UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
For the Year Ended December 31, 2004
FOR THE TRANSITION PERIOD FROM TO
Commission File Number 001-09240
Transcontinental Realty Investors, Inc.
(Exact Name of Registrant as Specified in Its Charter)
1800 Valley View Lane,
Suite 300, Dallas, Texas
(469) 522-4200
(Registrant’s Telephone Number, Including Area Code)
Securities Registered Pursuant to Section 12(b) of the Act:
Common Stock, $.01 par value
Securities Registered Pursuant to Section 12(g) of the Act:
NONE
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for at least the past 90 days. Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes ¨ No x
The aggregate market value of the shares of voting and non-voting common equity held by non-affiliates of the Registrant, computed by reference to the closing sales price of the Common Stock on the New York Stock Exchange as of June 30, 2004 (the last business day of the Registrant’s most recently completed second fiscal quarter) was $21,917,192 based upon a total of 1,622,294 shares held as of June 30, 2004 by persons believed to be non-affiliates of the Registrant. The basis of the calculation does not constitute a determination by the Registrant as defined in Rule 405 of the Securities Act of 1933, as amended, such calculation, if made as of a date within sixty days of this filing would yield a different value. As of March 24, 2005, there were 7,900,869 shares of common stock outstanding.
Documents Incorporated by Reference:
Consolidated Financial Statements of Income Opportunity Realty Investors, Inc.
Commission File No. 001-14784
Consolidated Financial Statements of American Realty Investors, Inc.
Commission File No. 001-15663
INDEX TO
ANNUAL REPORT ON FORM 10-K
Item 1.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
Item 15.
Signature Page
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FORWARD-LOOKING STATEMENTS
Certain Statements in the Form 10-K are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. The words “estimate,” “plan,” “intend,” “expect,” “anticipate,” “believe,” and similar expressions are intended to identify forward-looking statements. The forward-looking statements are found at various places throughout this Report and in the documents incorporated herein by reference. The Company disclaims any intention or obligations to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Although we believe that our expectations are based upon reasonable assumptions, we can give no assurance that our goals will be achieved. Important factors that could cause our actual results to differ from estimates or projections contained in any forward-looking statements are described under “Risk Factors Related to our Business” beginning on page 6.
PART I
ITEM 1. BUSINESS
Transcontinental Realty Investors, Inc. (“TCI” or the “Company” or “we” or “us”), a Nevada corporation, is the successor to a California business trust that was organized on September 6, 1983 and commenced operations on January 31, 1984. On November 30, 1999, TCI acquired all of the outstanding shares of beneficial interest of Continental Mortgage and Equity Trust (“CMET”), a real estate company, in a tax-free exchange of shares, issuing 1.181 shares of its Common Stock for each outstanding CMET share. Prior to January 1, 2000, TCI elected to be treated as a Real Estate Investment Trust (“REIT”) under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the “Code”). During the third quarter of 2000, due to a concentration of ownership TCI no longer met the requirement for tax treatment as a REIT. Under the Code, TCI cannot re-qualify for REIT tax status for at least five years after January 1, 2001.
TCI’s real estate at December 31, 2004, consisted of 111 properties held for investment, one partnership property, 11 construction properties and 6 properties held for sale. In 2004, TCI purchased 20 properties held for investment. TCI’s mortgage notes receivable portfolio at December 31, 2004, consisted of 23 mortgage loans. TCI’s real estate and mortgage notes receivable portfolios are more fully discussed in ITEM 2. “PROPERTIES.”
Effective March 31, 2003, TCI financial results were consolidated in the American Realty Investors, Inc. (“ARI”) Form 10-K and related consolidated financial statements. As of December 31, 2004, ARI owned 82.2% of the outstanding TCI common shares.
Business Plan and Investment Policy
TCI’s business is investing in real estate through direct equity ownership and partnerships and financing real estate and real estate related activities through investments in mortgage loans, including first, wraparound and junior mortgage loans. TCI’s real estate is located throughout the continental United States and one property is located in Poland. Information regarding TCI’s real estate and mortgage notes receivable portfolios is set forth in ITEM 2. “PROPERTIES”, and in Schedules III and IV to the Consolidated Financial Statements included in ITEM 8. “FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.” TCI has four operating segments; apartments, commercial properties, hotels and land ownership.
TCI’s business is not seasonal. Management has determined to continue to pursue a balanced investment policy, seeking both current income and capital appreciation. With respect to new real estate investments, management’s plan of operation is to consider all types of real estate with an emphasis on properties generating current cash flow. Management expects to invest in and improve these properties to maximize both their immediate and long-term value. Management has also considered the development of apartment properties in selected markets primarily in Texas. Management also expects to consider property sales opportunities for
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properties in stabilized real estate markets where TCI’s properties have reached their potential. Management also expects to be an opportunistic seller of properties in markets that have become overheated, i.e., an abundance of buyers. Management’s operating strategy with regard to TCI’s properties is to maximize each property’s operating income by aggressive property management through closely monitoring expenses while at the same time making property renovations and/or improvements where appropriate. While such expenditures increase the amount of revenue required to cover operating expenses, management believes that such expenditures are necessary to maintain or enhance the value of the properties.
Management does not expect that TCI will seek to fund or acquire new mortgage loans in 2005. However, TCI may originate mortgage loans in conjunction with providing purchase money financing of a property sale. Management intends to service and hold for investment the mortgage notes in TCI’s portfolio. TCI may borrow against its mortgage notes, using the proceeds from such borrowings for property acquisitions or for general working capital needs. Management also intends to pursue TCI’s rights vigorously with respect to mortgage notes that are in default. TCI’s Articles of Incorporation impose no limitations on its investment policy with respect to mortgage loans and does not prohibit it from investing more than a specified percentage of its assets in any one mortgage loan.
Management of the Company
Although the Board of Directors is directly responsible for managing the affairs of TCI and for setting the policies which guide it, its day-to-day operations were performed until July 1, 2003 by Basic Capital Management, Inc. (“BCM”), a contractual advisor under the supervision of the Board. Effective July 1, 2003, BCM was replaced as contractual advisor to TCI by Prime Asset Management, Inc., (“PAMI”) under the same terms as BCM’s advisory agreement. PAMI is owned by Realty Advisors (80.0%) and Syntek West, Inc. (20.0%), related parties. Syntek West, Inc. is owned by Gene Phillips. Effective August 18, 2003, PAMI changed its name to Prime Income Asset Management, Inc., (“PIAMI”). On October 1, 2003, Prime Income Asset Management, LLC (“Prime”), which is owned 100% by PIAMI, replaced PIAMI as the advisor to TCI. The duties of Prime include, among other things, locating, investigating, evaluating and recommending real estate, mortgage note investment and sales opportunities, as well as financing and refinancing sources. Prime also serves as a consultant in connection with TCI’s business plan and investment decisions made by the Board.
Prime is indirectly owned by a trust for the children of Gene E. Phillips, and Syntek West, Inc. (which is owned by Mr. Phillips), owns 20% of Prime. Mr. Phillips is not an officer or director of Prime, but serves as a representative of the trust, is involved in daily consultation with the officers of Prime and has significant influence over the conduct of Prime’s business, including the rendering of advisory services and the making of investment decisions for itself and for TCI. Prime is more fully described in ITEM 10. “DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT—The Advisor.”
BCM had provided advisory services to TCI from March 28, 1989 until June 30, 2003, when Prime replaced BCM as the contractual advisor to TCI. Prime also serves as advisor to ARI. The directors of TCI are also directors of ARI. The officers of TCI also serve as officers of ARI, BCM and Prime. As of March 24, 2004, TCI owned approximately 24.0% of IORI’s outstanding shares of common stock. ARI owns approximately 82.2% of the outstanding shares of TCI’s common stock.
Since February 1, 1990, affiliates of BCM and Prime have provided property management services to TCI. Currently, Triad Realty Services, Ltd. (“Triad”) provides such property management services. Triad subcontracts with other entities for the provision of property-level management services to TCI. The general partner of Triad is BCM. The limited partner of Triad is Highland Realty Services, Inc. (“Highland”). Triad subcontracts the property-level management and leasing of 24 of TCI’s commercial properties (office buildings, shopping centers and industrial warehouses) to Regis Realty I, LLC (“Regis I”), which is owned by Highland. Regis I receives property and construction management fees and leasing commissions in accordance with the terms of its property-level management agreement with Triad. Regis I is also entitled to receive real estate brokerage
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commissions in accordance with the terms of a non-exclusive brokerage agreement. Since January 1, 2003, Regis Hotel I, LLC, has managed TCI’s four hotels. The sole member of Regis I and Regis Hotel I, LLC is Highland. See ITEM 10. “DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT—The Advisor.”
TCI has no employees. Employees of Prime render services to TCI.
Competition
The real estate business is highly competitive and TCI competes with numerous entities engaged in real estate activities (including certain entities described in ITEM 13. “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS—Related Party Transactions”), some of which have greater financial resources than those of TCI. Management believes that success against such competition is dependent upon the geographic location of the property, the performance of property-level managers in areas such as marketing, collections and control of operating expenses, the amount of new construction in the area and the maintenance and appearance of the property. Additional competitive factors with respect to commercial properties are the ease of access to the property, the adequacy of related facilities, such as parking, and sensitivity to market conditions in setting rent levels. With respect to apartments, competition is also based upon the design and mix of units and the ability to provide a community atmosphere for the tenants. Management believes that beyond general economic circumstances and trends, the rate at which properties are renovated or the rate new properties are developed in the vicinity of each of TCI’s properties also are competitive factors. See also “Risk Factors Related to our Business.”
To the extent that TCI seeks to sell any of its properties, the sales prices for such properties may be affected by competition from other real estate entities and financial institutions also attempting to sell their properties located in areas in which TCI’s properties are located, as well as by aggressive buyers attempting to penetrate or dominate a particular market.
As described above and in ITEM 13. “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS—Related Party Transactions,” the officers and directors of TCI also serve as officers or directors of certain other entities, also advised by Prime, and which have business objectives similar to those of TCI. TCI’s directors, officers and advisor owe fiduciary duties to such other entities as well as to TCI under applicable law. In determining to which entity a particular investment opportunity will be allocated, the officers, directors and advisor consider the respective investment objectives of each such entity and the appropriateness of a particular investment in light of each such entity’s existing real estate portfolio. To the extent that any particular investment opportunity is appropriate to more than one of the entities, the investment opportunity will be allocated to the entity which has had funds available for investment for the longest period of time or, if appropriate, the investment may be shared among all or some of the entities.
In addition, as also described in ITEM 13. “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS—Certain Business Relationships,” TCI also competes with other entities which are affiliates of Prime and which have investment objectives similar to TCI’s and that may compete with it in purchasing, selling, leasing and financing of real estate and real estate related investments. In resolving any potential conflicts of interest which may arise, Prime has informed management that it intends to continue to exercise its best judgment as to what is fair and reasonable under the circumstances in accordance with applicable law.
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Risk Factors Related to our Business
Adverse events concerning TCI’s existing tenants or negative market conditions that may affect TCI’s existing tenants could have an adverse impact on TCI’s ability to attract new tenants, release space, collect rent or renew leases, and thus could adversely affect cash flow from operations and inhibit growth. Cash flow from operations depends on the ability to lease space to tenants on economically favorable terms. TCI could be adversely affected by various facts and events over which there is limited control, such as:
At any time, any tenant may experience a downturn in its business that may weaken its financial condition. As a result, a tenant may delay lease commencement, fail to make rental payments when due, decline to extend a lease upon its expiration, become insolvent or declare bankruptcy. Any tenant bankruptcy or insolvency, leasing delay or failure to make rental payments when due could result in the termination of the tenant’s lease and material losses to the Company.
