action pending further Order of the Court, if appropriate, following the Court’s ruling on the Defendants’ Motion to Dismiss. On March 28, 2005, Sunset also filed a Petition for Writ of Mandamus in the United States District Court for the Eastern District of Texas, Sherman Division, seeking a Writ of Mandamus to be issued by the Court directing the bankruptcy judge in the United States Bankruptcy Court for the Eastern District of Texas, Sherman Division, in the case styled In Re: ART Williamsburg, Inc., Case No. 03-43909BTR-11, and American Realty Trust, Inc., et al. v. Sunset Management LLC, Adversary Proceeding No. 03-4256, to rule on pending Motions for Summary Judgment within twenty days thereof. On April 11, 2005, the United States District Court for the Eastern District of Texas, Sherman Division, entered its Order denying Sunset’s Petition for Writ of Mandamus. On May 6, 2005, in the bankruptcy case styled In Re: ART Williamsburg, Inc., Case No. 03-43909BTR-11 pending in the United States Bankruptcy Court for the Eastern District of Texas, Sherman Division, Sunset filed a Motion for Allowance of Claim, Determination of the Value of its Lien, Allowance of Deficiency as an Unsecured Claim and Abandonment of Cash Collateral to Sunset. Such Motion seeks an Order (i) estimating and determining the allowed amount of Sunset’s claim for purposes of distribution, (ii) determining the method of value in Sunset’s secured claim, (iii) determining the value of the lien held by Sunset, (iv) declaring that Sunset’s claim is secured in the amount determined, (v) allowing Sunset a deficiency claim for the unsecured portion of its claim, and (vi) ordering a distribution to Sunset of the proceeds received by the Debtor from a specified note.

 

The ownership of property and provision of services to the public as tenants entails an inherent risk of liability. Although the Company and its subsidiaries are involved in various items of litigation incidental to and in the ordinary course of its business, in the opinion of management, the outcome of such litigation will not have a material adverse impact upon the Company’s financial condition, results of operations or liquidity.

 

23


ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

During the period covered by this report, Registrant did not purchase any of its equity securities. The following table sets forth a summary by month for the quarter the items described and the number of shares remaining to be purchased under a share repurchase program of the Registrant as of the end of each month.

 

Period


  

Total Number of

Shares Purchased


  

Average Price

Paid per Share


  

Total Number of

Shares Purchased as

Part of Publicaly

Announced Program


  

Maximum Number of

Shares that May

Yet be Purchased

Under the Program(a)


Balance as of December 31, 2004

                    219,090

January 1-31, 2005

   —      $ —      —      219,090

February 1-28, 2005

   —        —      —      219,090

March 1-31, 2005

   —        —      —      219,090
    
  

  
    

Total

   —      $ —      —       
    
  

  
    

(a) On June 23, 2000, the TCI Board of Directors approved a share repurchase program for up to 1,409,000 shares of our common stock. This repurchase program has no termination date.

 

24


ITEM 6. EXHIBITS

 

(a) Exhibits:

 

Exhibit
Number


 

Description


31.1   Certification Pursuant to Rules 13a-14(a) and 15d-14(a) Under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.
31.2   Certification Pursuant to Rules 13a-14(a) and 15d-14(a) Under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.
32.1   Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.

 

25


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: May 16, 2005   By:  

/s/ Ted P. Stokely


        Ted P. Stokely
        Chairman of the Board
    By:  

/s/ Samuel C. Perry


        Samuel C. Perry
        Controller (Acting Principal Financial and Accounting Officer)

 

26


TRANSCONTINENTAL REALTY INVESTORS, INC.

 

EXHIBITS TO

 

QUARTERLY REPORT ON FORM 10-Q

 

For the Quarter ended March 31, 2005

 

Exhibit

Number


 

Description


  

Page

Number


31.1   Certification Required by Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.    28
31.2   Certification Required by Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.    29
32.1   Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.    30

 

27