If tenants do not renew their leases as they expire, TCI may not be able to rent the space. Furthermore, leases that are renewed, and some new leases for space that is relet, may have terms that are less economically favorable than current lease terms, or may require TCI to incur significant costs, such as for renovations, tenant improvements or lease transaction costs. Any of these events could adversely affect cash flow from operations and TCI’s ability to make expected distributions to shareholders and service indebtedness. A significant portion of the costs, such as real estate taxes, insurance costs, and debt service payments, generally are not reduced when circumstances cause a decrease in cash flow from the properties.
TCI may not be able to compete successfully with other entities that operate in our industry. TCI experiences a great deal of competition in attracting tenants for the properties and in locating land to develop and properties to acquire.
In TCI’s effort to lease these properties, TCI competes for tenants with a broad spectrum of other landlords in each of the markets. These competitors include, among others, publicly-held REITs, privately-held entities, individual property owners and tenants who wish to sublease their space. Some of these competitors may be able to offer prospective tenants more attractive financial terms than TCI is able to offer.
If the availability of land or high quality properties in TCI’s markets diminishes, operating results could be adversely affected.
TCI may experience increased operating costs, which could adversely affect operations. TCI’s properties are subject to increases in operating expenses such as insurance, cleaning, electricity, heating, ventilation and air conditioning, administrative costs and other costs associated with security, landscaping, repairs and maintenance of the properties. While current tenants generally are obligated to pay a significant portion of these costs, there is no assurance that these tenants will make such payments or agree to pay these costs upon renewal or that new tenants will agree to pay these costs. If operating expenses increase in TCI’s markets, TCI may not be able to
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increase rents or reimbursements in all of these markets to meet increased expenses, without at the same time decreasing occupancy rates. If this occurs, TCI’s ability to make distributions to shareholders and service indebtedness could be adversely affected.
TCI’s ability to achieve growth in operating income depends in part on the ability to develop properties which may suffer under certain circumstances. TCI intends to continue to develop properties where warranted by market conditions. The decline in demand for real estate has reduced the amount of development TCI is undertaking. TCI has a number of ongoing development and land projects being readied for development.
Additionally, general construction and development activities includes the following risks:
TCI faces risk associated with property acquisitions. TCI acquires individual properties and portfolios of properties, and intends to continue to do so. The acquisition activities and their success are subject to the following risks:
TCI may acquire properties subject to liabilities and without any recourse, or with only limited recourse, with respect to unknown liabilities. As a result, if a liability were asserted against TCI based upon ownership of those properties, TCI might have to pay substantial sums to settle it, which could adversely affect cash flow.
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Many of TCI’s properties are concentrated in the Company’s primary markets, and, therefore may suffer economic harm as a result of adverse conditions in those markets. TCI’s properties are located principally in specific geographic areas in the Southwestern, Southeastern and Midwestern United States. Due to the concentration of properties in these areas, performance is dependent on economic conditions. These areas have experienced periods of economic decline.
TCI is highly leveraged and may not be able to meet our debt service obligations. TCI had total indebtedness at December 31, 2004 of approximately $644.1 million. Substantially all assets have been pledged to secure debt. These borrowings increase the risk of loss because they represent a prior claim on assets and require fixed payments regardless of profitability. TCI’s highly leveraged position makes it vulnerable to changes in economic conditions and may limit the ability to capitalize on significant business opportunities in the future.
TCI may not be able to access financial markets to obtain capital on a timely basis, or on acceptable terms. TCI relies on proceeds from property dispositions and third party capital sources for a portion of its capital needs, including capital for acquisitions and development. The public debt and equity markets are among the sources relied on. There is no guarantee TCI will be able to access these markets, or any other source of capital. The ability to access the public debt and equity markets depends on a variety of factors, including:
TCI may suffer adverse effects as a result of the terms of and covenants relating to our indebtedness. Required payments on TCI’s indebtedness generally are not reduced if the economic performance of the portfolio declines. If the economic performance declines, net income, cash flow from operations and cash available for distribution to stockholders will be reduced. If payments on debt cannot be made, TCI could sustain a loss, or in the case of mortgages, suffer foreclosures by mortgagees or suffer judgments. Further, some obligations contain cross-default and/or cross-acceleration provisions, which means that a default on one obligation may constitute a default on other obligations.
TCI anticipates only a small portion of the principal of our debt will be repaid prior to maturity. Therefore, TCI is likely to need to refinance at least a portion of its outstanding debt as it matures. There is a risk that TCI may not be able to refinance existing debt or the terms of any refinancing will not be as favorable as the terms of the existing debt. If principal payments due at maturity cannot be refinanced, extended or repaid with proceeds from other sources, such as the proceeds of sales of assets or new equity securities, cash flow will not be sufficient to repay all maturing debt in years when significant “balloon” payments come due.
TCI’s credit facilities and unsecured debt securities contain customary restrictions, requirements and other limitations on the ability to incur indebtedness, including total debt to asset ratios, secured debt to total asset ratios, debt service coverage ratios and minimum ratios of unencumbered assets to unsecured debt which we must maintain. Our continued ability to borrow is subject to compliance with financial and other covenants. In addition, failure to comply with such covenants could cause a default under credit facilities, and TCI may then be required to repay such debt with capital from other sources. Under those circumstances, other sources of capital may not be available, or be available only on unattractive terms.
TCI’s degree of leverage could limit the ability to obtain additional financing or affect the market price of our common stock. The degree of leverage could affect TCI’s ability to obtain additional financing for working capital, capital expenditures, acquisitions, development or other general corporate purposes. The degree of leverage could also make TCI more vulnerable to a downturn in business or the economy, in general.
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An increase in interest rates would increase TCI’s interest costs on variable rate debt and could adversely impact the ability to refinance existing debt. TCI currently has, and may incur more, indebtedness that bears interest at variable rates. Accordingly, if interest rates increase, so will the interest costs, which would adversely affect cash flow and the ability to pay principal and interest on TCI’s debt and the ability to make distributions to shareholders. Further, rising interest rates could limit TCI’s ability to refinance existing debt when it matures.
Unbudgeted capital expenditures or cost overruns could adversely affect our business operations and cash flow. If capital expenditures on ongoing or planned development projects, renovations or condominium conversions exceed our expectations, the additional cost of these expenditures could have an adverse effect on business operations and cash flow. In addition, TCI might not have access to funds on a timely basis to meet the unexpected expenditures.
Construction costs are funded in large part through construction financing, which the Company often guarantees, and the Company’s obligation to pay interest on this financing continues until the rental project is completed, leased up, and permanent financing is obtained, or the for sale project is sold out. Unexpected delays in completion of one or more ongoing projects could also have a significant adverse impact on business operations and cash flow.
TCI may need to sell properties from time-to time for cash flow purposes. Because of the lack of liquidity of real estate investments generally, TCI’s ability to respond to changing circumstances may be impaired. Real estate investments generally cannot be sold quickly. In the event that TCI must sell assets to generate cash flow, TCI cannot predict whether there will be a market for those assets in the time period desired or need to sell them, or whether TCI will be able to sell them at a price that will allow the Company to fully recoup our investment. TCI may not be able to realize the full potential value of the assets, and may incur costs related to the early pay-off of the debt secured by such assets.
TCI intends to devote increasing resources to the development of new projects. TCI plans to continue developing new projects as opportunities arise in the future. Development and construction activities entail a number of risks, including but not limited to the following:
TCI’s overall business is subject to all of the risks associated with the real estate industry. TCI is subject to all risks incident to investment in real estate, many of which relate to the general lack of liquidity of real estate investments, including, but not limited to:
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Available Information
TCI maintains an internet site at http://www.transconrealty-invest.com. TCI has available through their website free of charge Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, reports filed pursuant to Section 16 and amendments to those reports as soon as reasonably practicable after we electronically file or furnish such materials to the Securities and Exchange Commission. In addition, the Company has posted the charters for our Audit Committee, Compensation Committee and Governance and Nominating Committee, as well as our Code of Business Conduct and Ethics, Corporate Governance Guidelines on Director Independence and other information on the website. These charters and principles are not incorporated in this Report by reference. TCI will also provide a copy of these documents free of charge to stockholders upon written request. The Company issues Annual Reports containing audited financial statements to its common stockholders.
ITEM 2. PROPERTIES
TCI’s principal offices are located at 1800 Valley View Lane, Suite 300, Dallas, Texas 75234 and are, in the opinion of management, suitable and adequate for TCI’s present operations.
Details of TCI’s real estate and mortgage notes receivable portfolios at December 31, 2004, are set forth in Schedules III and IV to the Consolidated Financial Statements included at ITEM 8. “FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.” The discussions set forth below under the headings “Real Estate” and “Mortgage Loans” provide certain summary information concerning TCI’s real estate and mortgage notes receivable portfolios.
TCI’s real estate portfolio consists of properties held for investment, properties held for sale, properties subject to sales contract, and investments in partnerships. The discussion set forth below under the heading “Real Estate” provides certain summary information concerning TCI’s real estate and further summary information with respect to its properties held for investment, properties held for sale and its investment in partnerships.
At December 31, 2004, none of TCI’s properties, mortgage notes receivable or investments in partnerships exceeded 10.0% of total assets. At December 31, 2004, 71.5% of TCI’s assets consisted of properties held for investment, 5.4% consisted of properties held for sale, 7.6% consisted of properties subject to sales contract, 6.2% consisted of mortgage notes and interest receivables and 1.9% consisted of investments in partnerships and equity investees. The remaining 7.4% of TCI’s assets were invested in cash, cash equivalents and other assets. The percentage of TCI’s assets invested in any one category is subject to change and no assurance can be given that the composition of TCI’s assets in the future will approximate the percentages listed above.
TCI’s real estate is geographically diverse. At December 31, 2004, TCI held investments in apartments and commercial properties in each of the geographic regions of the continental United States, although its apartments and commercial properties were concentrated in the Southeast and Southwest regions, as shown more specifically in the table under “Real Estate” below. At December 31, 2004, TCI held mortgage notes receivable secured by apartments and commercial properties in the Southwest and Southeast regions of the continental United States, as shown more specifically in the table under “Mortgage Loans” below.
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Geographic Regions
TCI has divided the continental United States into the following geographic regions.
Excluded from the above is one hotel in Wroclaw, Poland and a partnership property, as described below.
Real Estate
At December 31, 2004, approximately 84.5% of TCI’s assets were invested in real estate. TCI invests primarily in real estate located throughout the continental United States, either on a leveraged or non-leveraged basis. TCI’s real estate portfolio consists of properties held for investment, investments in partnerships and properties held for sale.
Types of Real Estate Investments. TCI’s real estate consists of commercial properties (office buildings, industrial warehouses and shopping centers), hotels and apartments having established income-producing capabilities. In selecting real estate for investment, the location, age and type of property, gross rents, lease terms, financial and business standing of tenants, operating expenses, fixed charges, land values and physical condition are among the factors considered. TCI may acquire properties subject to or assume existing debt and may mortgage, pledge or otherwise obtain financing for its properties. The Board of Directors may alter the types of criteria for selecting new real estate investments and for obtaining financing without a vote of stockholders.
TCI’s current real estate portfolio consists of 129 owned properties. Of the 129 properties, 12 apartments were sold to partnerships controlled by Metra Capital, LLC (“Metra”). See NOTE 8. “RELATED PARTY TRANSACTIONS.” Because the Metra sales transaction was accounted for as a finance transaction, TCI continues to account for the 12 properties as owned properties.
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TCI typically invests in developed real estate. However, TCI has recently invested in unimproved land and apartment development and construction. To the extent that TCI continues to invest in development and construction projects, it will be subject to business risks, such as cost overruns and construction delays, associated with higher risk projects.
At December 31, 2004, TCI had the following properties under construction:
Property
Location
Apartments
Blue Lake Villas II
Bluffs at Vista Ridge
Bridges on Kinsey
Dakota Arms
Kingsland Ranch
Laguna Vista
Lake Forest
Parc at Maumelle
Stonebridge at City Park (formerly288 City Park)
Vistas of Vance Jackson
Wildflower Villas
For the period ending December 31, 2004, TCI completed the 248 unit DeSoto Ranch Apartments in DeSoto, Texas, the 314 unit Verandas at Cityview Apartments in Fort Worth, Texas, the 216 unit Mariposa Villas (Echo Valley) in Dallas, Texas, the 176 unit Breakwater Bay Apartments in Beaumont, Texas, the 156 unit Capitol Hill Apartments in Little Rock, Arkansas and the 332 unit Vistas of Pinnacle Park Apartments in Dallas, Texas.
In 2003, TCI completed 186 unit Blue Lake Villas in Waxahachie, Texas, the 284 unit Falcon Lakes in Arlington, Texas, the 180 unit River Oaks Apartments in Wiley, Texas, the 384 unit Sendero Ridge Apartments in San Antonio, Texas, the 256 unit Spyglass Apartments in Mansfield, Texas and the 188 unit Windsong Apartments in Fort Worth, Texas.
In the opinion of management, the properties owned by TCI are adequately covered by insurance.
The following table sets forth the percentages, by property type and geographic region, of TCI’s real estate (other than four hotels in the Pacific and Midwest regions, one hotel in Poland and 38 parcels of unimproved land, as described below) at December 31, 2004.
Region
Pacific
Midwest
Mountain
Southwest
Southeast
The foregoing table is based solely on the number of apartment units and amount of commercial square footage and does not reflect the value of TCI’s investment in each region. TCI owns 38 parcels of unimproved land, two parcels for a total of 21.23 acres in the Southeast region and 36 parcels for a total of 969.30 acres in the Southwest region. See Schedule III to the Consolidated Financial Statements included at ITEM 8. “FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” for a detailed description of TCI’s real estate portfolio.
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During 2004, the activity in TCI’s owned real estate portfolio was:
Owned properties at January 1, 2004
Properties purchased (excluding additions to existing land parcels or land for construction)
Properties added from consolidation of partnerships
Properties sold (excluding partial sales)
Owned properties at December 31, 2004
Properties Held for Investment. Set forth below are TCI’s properties held for investment and the monthly rental rate for apartments, the average annual rental rate for commercial properties and the average daily room rate and room revenue divided by total available rooms for hotels and occupancy at December 31, 2004, 2003 and 2002, for apartments and commercial properties and average occupancy during 2004, 2003 and 2002 for hotels:
Rent Per
Square Foot
Units/Square Footage
4400
Apple Lane
Arbor Point
Ashton Way
Autumn Chase
Blue Lake Villas
Breakwater Bay
By the Sea
Capitol Hill
Courtyard
Coventry
DeSoto Ranch
El Chapparal
Fairway View Estates
Fairways
Falcon Lakes
Fountain Lake
Fountains of Waterford
Harper’s Ferry
Heather Creek
Hunters Glen
Limestone Canyon
Limestone Ranch
Mariposa Villas
Mountain Plaza
Oak Park IV
Paramount Terrace
Plantation
Quail Oaks
River Oaks
Sendero Ridge
Somerset
Southgate
Spy Glass
Sunchase
Terrace Hills
Tivoli
Timbers
Treehouse
Verandas at City View
Vistas at Pinnacle Park
Westwood
Willow Creek
Willo-Wick Gardens
Windsong
Woodview
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Office Buildings
1010 Common
225 Baronne
Amoco
Bay Plaza
Bay Plaza II
Eton Square
Executive Court
Forum
Lexington Center
Parkway North
Signature
Westgrove Air Plaza
Industrial Warehouses
5360 Tulane
Addison Hanger
Addison Hanger II
Encon
Space Center
Shopping Centers
Bridgeview Plaza
Cullman
Dunes Plaza
Promenade
Total Room Revenues
Divided By
Total Available Rooms
Hotels
Willows
City Suites
Majestic Inn
The Majestic
Akademia
Land
1013 Common
2301 Valley Branch
Alamo Springs
Centura
Cooks Lane
Denton-Coonrod
DeSoto
Dominion
Fiesta
Fruitland
Folsom
Granbury Station
Hollywood Casino
Lacy Longhorn
Lakeshore Villas
Lamar/Palmer
Las Colinas
LCLLP
Lemmon Carlisle
Limestone Canyon II
Lubbock
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Manhattan
Marine Creek
Mason Park
McKinney 36
Mira Lago
Nashville
Pac Trust
Payne (TCI owns a 50% Tenant-In-Common interest)
Pulaski
Railroad
Rochelle I
Rochelle II
Rogers
Round Mountain
Seminary West
Sheffield Village
Valley Ranch
West End
Occupancy presented here and throughout this ITEM 2. is without reference to whether leases in effect are at, below or above market rates.
NOTE 2. REAL ESTATE
In 2004, TCI purchased the following properties:
Net
CashPaid/
(Received)
Debt
Incurred
Interest
Rate
Maturity
Date
288 City Park(1)
Blue Lake Villas II(1)
Bridges on Kinsey(1)
Dakota Arms(1)
Laguna Vista(1)
Lake Forest(1)
Parc at Maumelle(1)
Treehouse(2)
Vistas of Vance Jackson(1)
Wildflower Villas(1)
Commercial
Executive Court(4)
Cooks Lane land
Denton-Coonrod land
DeSoto land
Granbury Station land
Lacy Longhorn land(5)
Las Colinas land(6)
Lubbock land
Railroad land
Rogers land
Vista Ridge land(8)
West End land(9)
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In 2004, TCI sold the following properties:
CashReceived
Cliffs of El Dorado(2)
In The Pines
Sandstone
Waters Edge IV(5)
Office Building
4135 Beltline
Atrium
Ambulatory Surgery Center
Brandeis(7)
Centura Tower(8)
Corporate Pointe
Countryside Harmon
Countryside Retail
Countryside Mimado
Durham Centre(9)
One Steeplechase
Venture Center
Industrial Warehouse
Kelly (Cash Road)
Kelly (Pinewood)
Ogden Industrial
Texstar Warehouse(12)
Other
Signature Athletic Club(11)
Shopping Center
K-Mart(12)
Sadler Square
Allen
Marine Creek(15)
Rasor
Red Cross
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In 2004, TCI financed/refinanced the following properties:
Sq. Ft./
Units/Rooms/
Acres
Discharged
Net Cash
Received/
(Paid)
Centura Tower
Centura Tower(2)
Warehouse
Addison Hangers I & II(6)
Centura land
Hollywood, Dominion &Mira Lago(7)
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Properties Held for Sale. Set forth below are TCI’s properties held for sale.
Bay Walk
Island Bay
Marina Landing
9033 Wilshire
Institute Place
5700 Tulane
Partnership Properties. TCI accounts for partnership properties using the equity method. TCI had no property information for properties owned by partnerships.
TCI is a 30% general partner in Sacramento Nine (“SAC 9”), which owned the Prospect Park #29 Office Building. In December 2004, SAC 9 sold the Prospect Park #29 office building for $3.7 million, of which TCI received $1.1 million after closing costs and fees. TCI recognized a gain on the sale of investment in SAC 9 of $882,000 relating to this transaction.
In December 2004, TCI sold a 95% interest in Garden Centura, L.P. that owns the 410,901 sq. ft. Centura Tower office building located in Farmers Branch, Texas. TCI retained a non-controlling 1% general partner and 4% limited partner interest in Garden Centura, L.P. TCI will account for its investment in this partnership on the cost basis.
Provision for Asset Impairments. TCI recorded asset impairments of $6.1 million in 2004, $4.7 million for 2003 and $2.6 million for 2002, representing the write down of certain operating properties to current estimated fair value. The assets for 2004 include the following properties:
Costs to
Sell
Harmon
Mimado
The Harmon and Mimado buildings were sold and the contractual sales prices were used as fair value. The costs to sell were the estimated closing costs and commissions to be paid by TCI. It was determined that the fair value of 225 Baronne was less than the current book value due to the pending loss of the anchor tenant. It was determined that future leases on the vacated space will be below market rates and the projected future cash flows of 225 Baronne will not be sufficient to recover the current book value.
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The assets for 2003 include the following properties:
Brandeis
Brandeis was returned to the lien holder via a Deed in Lieu of Foreclosure on February 27, 2004 and the outstanding debt and accrued interest was used as the fair value. The gross impairment for Brandeis was $4.9 million but was reduced by $452,000 for the minority interest portion. The Red Cross land was sold on January 30, 2004 and the actual sales price less selling costs was used as the fair value.
The assets for 2002 include the following properties:
Fairway View
The Red Cross land was under contract to sell in 2002 and the sales price was used as fair value. The fair value determined for the four apartments above were agreed upon purchase prices as part of the refinancing transaction with Metra Capital, LLC. The costs to sell were actual fees paid to refinance the properties. TCI refinanced the Plantation Apartments in May 2003, incurring a new note for $2.3 million and discharging debt of $1.9 million. See NOTE 7. “NOTES AND INTEREST PAYABLE.”
Mortgage Loans
In addition to investments in real estate, a portion of TCI’s assets are invested in mortgage notes receivable, principally secured by real estate. TCI may originate mortgage loans in conjunction with providing purchase money financing of property sales. Management intends to service and hold for investment the mortgage notes in TCI’s portfolio. TCI’s mortgage notes receivable consist of first, wraparound and junior mortgage loans.
Types of Mortgage Activity. TCI has originated its own mortgage loans, as well as acquired existing mortgage notes either directly from builders, developers or property owners, or through mortgage banking firms, commercial banks or other qualified brokers. Premier Funding, a related party, services TCI’s mortgage notes. TCI’s investment policy is described in ITEM 1. “BUSINESS—Business Plan and Investment Policy.”
Types of Properties Securing Mortgage Notes. The properties securing TCI’s mortgage notes receivable portfolio at December 31, 2004, consisted of three apartments, five office buildings, three parcels of unimproved land, various partnership and membership interests, and four unsecured loans. The Board of Directors may alter the types of properties securing or collateralizing mortgage loans in which TCI invests without a vote of stockholders. TCI’s Articles of Incorporation impose certain restrictions on transactions with related parties, as discussed in ITEM 13. “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.”
At December 31, 2004, TCI’s mortgage notes receivable portfolio included nine mortgage loans with an aggregate principal balance of $40.5 million secured by income-producing real estate located in the Southeast
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and Southwest regions of the continental United States, three mortgage loans with an aggregate principal balance of $3.3 million secured by unimproved land in the Southwest region of the continental United States, six loans with a principal balance of $6.3 million secured by partnership or membership interests and four unsecured loans with a principal balance of $3.9 million. At December 31, 2004, 6.2% of TCI’s assets were invested in notes and interest receivables.
The following table sets forth the percentages (based on the mortgage note principal balance) by property type and geographic region, of the income producing properties that serve as collateral for TCI’s mortgage notes receivable at December 31, 2004. Excluded are $13.5 million of mortgage notes that are secured by unimproved land or other security, or are unsecured. See Schedule IV to the Consolidated Financial Statements included at ITEM 8. “FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” for further details of TCI’s mortgage notes receivable portfolio.
A summary of the activity in TCI’s mortgage notes receivable portfolio during 2004 is as follows:
Mortgage notes receivable at January 1, 2004
Loans paid off
Loans funded
Mortgage notes receivable at December 31, 2004
During 2004, $7.2 million was collected in full payment of three mortgage notes and $1.6 million in principal payments were received on other mortgage notes. At December 31, 2004, 0.4% of TCI’s assets were invested in mortgage notes secured by non-income producing real estate, comprised of a second lien mortgage note secured by 33 acres of unimproved land in Travis County, Texas, a second lien note secured by 13 acres of unimproved land in Harris County, Texas and a second lien note secured by 22.3 acres of unimproved land in Collin County, Texas
First Mortgage Loans. TCI invests in first mortgage notes with short, medium or long-term maturities. First mortgage loans generally provide for level periodic payments of principal and interest sufficient to substantially repay the loan prior to maturity, but may involve interest-only payments or moderate amortization of principal and a “balloon” principal payment at maturity. With respect to first mortgage loans, the borrower is required to provide a mortgagee’s title policy or an acceptable legal title opinion as to the validity and the priority of the mortgage lien over all other obligations, except liens arising from unpaid property taxes and other exceptions normally allowed by first mortgage lenders in the relevant area. TCI may grant participations in first mortgage loans it originates to other lenders.
The following discussion briefly describes first mortgage loans funded in 2004, as well as events during 2004 that affected previously funded first mortgage loans.
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 $788,000 of the additional line of credit.
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Junior Mortgage Loans. TCI may invest in junior mortgage loans, secured by mortgages that are subordinate to one or more prior liens either on the fee or a leasehold interest in real estate. Recourse on such loans ordinarily includes the real estate on which the loan is made, other collateral and personal guarantees by the borrower. The Board of Directors restricts investment in junior mortgage loans, excluding wraparound mortgage loans, to not more than 10.0% of TCI’s assets. At December 31, 2004, 4.2% of TCI’s assets were invested in junior and wraparound mortgage loans.
The following discussion briefly describes the junior mortgage loans that TCI originated in 2004 as well as events that affected previously funded junior mortgage loans during 2004.
In August 2001, TCI agreed to fund up to $5.6 million secured by a second lien on an office building in Dallas, Texas. The note receivable bears interest at a variable rate, currently 9.0% per annum, requires monthly interest only payments and matured in January 2003. As of March 2004, TCI has funded a total of $4.3 million. On January 22, 2003, TCI agreed to extend the maturity date until May 1, 2003. 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 was set to a fixed rate of 9.0% per annum and all principal and interest is due October 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 also agreed to reduce 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. As a result of this modification, TCI has released $1.4 million of allowance for loan losses to expense. The following notes were assigned to TCI as payment on the note:
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 all $300,000 of the line of credit.
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 requires all interest and principal payments be paid at maturity in 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 agreed to discount the note $2,000 and recognized a loss of $2,000.
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
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secured note bore interest at 7% and matured in September 2004. The buyer had the option to convey the contingent land back to TCI for cancellation of the note. 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 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 then extended the note an additional 30 days to April 2005 by paying an extension fee of 0.5% of the outstanding principal balance.
Related Parties. In January 2002, TCI purchased 100% of the outstanding common shares of ART Two Hickory Corporation (“Two Hickory”), a wholly-owned subsidiary of ARI, a related party, for $4.4 million cash. Two Hickory owns the 96,217 sq. ft. Two Hickory Centre Office Building in Farmers Branch, Texas. ARI has guaranteed that the asset shall produce at least a 12.0% 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 has 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 the assumed debt, 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 wholly-owned subsidiaries of ARI, a related party, for $10.0 million. One Hickory owns the 120,615 sq. ft. One Hickory Centre Office Building in Farmers Branch, Texas. Confederate Point owns the 206 unit Confederate Apartments in Jacksonville, Florida. Foxwood owns the 220 unit Foxwood Apartments in Memphis, Tennessee. Woodsong owned the 190 unit Woodsong Apartments in Smyrna, Georgia. ARI has guaranteed 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 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 has 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 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 December 2003, TCI purchased a note receivable secured by 33 acres of raw land in Travis County, Texas from ARI for $2.4 million, which reduced ARI’s affiliate payable to Prime and TCI. The note bears interest at 10.0% per annum, requires interest only payments beginning in November 2007 and matures in October 2008. Outstanding accrued interest is added to the principal balance on an annual basis until 2007. During 2004, $240,000 of accrued interest was added to the principal balance of the note.
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In December 2003, TCI sold a tract of Marine Creek land to a subsidiary of United Housing Foundation, Inc. (“UHF”) for $1.5 million, receiving cash and a note receivable. This sale was not recognized due to UHF being a related party and TCI having continuing involvement and control. In February 2004, Marine Creek was refinanced by UHF, which paid off TCI’s note payable on the land. TCI recorded the sale of the land and received a note receivable of $270,000, which was the difference between the sales price and the amount of TCI’s note payable. The note bears interest at 6.0%, requires quarterly payments from available surplus cash and matures in December 2007. See Note 8. “RELATED PARTY TRANSACTIONS.”
In October 2004, TCI sold the Durham Centre in Durham, North Carolina to a partnership, of which the managing general partner is a subsidiary of ARI, for $21.3 million for cash and an all-inclusive wraparound note of $14.5 million. The note bears interest at a fixed rate of 7.63%, requires monthly interest payments and matures in September 2007. TCI also made a loan to the partnership for $3.3 million. The note bears interest at a fixed rate of 7.63%, requires monthly interest payments and matures in September 2017.
In October 2004, TCI contemplated the sale of the common stock of TCI Lexington Corporation, which owns the Lexington Center office building in Colorado Springs, Colorado, to One Realco Office Investors, Inc., a related party, for the assumption of debt of $4.9 million, which was subject to lender approval, and a seller note of $237,000. The assumption of debt by One Realco Office Investors, Inc. was not approved by the lender; therefore, TCI’s Board of Directors rescinded their approval of the transaction. TCI extended the loan on the Lexington Center with the lender in December 2004.
Other. In July 2003, TCI advanced $2.3 million to the Class A Limited Partners of TCI Countryside, L.P. of which TCI is the general partner. This loan bears interest at 7.25% and matures in January 2007. TCI also agreed to advance $1.1 million to the Class A Limited Partners by advancing $105,000 in July 2003 and every year thereafter for ten years. This loan bears interest at 7.25% and matures in July 2012. Interest due to TCI will be deducted for the quarterly return owed by TCI to the Class A Limited Partners, eliminating the quarterly payments. After January 2007, TCI may retire the Class A Limited Partners interests in exchange for cancellation of both notes, subject to the $1.1 million advance being fully advanced by TCI.
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 7.75%, and matures in April 2005.
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 7.75%, and matures in April 2005.
Partnership mortgage loans. TCI owns a 60.0% general partner interest and IORI owns a 40.0% general partner interest in Nakash Income Associates (“NIA”), which owns a wraparound mortgage note receivable secured by a building occupied by a Wal-Mart in Maulden, Missouri.
ITEM 3. LEGAL PROCEEDINGS
Innovo Realty, Inc. On August 10, 2004, American Realty Investors, Inc. (“ARI”), TCI and Income Opportunity Realty Investors, Inc. (“IOT”) 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, Hubert Guez, Third Millennium Partners LLC, Third Millennium Partners, Inc., Third Millennium Group LLC and Sunridge Management Group, Inc., Defendants. Plaintiffs’ Complaint alleges that Joseph Mizrachi, a former director of 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
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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 are affiliates of, or controlled by, Joseph Mizrachi. Plaintiffs’ Complaint alleges that the overall transaction required the establishment of a sinking fund by the Defendants and the 22 limited partnerships as a trust for the benefit of certain preferred shareholders of Innovo Group, Inc. and the payment of certain proceeds to the Plaintiffs. Plaintiffs assert that payments have not been made pursuant to the agreement of the parties. Plaintiffs allege that Defendants’ conduct constituted a common business enterprise, alleges breach of contract and derivative claims on behalf of Innovo Group, Inc. against Joseph Mizrachi and others, and requests declaratory relief involving the Plaintiffs’ rights in the partnerships, an accounting of proceeds, and the creation of a constructive trust. Plaintiffs’ Complaint also alleges that Joseph Mizrachi engaged in fraud, negligent misrepresentation and/or breach of fiduciary duty and seeks unspecified damages, attorneys’ fees, the establishment of a constructive trust and other relief.
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. (“BCM”), Prime Income Asset Management, Inc. (“PIAMI”), Prime Income Asset Management LLC (“Prime”), Income Opportunity Realty Investors, Inc., United Housing Foundation, Inc. (“United”), Regis Realty, Inc. (“Regis”), TCI, TCI’s current directors and officers and others. Sunset’s Complaint was instituted as Case No. 3:04-CV-02162-B styled Sunset Management LLC, Derivatively on Behalf of Transcontinental Realty Investors, Inc. v. American Realty Investors, Inc., et al. Sunset’s Complaint alleges (i) Sunset is the owner of 10 shares of Common Stock of TCI and Sunset is the pledgee and beneficial owner of 3,673,115 shares of Common Stock of TCI, (ii) Sunset is a single-member limited liability company, (iii) all of the Defendants have in their various capacities breached fiduciary duties to TCI, and (iv) unjust enrichment of the various Defendants. Sunset’s Complaint seeks an injunction prohibiting TCI from entering into any related-party transactions that are not fair to TCI and approved by disinterested directors and/or the stockholders of TCI with full knowledge of the common interest of the directors and/or officers, unspecified damages, attorneys’ fees and costs. Individual directors and officers of TCI do not believe their interests are adverse to TCI in this matter. All Defendants believe the action is not properly brought as a derivative action on behalf of TCI, as Sunset’s interests are adverse to the interests of TCI. The current action brought by Sunset contains many of the same allegations raised by Sunset in four other cases which, as rulings have occurred, have resulted in a denial of Sunset’s requested relief. The Defendants intend to vigorously defend the action, and on November 8, 2004, filed a Motion to Dismiss the case 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 exception for stockholder derivative actions, and that Sunset cannot fairly and adequately represent the interests of other stockholders. On January 4, 2005, the Defendants also filed a Motion to Stay Discovery and for Protective Order based on the concept that the Motion to Dismiss should dispose of the matter. No hearing has been held or Order issued by the Court on either Motion through March 31, 2005. Separately, one of the individual Defendants filed on January 4, 2005, a Motion to Disqualify Sunset’s Counsel.
The current Sunset Complaint is the fifth in a continuing series of actions involving Sunset, certain subsidiaries of ARI and ARI resulting from a loan in September 2001 to BCM and three subsidiaries of ARI in the original amount of $30 million ($19.5 million of which bore interest at 24% per annum, while the remaining $10.5 million of which bore interest at 20%). In September 2002, $15 million in principal was repaid leaving a $15 million aggregate balance, which Sunset orally agreed to extend the maturity date and accept substitute collateral, an arrangement which Sunset did not honor, resulting in the original litigation filed in Texas State Court during October 2002 as Cause No. 02-09433-I in the 162nd Judicial District Court of Dallas County, Texas styled American Realty Trust, Inc., ART Williamsburg, Inc., Basic Capital Management, Inc. and EQK Holdings, Inc. v. Sunset Management LLC (the “Texas Litigation”). The Texas Litigation alleged breach of contract, misrepresentation, breach of duty of good faith and fair dealing and slander of title by Sunset and sought certain declaratory relief against Sunset, as well as temporary and permanent anti-suit injunction against Sunset.
During January 2003, without notice to the Plaintiffs in the Texas Litigation, Sunset instituted an action in Federal District Court in Las Vegas, Nevada against Commonwealth Land Title (“Commonwealth”) seeking
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disposition of certain shares of Common Stock of TCI held by Commonwealth as Pledge Holder. On January 31, 2003, after a Temporary Restraining Order was issued in the Texas Litigation against Sunset, Sunset instituted a separate lawsuit in Nevada State Court styled Sunset Management LLC v. American Realty Trust, Inc., et al., Cause No. A462587 pending in District Court of Clark County, Nevada (the “Nevada Litigation”). On February 12, 2003, the Nevada State Court held a hearing on Sunset’s request for emergency relief and denied all of Sunset’s requested relief and indicated that a stay of the Nevada Litigation may be appropriate, which stay of litigation (including claims against TCI) was granted on May 2, 2003. Notwithstanding the stay of the Nevada Litigation, Sunset has attempted to re-litigate the underlying issues already determined in the Texas Litigation and the Nevada Litigation through cross-claims and counterclaims in the Texas Litigation and renewed motions for injunctions and the appointment of a receiver in the Nevada Litigation. During September 2003, the Texas Litigation was removed to Bankruptcy Court for the Northern District of Texas and subsequently transferred to the Eastern District of Texas. Sunset and the Plaintiffs have filed cross-motions for partial summary judgment in the Bankruptcy Court which had been briefed but remain pending at this time. The parties have also filed an Agreed Motion to Withdraw the reference and have the case transferred to a United States District Judge for trial, which has been denied without prejudice pending resolution of pre-trial motions, including the motions for summary judgment.
On February 10, 2004, Sunset filed yet another lawsuit in Nevada styled Sunset Management LLC v. Transcontinental Realty Investors, Inc., Case No. CV04-00345 in the Superior Court of Washoe County, seeking to compel a new election of directors, alleging that Sunset was improperly denied voting rights with respect to certain pledged shares at the 2003 stockholders meeting of TCI. TCI responded to that action by informing the Nevada Court that the issue of the validity and effectiveness of proxies purportedly held by Sunset in connection with the loan was already pending before the Bankruptcy Court. On May 12, 2004, the Nevada District Court denied Sunset’s motion to compel an election of corporate directors because of the dispute pending in the Texas Bankruptcy Court concerning the status of the loan. Subsequently, the Nevada District Court denied two motions for reconsideration filed by Sunset. Sunset is currently appealing the rulings of the Washoe County District Court.
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders was held on November 22, 2004, at which meeting stockholders were asked to consider and vote upon the election of Directors and the ratification of the selection of the independent public accountants for TCI for the fiscal year ending December 31, 2004. At the meeting, stockholders elected the following individuals as Directors:
Director
Henry A. Butler
Sharon Hunt
Ted R. Munselle
Ted P. Stokely
Martin L. White
There were no no votes or broker non-votes on the election of Directors. With respect to the ratification of the appointment of Farmer, Fuqua & Huff, P.C. as independent auditors of the Company for the fiscal year ending December 31, 2004, and any interim period, at least 7,320,494 votes were received in favor of such proposal, 8,335 votes were received against such proposal, and 3,218 votes abstained.
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PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASED EQUITY SECURITIES
TCI’s Common Stock is traded on the New York Stock Exchange (“NYSE”) using the symbol “TCI”. The following table sets forth the high and low sales prices as reported in the consolidated reporting system of the NYSE.
Quarter Ended
March 31, 2005 (through March 24, 2005)
March 31, 2004
June 30, 2004
September 30, 2004
December 31, 2004
March 31, 2003
June 30, 2003
September 30, 2003
December 31, 2003
As of March 24, 2005, the closing price of TCI’s Common Stock as reported in the consolidated reporting system of the NYSE was $19.29 per share.
As of March 24, 2005, TCI’s Common Stock was held by 4,464 holders of record.
TCI paid no dividends in 2004, 2003 or 2002, and management believes no dividends will be paid in 2005. The payment of dividends, if any, will be determined by the Board of Directors in light of conditions then existing, including the Company’s financial condition and requirements, future prospects, restrictions in financing agreements, business conditions and other factors deemed relevant by the Board of Directors.
In December 1989, the Board of Directors approved a share repurchase program, authorizing the repurchase of a total of 687,000 shares of TCI’s Common Stock. In October 2000, the Board increased this authorization to 1,409,000 shares. Through December 31, 2004, a total of 1,189,910 shares have been repurchased at a cost of $15.9 million. No shares were repurchased in 2002 or 2003. In November 2004, the Board approved a private block purchase of 212,800 shares of Common Stock for a total cost of $3.1 million. The following table represents shares repurchased during each of the three months ended December 31, 2004:
Period
Total Number of
Shares Purchased
Average Price
Paid per Share
Shares Purchased as
Part of Publicly
Announced Program
Maximum Number of
Shares that May
Yet be Purchased
Under the Program(a)
Balance as of September 30, 2004
October 1-31, 2004
November 1-30, 2004
December 1-31, 2004
Total
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ITEM 6. SELECTED FINANCIAL DATA
EARNINGS DATA
Rents
Property expense
Operating income
Gain on land sales
Income from operations
Other income
Gain on real estate
Total other income
Other expense
Income (loss) from before tax
Income tax benefit
Net income/(loss) from continuing operations
Discontinued operations, net of taxes
Net income (loss)
Preferred dividend requirement
Net income (loss) applicable to Common shares
Basic and Diluted Earnings Per Share
Basic
Diluted
Dividends per Common share
Weighted Average Common Shares Outstanding
BALANCE SHEET DATA
Real estate held for investment, net
Real estate held for sale
Real estate subject to sales contract
Notes and interest receivable, net
Total assets
Notes and interest payable
Stockholders’ equity
Book value per share
TCI purchased 20 properties for a total of $86.7 million in 2004, 10 properties for a total of $36.9 million in 2003, 16 properties for a total of $107.7 million in 2002, 17 properties for a total of $62.5 million in 2001, and
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18 properties for a total of $103.9 million in 2000. TCI sold 20 properties, the two remaining warehouses in the Kelly portfolio and four parcels of land for $276.7 million in 2004, 13 properties, two warehouses in the Kelly portfolio and 5 parcels of land for $86.6 million in 2003, 18 properties and a partial land parcel for a total of $117.6 million in 2002, 22 properties, one warehouse in the Kelly portfolio and three partial land parcels in 2001 for a total of $161.5 million, and 20 properties in 2000 for a total of $113.5 million. See ITEM 2. “PROPERTIES—Real Estate” and ITEM 8. “FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.”
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Introduction
TCI invests in real estate through acquisitions, leases and partnerships and in mortgage loans on real estate, including first, wraparound and junior mortgage loans. TCI is the successor to a California business trust organized on September 6, 1983, which commenced operations on January 31, 1984. On November 30, 1999, TCI acquired all of the outstanding shares of beneficial interest of CMET, a real estate company, in a tax-free exchange of shares, issuing 1.181 shares of its Common Stock for each outstanding CMET share. TCI accounted for the merger as a purchase.
Prior to January 1, 2000, TCI elected to be treated as a Real Estate Investment Trust (“REIT”) under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the “Code”). During the third quarter of 2000, TCI no longer met the requirement for tax treatment as a REIT due to a concentration of ownership.
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 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 the carrying value is not recoverable from estimated net sales proceeds, the property is written down to estimated fair value less costs to sell and an impairment loss is recognized within income from continuing operations. TCI’s estimates of cash flow and fair values of the properties are based on current market conditions and consider matters such as rental rates and occupancies for comparable properties, recent sales data for comparable properties and, where applicable, contracts or the results of negotiations with purchasers or prospective purchasers. TCI’s estimates are subject to revision as market conditions and TCI’s assessments of them change. In the third quarter of 2004, TCI recognized $1.6 million and $2.9 million of impairment losses, and in the fourth quarter of 2004, recognized $1.7 million of impairment losses. In the fourth quarter of 2003, TCI recognized $4.4 million and $192,000 as impairment losses, and in the second and third quarter of 2002, TCI recognized $1.9 million and $700,000 as impairment losses.
TCI’s allowance for doubtful accounts receivable and notes receivable is established based on analysis of the risk of loss on specific accounts. The analysis places particular emphasis on past due accounts. Management considers such information as the nature and age of the receivable, the payment history of the tenant or other debtor, the financial condition of the tenant or other debtor and TCI’s assessment of its ability to meet its lease or interest obligations. TCI’s estimate of the required allowance, which is reviewed on a quarterly basis, is subject to revision as these factors change and is sensitive to the effects of economic and market conditions.
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TCI’s management periodically discusses criteria for estimates and disclosure of its estimates with the audit committee of TCI’s Board of Directors.
Obligations and Commitments
TCI has contractual obligations and commitments primarily with regards to the payment of mortgages.
The following table aggregates TCI’s expected contractual obligations and commitments subsequent to December 31, 2004.
Long-Term Debt(1)
Capital Lease Obligations
Operating Leases
Purchase Obligations
Other Long-Term Liabilities
Other long-term liabilities represent TCI’s intentions to purchase the interests of general and limited partners formed to construct residential properties.
Liquidity and Capital Resources
Cash and cash equivalents were $21.8 million, $6.4 million, and $10.6 million at December 31, 2004, 2003 and 2002, respectively. The principal reasons for the change in cash are discussed in the paragraphs below.
TCI’s principal sources of cash have been and will continue to be from property operations, proceeds from property sales, and the collection of mortgage notes receivable, borrowings and to a lesser extent, distributions from partnerships. Management anticipates that TCI’s cash at December 31, 2004, along with cash that will be generated in 2005 from property operations, will not be sufficient to meet all of TCI’s cash requirements. Management intends to selectively sell income producing real estate, refinance or extend real estate debt and seek additional borrowings against real estate to meet its cash requirements. Historically, management has been successful at extending its current maturity obligations. Management also anticipates funding ongoing real estate construction projects and the acquisition of new real estate from cash generated by property sales, debt refinancings or extensions, and additional borrowings.
Net cash used in operations was $13.2 million in 2004 compared to net cash provided in operations of $3.7 million in 2003 and net cash used of $9.1 million in 2002. Cash flow from property operations is rents collected, less payment for property operating expenses or net rental income. Although operating income was higher in 2004 compared to 2003 due to increased income from residential properties, cash from operations was less in 2004 compared to 2003 due to higher spending on general and administrative expenses, advisory fees and net income fees and an increase in non-cash gains from property sales and foreign currency transactions in 2004 compared to 2003. The increase in operating cash from 2002 to 2003 was due to an increase in net rental income from new apartments that finished construction in 2002 and 2003, and an increase in commercial net rental income due to Centura Tower, which was purchased in June 2002. Cash also increased due to less spending on general and administrative expenses from 2002 to 2003. These gains were offset by the sales of real estate during 2002 and 2003 and from higher interest expense paid during 2003. Management believes that cash flow may decrease from property operations as a result of selling income producing properties.
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Management expects that funds from existing cash resources, selective sales of income producing properties, refinancing of real estate, and additional borrowings against real estate will be sufficient to meet TCI’s cash requirements associated with its current and anticipated level of operations, maturing debt obligations and existing commitments. To the extent that TCI’s liquidity permits or financing sources are available, management intends to make new real estate investments.
Net cash used in investing activities was $18.9 million in 2004 compared to $26.9 million in 2003 and $67.0 million in 2002. Cash from investing activities increased in 2004 compared to 2003 due to higher proceeds from the sales of real estate and collections on notes receivable, reduced by increased spending on real estate construction and improvements and real estate acquisitions, and an increase in payments to TCI’s advisor. Cash from investing activities increased in 2003 compared to 2002 due to TCI spending less on real estate construction and improvements and an increase in payments received from TCI’s advisor. These cash increases were offset by cash decreases due to less collected on notes receivable, less real estate sold, the purchase of marketable securities and increases in deposits on pending real estate purchases.
Net cash provided by financing activities was $47.6 million in 2004 compared to $19.0 million in 2003 and $76.3 million in 2002. Cash from financing activities increased in 2004 compared to 2003 due to higher proceeds from refinancing of notes payable, which was reduced by higher payments on notes payable and the repurchase of TCI’s common stock. Cash from financing activities decreased in 2003 compared to 2002 due to higher payments on notes payable and lower proceeds from notes payable refinancings.
Management reviews the carrying values of TCI’s properties and mortgage notes receivable at least annually and whenever events or a change in circumstances indicate that impairment may exist. Impairment is considered to exist if, in the case of a property, the future cash flow from the property (undiscounted and without interest) is less than the carrying amount of the property. For notes receivable, impairment is considered to exist if it is probable that all amounts due under the terms of the note will not be collected. If impairment is found to exist, a provision for loss is recorded by a charge against earnings. The note receivable review includes an evaluation of the collateral property securing such note. The property review generally includes: (1) selective property inspections; (2) a review of the property’s current rents compared to market rents; (3) a review of the property’s expenses; (4) a review of maintenance requirements; (5) a review of the property’s cash flow; (6) discussions with the manager of the property; and (7) a review of properties in the surrounding area.
Results of Operations
2004 Compared to 2003. TCI had net income of $23.1 million in 2004, including gains on sale of real estate totaling $63.3 million and net income of $673,000 in 2003, including gains on sale of real estate totaling $21.7 million. Fluctuations in the components of revenues and expense between 2004 and 2003 are discussed below.
Rents were $93.0 million in 2004 compared to $77.8 million in 2003. The increase in rents from 2004 to 2003 is primarily due to new rental income from completed apartment projects since 2001 and a slight increase in hotel revenues.
Property operations expenses were $59.2 million in 2004 compared to $55.8 million in 2003. This increase is primarily due to additional operations expense from the completion of apartment projects since 2001, which is offset by decreases in hotel and land operations during 2004.
Interest and other income was $3.7 million in 2004 compared to $6.7 million in 2003. The higher other income in 2003 was due to a $3.8 million litigation settlement received by TCI.
Equity losses of investees was $1.5 million in 2004 compared to $4.3 million in 2003. The losses from equity investees are primarily attributed to operating losses for IORI and ARI. IORI and ARI had lower losses from continuing operations in 2004.
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Gain on settlement of debt was $4.4 million in 2003. The gain resulted from a favorable ruling in a lender dispute regarding the mortgage loans on three office buildings in New Orleans, Louisiana.
Gain on condemnation award was $4.8 million in 2003, resulting from the settlement of a dispute regarding a land parcel in Dallas, Texas.
Gain on foreign currency translation was $3.8 million in 2004. Gain or loss on foreign currency transaction is the result of Hotel Akademia converting long-term debt, which is denominated in Euros, into the functional currency, the Polish Zloty. The Euro weakened against the Zloty during 2004, which has resulted in TCI recognizing this gain.
Interest expense was $32.4 million in 2004 compared to $23.7 million in 2003. Interest expense increased in 2004 primarily due to increased debt due to apartment construction projects being completed since 2001. Changes in other segments interest expense was nominal from 2004 to 2003.
Depreciation expense was $17.7 million in 2004 compared to $13.2 million in 2003. Depreciation expense increased in 2004 primarily due to apartment construction projects being completed since 2001.
TCI recorded asset impairments of $1.7 million in 2004 and $198,000 in 2003, representing the write-down of certain operating properties to current estimated fair value.
The assets for 2004 include the following properties:
It was determined that the fair value of 225 Baronne was less than the current book value due to the pending loss of the anchor tenant. It was determined that future leases on the vacated space will be below market rates and the projected future cash flows of 225 Baronne will not be sufficient to recover the current book value.
The Red Cross land was sold on January 30, 2004 and the actual sales price less selling costs was used as the fair value.
Advisory fee expense was $6.7 million in 2004 compared to $4.9 million in 2003. The increase in 2004 was due to higher average gross assets during the year. Also, TCI received an operating expense refund from Prime of $1.3 million in 2003. See NOTE 12. “ADVISORY AGREEMENT.”
Net income fee to affiliate was $1.9 million in 2004. The net income fee is payable to TCI’s advisor based on 7.5% of TCI’s net income. TCI had a net loss for 2003, so no net income fee was due.
General and administrative expenses were $9.3 million in 2004 compared to $9.1 million in 2003. The increase in 2004 was due to an increase in state income taxes and cost reimbursements to the Advisor, offset by lower legal cost and professional fees.
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Loss on foreign currency transaction was $3.3 million in 2003. Loss on foreign currency transaction is the result of Hotel Akademia converting long-term debt, which is denominated in Euros, into the functional currency, the Polish Zloty. The Euro strengthened against the Zloty during 2003, which has resulted in TCI recognizing this charge.
Income from discontinued operations was $58.4 million in 2004 compared to $17.9 million in 2003. Income from discontinued operations relates to 22 operating properties sold during 2004, three apartments, two office buildings and one industrial warehouse designated as held for sale and 15 operating properties TCI sold during 2003. The following table summarizes revenue and expense information for these properties sold and held-for-sale.
Revenue
Rental
Property operations
Expenses
Depreciation
Net income (loss) from discontinued operations before gains on sale of real estate
Gain on sale of operations
Write-down of assets held for sale
Equity in investees gain on sale of real estate
Income from discontinued operations
Discontinued operations have not been segregated in the consolidated statements of cash flows. Therefore, amounts for certain captions will not agree with respective consolidated statements of operations.
In 2004 and 2003, gains on sale of real estate totaling $63.3 million and $21.7 million were recognized. See NOTE 2. “REAL ESTATE.”
2003 Compared to 2002. TCI had net income of $673,000 in 2003, including gains on sale of real estate totaling $21.7 million and net income of $4.9 million in 2002, including gains on sale of real estate totaling $38.3 million. Fluctuations in the components of revenues and expense between 2003 and 2002 are discussed below.
Rents were $77.8 million in 2003 compared to $62.2 million in 2002. The increase in rents from 2003 to 2002 is due to new rental income from completed apartment projects and increases in commercial rents and hotel revenues.
Property operations expenses were $55.8 million in 2003 compared to $46.3 million in 2002. This increase is primarily due to additional operations expense from the completion of multiple apartment projects during 2001 and 2002.
Interest and other income was $6.7 million in 2003 compared to $4.1 million in 2002. The increase in 2003 was due to a $3.8 million litigation settlement received by TCI.
Equity losses of investees was $4.3 million in 2003 compared to $3.8 million in 2002. The losses from equity investees are primarily attributed to operating losses for IORI and ARI.
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Interest expense was $23.7 million in 2003 compared to $20.4 million in 2002. Interest expense increased in 2003 primarily due to increased debt due to apartment construction projects being completed in 2001 and 2002, offset by a decrease in commercial interest expense during 2003.
Depreciation expense was $13.2 million in 2003 compared to $11.7 million in 2002. Depreciation expense increased in 2003 primarily due to apartment construction projects being completed in 2001 and 2002.
TCI recorded asset impairments of $198,000 in 2003 and $2.6 million for 2002, representing the write-down of certain operating properties to current estimated fair value.
The Red Cross land was under contract to sell in 2002 and the sales price was used as fair value. The fair value determined for four apartments above were agreed upon purchase prices as part of the refinancing transaction with Metra Capital, LLC. The costs to sell were actual fees paid to refinance the properties. TCI refinanced the Plantation Apartments in May 2003, incurring a new note for $2.3 million and discharging debt of $1.9 million. See NOTE 7. “NOTES AND INTEREST PAYABLE.”
Advisory fee expense was $4.9 million in 2003 compared to $4.5 million in 2002. The increase in 2003 was due to higher average gross assets during the year. TCI received operating expense refunds from BCM of $1.3 million in 2003 and $1.4 million in 2002. See NOTE 12. “ADVISORY AGREEMENT.”
Net income fee to affiliate was $374,000 in 2002. The net income fee is payable to TCI’s advisor based on 7.5% of TCI’s net income. TCI had a net loss for 2003, so no net income fee was due.
General and administrative expenses were $9.1 million in 2003 compared to $8.8 million in 2002. The increase in 2003 was due to an increase in legal fees and state income taxes, offset by lower real estate insurance premiums and cost reimbursements to the Advisor.
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Loss on foreign currency transaction was $3.3 million in 2003 compared to $2.5 million in 2002. Loss on foreign currency transaction is the result of Hotel Akademia converting long-term debt, which is denominated in Euros, into the functional currency, the Polish Zloty. The Euro has strengthened against the Zloty during 2002 and 2003, which has resulted in TCI recognizing this charge.
Income from discontinued operations was $17.9 million in 2003 compared to $37.9 million in 2002. Income from discontinued operations relates to 15 properties that TCI sold during 2003 and 18 properties that TCI sold during 2002. The following table summarizes revenue and expense information for these properties sold and held-for-sale.
In 2003 and 2002, gains on sale of real estate totaling $21.7 million and $38.3 million were recognized. See NOTE 2. “REAL ESTATE.”
Related Party Transactions
Historically, TCI, ARI, IORI, and others have each engaged in and may continue to engage in business transactions, including real estate partnerships, with related parties. Management believes that all of the related party transactions represented the best investments available at the time and were at least as advantageous to TCI as could have been obtained from unrelated parties.
Operating Relationships
TCI received rents of $69,000 in 2004, $175,000 in 2003, and $88,000 in 2002 from BCM for BCM’s lease at Addison Hanger. BCM owns a corporate jet that is housed at the hanger and TCI has available space at the hanger.
Property Transactions
Activity in 2004 included:
In December 2003, TCI sold six properties to subsidiaries of United Housing Foundation, Inc. (“UHF”), a Texas Non-Profit 501(c)3 Corporation. TCI sold 10.72 acres of Marine Creek land for $1.5 million, Limestone at Vista Ridge apartments for $19.0 million, the Cliffs of El Dorado apartments for $13.4 million, the Limestone
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Canyon apartments for $18.0 million, the Sendero Ridge apartments for $29.4 million and the Tivoli apartments for $16.1 million. Ted Stokely, Chairman of the Board of TCI, is the General Manager of UHF. Richard Humphrey, who is employed by Regis I, an affiliate, is President of UHF. Due to UHF being considered a related party to TCI and TCI having continued involvement and control of these entities, these transactions have not been recorded as sales. Instead, these transactions will be accounted for on the deposit method and the properties and corresponding debt will continue to be consolidated by TCI. The loans on Limestone Canyon apartments and Limestone at Vista Ridge apartments were approved by their prospective lenders for transfer to the purchasing entities. TCI has guaranteed the loans on both of these transfers. Also, Marine Creek land and the Cliffs of El Dorado apartments were recognized as sales during 2004. Management is seeking lender approval on the transfer of the notes associated with the Tivoli apartments and Sendero Ridge apartments.
In January 2004, TCI purchased the Vista Ridge land tract from ARI for $2.6 million. This transaction decreased TCI’s affiliate receivable from Prime by $2.6 million.
In February 2004, TCI incurred a debt for $1.0 million used for the purchase of land by ARI. This transaction increased TCI’s affiliate receivable from Prime 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 holds a note receivable balance of $270,000 remaining that bears interest at 12.00% 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 May 2004, TCI purchased the Treehouse Apartments from an affiliate with a net purchase price of $7.5 million for the assumption of debt and a note receivable, less cash received of $498,000. The note receivable was from the sale of the Cliffs of El Dorado Apartments to a related party in 2003. At that time, the sale of the Cliffs of El Dorado Apartments was not recorded as a sale for accounting purposes. TCI recorded the sale of the Cliffs of El Dorado in May 2004 upon payment received for the Cliffs of El Dorado note receivable.
In January 2004, TCI purchased the Lacy Longhorn land tract from ARI for $4.5 million. This transaction decreased TCI’s affiliate receivable from Prime by $4.5 million.
In June 2004, TCI sold Waters Edge IV apartments to ARI for $5.0 million. This transaction increased TCI’s affiliate receivable from Prime by $5.0 million.
In June 2004, TCI refinanced the 1010 Common office building, Lacy Longhorn land and certain tracts of Marine Creek land. TCI paid-off an existing note payable for ARI for $1.9 million, increasing the affiliate receivable balance from Prime by $1.9 million.
In September 2004, TCI sold Limestone Canyon II land to a subsidiary of UHF for $720,000 in the form of a seller note receivable. Due to no cash received and common control, TCI has elected to continue consolidating this tract of land until the requirements for a sale have been met. No sale has recognized and no note receivable has been recorded.
In December 2004, TCI purchased five tracts of land from ARI, including the LCLLP tract (45.49 acres); the Payne tract (268 acres), of which TCI owns a 50% Tenant-In-Common interest; the Rochelle I tract (10.096 acres); the Rochelle II tract (21.269 acres); and the Valley Ranch tract (29.9 acres) for $39.1 million, including the assumption of debt. This transaction reduced TCI’s affiliate receivable from Prime by $29.1 million.
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Environmental Matters
Under various federal, state and local environmental laws, ordinances and regulations, TCI may be potentially liable for removal or remediation costs, as well as certain other potential costs, relating to hazardous or toxic substances (including governmental fines and injuries to persons and property) where property-level managers have arranged for the removal, disposal or treatment of hazardous or toxic substances. In addition, certain environmental laws impose liability for release of asbestos-containing materials into the air, and third parties may seek recovery for personal injury associated with such materials.
Management is not aware of any environmental liability relating to the above matters that would have a material adverse effect on TCI’s business, assets or results of operations.
Inflation
The effects of inflation on TCI’s operations are not quantifiable. Revenues from property operations tend to fluctuate proportionately with inflationary increases and decreases in housing costs. Fluctuations in the rate of inflation also affect sales values of properties and the ultimate gain to be realized from property sales. To the extent that inflation affects interest rates, TCI’s earnings from short-term investments, the cost of new financings as well as the cost of variable interest rate debt will be affected.
Tax Matters
Prior to the year 2000, TCI elected and in the opinion of management, qualified to be taxed as a REIT as defined under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended. During the third quarter of 2000, due to a concentration in ownership, TCI no longer met the requirements for tax treatment as a REIT under the Code. Under the Code, TCI is prohibited from re-qualifying for REIT tax status for at least five years after January 1, 2001.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES REGARDING MARKET RISK
TCI’s future operations, cash flow and fair values of financial instruments are partially dependent on the then existing market interest rates and market equity prices. Market risk is the changes in the market rates and prices, and the effect of the changes on future operations. Market risk is managed by matching a property’s anticipated net operating income to an appropriate financing.
TCI is exposed to interest rate risk associated with variable rate notes payable and maturing debt that has to be refinanced. TCI does not hold financial instruments for trading or other speculative purposes, but rather issues these financial instruments to finance its portfolio of real estate assets. TCI’s interest rate sensitivity position is managed by TCI’s capital markets department. Interest rate sensitivity is the relationship between changes in market interest rates and the fair value of market rate sensitive assets and liabilities. TCI’s earnings are affected as changes in short-term interest rates impact its cost of variable rate debt and maturing fixed rate debt. A large portion of TCI’s market risk is exposure to short-term interest rates from variable rate borrowings. The impact on TCI’s financial statements of refinancing fixed debt that matured during 2004 was not material. As permitted, management intends to convert a significant portion of those borrowings from variable rates to fixed rates in 2005. If market interest rates for variable rate debt average 100 basis points more in 2005 than they did during 2004, TCI’s interest expense would increase, and income would decrease by $1.5 million. This amount is determined by considering the impact of hypothetical interest rates on TCI’s borrowing cost. This analysis did not consider the effects of the reduced level of overall economic activity that could exist in such an environment. Further, in the event of a change of such magnitude, management would likely take actions to further mitigate its exposure to the change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, the sensitivity analysis assumes no change in TCI’s financial structure.
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The following table contains only those exposures that existed at December 31, 2004. Anticipation of exposures or risk on positions that could possibly arise was not considered. TCI’s ultimate interest rate risk and its effect on operations will depend on future capital market exposures, which cannot be anticipated with a probable assurance level. Dollars in thousands.
Assets
Notes receivable
Variable interest rate-fair value
Instrument’s maturities
Instrument’s amortization
Average rate
Fixed interest rate-fair value
Liabilities
Non-trading Instruments-Equity Price Risk
Notes payable
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Statements
Report of Independent Registered Public Accounting Firms
Consolidated Balance Sheets—December 31, 2004 and 2003
Consolidated Statements of Operations—Years Ended December 31, 2004, 2003 and 2002
Consolidated Statements of Stockholders’ Equity—Years Ended December 31, 2004, 2003 and 2002
Consolidated Statements of Cash Flows—Years Ended December 31, 2004, 2003 and 2002
Notes to Consolidated Financial Statements
Financial Statement Schedules
Schedule III—Real Estate and Accumulated Depreciation
Schedule IV—Mortgage Loans on Real Estate
All other schedules are omitted because they are not required, are not applicable or the information required is included in the Consolidated Financial Statements or the notes thereto.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors of
Dallas, Texas
We have audited the accompanying consolidated balance sheet of Transcontinental Realty Investors, Inc. and Subsidiaries as of December 31, 2004, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the year ended December 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As described in Note 23, Transcontinental Realty Investors, Inc.’s management has indicated its intent to both sell income producing properties and refinance or extend debt secured by real estate to meet its liquidity needs.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Transcontinental Realty Investors, Inc. as of December 31, 2004, and the results of its operations and its cash flows for the year ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the consolidated financial statements taken as a whole. Schedules III and IV are presented for the purpose of complying with the Securities and Exchange Commission’s rules and is not a required part of the basic consolidated financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the consolidated financial statements and, in our opinion, fairly states, in all material respects, the financial data required to be set forth therein in relation to the consolidated financial statements taken as a whole.
FARMER, FUQUA & HUFF, PC
Plano, Texas
March 31, 2005
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We have audited the accompanying consolidated balance sheets of Transcontinental Realty Investors, Inc. and Subsidiaries as of December 31, 2003 and the related consolidated statements of operations, stockholders’ equity, other comprehensive income/(loss) and cash flows for each of the two years in the period ended December 31, 2003. We have also audited the schedules listed in the accompanying index. These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and schedules are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and schedules. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedules. We believe that our audits provide a reasonable basis for our opinion.
As described in Note 23, Transcontinental Realty Investors, Inc.’s management has indicated its intent to both sell income producing properties and refinance or extend debt secured by real estate, to meet its liquidity needs.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Transcontinental Realty Investors, Inc. and Subsidiaries as of December 31, 2003 and the consolidated results of their operations and their cash flows for each of the two years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.
Also, in our opinion, the schedules present fairly, in all material respects, the information set forth therein.
BDO SEIDMAN, LLP
March 30, 2004 (except for Notes 19, 20 and 21 which are as of March 31, 2005.)
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TRANSCONTINENTAL REALTY INVESTORS, INC.
CONSOLIDATED BALANCE SHEETS
Real estate held for investment
Less—accumulated depreciation
Real estate subject to sales contract (See Note 8.)
Notes and interest receivable
Performing (including $40,496 in 2004 and $18,793 in 2003 from affiliates and related parties)
Non-performing, non-accruing
Less—allowance for estimated losses
Investment in real estate entities
Marketable equity securities, at market value
Cash and cash equivalents
Other assets (including $14,125 in 2004 and $4,819 in 2003 from affiliates and related parties)
Liabilities:
Liabilities related to assets held for sale
Liabilities subject to sales contract (See Note 8.)
Other liabilities (including $2,282 in 2004 and $607 in 2003 to affiliates and related parties)
Commitments and contingencies
Minority interest
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 in 2004 and 8,113,669 shares in 2003
Paid-in capital
Treasury stock
Accumulated deficit
Accumulated other comprehensive income
The accompanying notes are an integral part of these Consolidated Financial Statements.
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CONSOLIDATED STATEMENTS OF OPERATIONS
Property revenue:
Rents (including $69 in 2004 and $175 in 2003 from affiliates)
Property operations (including $4,849 in 2004 and $4,546 in 2003 to affiliates)
Land Operations:
Sales
Cost of Sales
Deferred Gain on Sale
Gain on Sales
Other income:
Interest and other income (including $2,069 in 2004 and $1,459 in 2003 from affiliates)
Equity in loss of equity investees
Gain on settlement of debt
Gain on condemnation award
Gain on foreign currency transaction
Dividends received
Other expense:
Interest (including $379 in 2004 to affiliates)
Provision for asset impairment
Provision for losses
Discount on sale of note receivables
Advisory fees
Net income fee
General and administrative (including $2,181 in 2004 and $1,630 in 2003 to affiliates)
Loss on foreign currency transactions
Total Other expenses
Net loss from continuing operations before taxes
Net loss from continuing operations
Discontinued Operations (Note 19):
Less: Income tax expense
Net income from discontinued operations
Net income
Net income applicable to Common shares
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CONSOLIDATED STATEMENTS OF OPERATIONS—(Continued)
Basic earnings per share:
Correction of accounting error in prior period (See Note 21.)
Discontinued operations
Diluted earnings:
Weighted average Common shares used in computing earnings per share:
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CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
Accumulated
Deficit
Comprehensive
Income
Balance, January 1, 2002
Comprehensive income
Unrealized (loss) on foreign currency translation
Issuance of Common Stock upon exercise of stock options
Series A Preferred Stock cash dividends ($5.00 per share)
Series C Preferred Stock cash dividends ($5.00 per share)
Balance, December 31, 2002
Net income (As Restated)
Series C Preferred Stock cash dividends ($6.00 per share)
Conversion of 5,829 Series A Preferred Stock into Common Stock
Balance, December 31, 2003 (As Restated)
Unrealized loss on foreign currency translation
Unrealized gain on marketable securities
Repurchase of common stock
Series C Preferred Stock cash dividends ($7.00 per share)
Balance, December 31, 2004
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CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash Flows from Operating Activities:
Reconciliation of net loss to net cash used by operating activities
Net Income
Adjustments to reconcile net loss to net cash provided by <used in> operating activities:
Depreciation and amortization
Provision for loss
Amortization of deferred borrowing costs
Gain on sale of real estate
Loss on foreign currency transaction
<Gain>loss allocated to minority interest
Increase in interest receivable
<Increase> decrease in other assets
Increase <decrease> in interest payable
Increase in other liabilities
Net cash provided by <used in> operating activities
Cash Flows from Investing Activities:
Collections on notes receivable (including $718 in 2004 and $1,241 in 2003 from affiliates)
Funding of notes receivable (including $3,297 in 2004 from affiliates)
Acquisitions of real estate
Real estate improvements
Real estate construction (including $5,625 in 2004 and $4,050 in 2003 to affiliates)
Proceeds from sale of real estate
Payments made under interest rate swap agreement
Purchase of marketable equity securities
Deposits on pending purchase
Payments (to) from advisor
Net advance to affiliates
Distributions <contributions> to equity investees
Net cash used in investing activities
Cash Flows from Financing Activities:
Payments on notes payable (including $226 in 2004 to affiliates)
Proceeds from notes payable
Payments to minority interests
Dividends paid
Dividends paid to preferred shareholders
Repurchase of Common Stock
Deferred financing costs
Proceeds from exercise of stock options
Net cash provided by financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents, beginning of year
Cash and cash equivalents, end of year
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CONSOLIDATED STATEMENTS OF CASH FLOWS—(Continued)
Supplemental Disclosures of Cash Flow Information:
Cash paid for interest
Notes payable assumed on purchase of real estate
Notes payable assumed by buyer on sale of real estate
Funds collected by affiliate on sale of note receivable
Notes receivable received from sale of real estate
Real estate refinancing proceeds received by affiliate
Real estate received on exchange with related party
Real estate received from related party to satisfy debt
Real estate sold to a related party to satisfy debt
Note payable proceeds used by affiliate for purchase of real estate
Note payable proceeds used by affiliate to satisfy debt
Note payable paid-off on behalf of affiliate
Notes receivable payments received by affiliate and added to affiliate receivable balance
Asset impairment write-down
Issuance of note payable for which cash proceeds were received by the advisor
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The accompanying Consolidated Financial Statements of Transcontinental Realty Investors, Inc. and consolidated entities have been prepared in conformity with accounting principles generally accepted in the United States of America, the most significant of which are described in NOTE 1. “SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.” The Notes to Consolidated Financial Statements are an integral part of the Consolidated Financial Statements. The data presented in the Notes to Consolidated Financial Statements are as of December 31 of each year and for the year then ended, unless otherwise indicated. Dollar amounts in tables are in thousands, except per share amounts.
Effective March 31, 2003, TCI financial results have been consolidated in the American Realty Investors, Inc. (“ARI”) Form 10-K and related consolidated financial statements. As of December 31, 2004, ARI owned 82.2% of the outstanding TCI common shares.
Certain balances for 2003 and 2002 have been reclassified to conform to the 2004 presentation.
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and business. Transcontinental Realty Investors, Inc. (“TCI”), a Nevada corporation, is successor to a California business trust which was organized on September 6, 1983, and commenced operations on January 31, 1984. TCI invests in real estate through direct ownership, leases and partnerships and it also invests in mortgage loans on real estate. In October 2001, TCI announced a preliminary agreement for the acquisition of TCI by American Realty Investors, Inc. (“ARI”). See NOTE 22. “COMMITMENTS AND CONTINGENCIES AND LIQUIDITY.”
Basis of consolidation. The Consolidated Financial Statements include the accounts of TCI and controlled subsidiaries and partnerships. All significant intercompany transactions and balances have been eliminated.
Accounting estimates. In the preparation of Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States of America, it is necessary for management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the Consolidated Financial Statements and the reported amounts of revenues and expense for the year ended. Actual results could differ from those estimates.
Interest recognition on notes receivable. It is TCI’s policy to cease recognizing interest income on notes receivable that have been delinquent for 60 days or more. In addition, accrued but unpaid interest income is only recognized to the extent that the net realizable value of the underlying collateral exceeds the carrying value of the receivable.
Allowance for estimated losses. Valuation allowances are provided for estimated losses on notes receivable considered to be impaired. Impairment is considered to exist when it is probable that all amounts due under the terms of the note will not be collected. Valuation allowances are provided for estimated losses on notes receivable to the extent that the Company’s investment in the note exceeds the estimated fair value of the collateral securing such note.
Recent Accounting pronouncements. SFAS No. 151—In November 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 151, “Inventory Costs, an Amendment of ARB No. 43, Chapter 4” (“SFAS No. 151”). SFAS No. 151 amends ARB 43, Chapter 4, to clarify that abnormal amounts of idle facility expense, freight, handling costs and wasted materials (spoilage) be recognized as current period charges. It also requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 is effective for inventory costs
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
incurred during fiscal years beginning after June 15, 2005. The adoption of SFAS No. 151 is not expected to have a material impact on the consolidated financial position or results of operations of TCI.
SFAS No. 152—In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 152, “Accounting for Real Estate Time-Sharing Transactions” (“SFAS No. 152”). SFAS No. 152 amends FASB Statement No. 66, Accounting for Sales of Real Estate, to reference the financial accounting and reporting guidance for real estate time-sharing transactions that is provided in AICPA Statement of Position 04-2, Accounting for Real Estate Time-Sharing Transactions (“SOP 04-2”). This Statement also amends FASB Statement No. 67, Accounting for Costs and Initial Rental Operations of Real Estate Projects, to state that the guidance for (a) incidental operations and (b) costs incurred to sell real estate projects does not apply to real estate time-sharing transactions. The accounting for those operations and costs is subject to the guidance in SOP 04-2.
SFAS No. 152 is effective for financial statements for fiscal years beginning after June 15, 2005, and is to be reported as a cumulative effect of a change in accounting principle. The adoption of SFAS No. 145 is not expected to have a material impact on the consolidated financial position or results of operations of TCI.
SFAS No. 123—In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, Share-Based Payment, revised (“SFAS No. 123R”). SFAS No. 123R addresses the accounting for share-based payments to employees, including grants of employee stock options. Under the new standard, companies will no longer be able to account for share-based compensation transactions using the intrinsic method in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees. Instead, companies will be required to account for such transactions using a fair-value method and recognize the expense in the consolidated statement of income. SFAS No. 123R will be effective for periods beginning after June 15, 2005 and allows, but does not require, companies to restate the full fiscal year of 2005 to reflect the impact of expensing share-based payments under SFAS No. 123R. The Company has not yet determined which fair-value method and transitional provision it will follow. The adoption of SFAS No. 123R is not expected to have a material impact on the Company’s consolidated financial position or results of operations. See Stock-Based Employee Compensation for the pro forma impact on net income and net income per share from calculating stock-based compensation costs under the fair value alternative of SFAS No. 123.
SFAS No. 153—In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 153, Exchanges of Non-monetary Assets, An Amendment of APB Opinion No. 29 (“SFAS No. 153”). The guidance in APB Opinion No. 29, Accounting for Non-monetary Transactions, is based on the principle that exchanges of non-monetary assets should be measured based on the fair value of the assets exchanged. The guidance in APB Opinion No. 29, however, included certain exceptions to that principle. SFAS No. 153 amends APB Opinion No. 29 to eliminate the exception for non-monetary exchanges of similar productive assets and replaces it with a general exception for exchanges of non-monetary assets that do not have commercial substance. A non-monetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 is effective for non-monetary asset exchanges in fiscal periods beginning after June 15, 2005. The adoption of SFAS No. 153 is not expected to have a material impact on the consolidated financial position or results of operations of TCI.
Real estate held for investment and depreciation. Real estate held for investment is carried at cost. Statement of Financial Accounting Standards No. 144 (“SFAS No. 144”) requires that a property be considered impaired, if the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the property. If impairment exists, an impairment loss is recognized, by a charge against earnings, equal to the amount by which the carrying amount of the property exceeds the fair value of the property. If impairment of a property is recognized, the carrying amount of the property is reduced by the amount
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of the impairment, and a new cost for the property is established. Such new cost is depreciated over the property’s remaining useful life. Depreciation is provided by the straight-line method over estimated useful lives, which range from five to 40 years.
Real estate held for sale. Foreclosed real estate is initially recorded at new cost, defined as the lower of original cost or fair value minus estimated cost of sale. SFAS No. 144 also requires properties held for sale be reported at the lower of carrying amount or fair value less costs of sale. If a reduction in a held for sale property’s carrying amount to fair value less costs of sale is required, a provision for loss is recognized by a charge against earnings. Subsequent revisions, either upward or downward, to a held for sale property’s estimated fair value less costs of sale is recorded as an adjustment to the property’s carrying amount, but not in excess of the property’s carrying amount when originally classified as held for sale. A corresponding charge against or credit to earnings is recognized. Properties held for sale are not depreciated.
Foreign Currency Translation. Foreign currency denominated assets and liabilities of subsidiaries with local functional currencies are translated to United States dollars at year-end exchange rates. The effects of translation are recorded in the accumulated other comprehensive income component of shareholders’ equity. Subsidiaries with a United States dollar functional currency remeasure monetary assets and liabilities at year-end exchange rates and non-monetary assets and liabilities at historical exchange rates. The effects of remeasurement are included in income. Exchange gains and losses arising from transactions denominated in foreign currencies are translated at average exchange rates. The effects of these exchange adjustments resulted in gains of $3.8 million in 2004 and losses of $3.3 million in 2003.
Revenue recognition on the sale of real estate. Sales of real estate are recognized when and to the extent permitted by Statement of Financial Accounting Standards No. 66, “Accounting for Sales of Real Estate” (“SFAS No. 66”), as amended by SFAS No. 144. Until the requirements of SFAS No. 66 for full profit recognition have been met, transactions are accounted for using either the deposit, installment, cost recovery or the financing method, whichever is appropriate.
Investment in noncontrolled equity investees. The equity method is used to account for investments in partnerships which TCI does not control but for which significant influence can be exerted, and for its investment in the shares of common stock of Income Opportunity Realty Investors, Inc., (“IORI”) and ARI. Under the equity method, an initial investment, recorded at cost, is increased by a proportionate share of the investee’s operating income and any additional advances and decreased by a proportionate share of the investee’s operating losses and distributions received.
Operating segments. Management has determined reportable operating segments to be those that are used for internal reporting purposes, which disaggregates operations by type of real estate.
Fair value of financial instruments. The following assumptions were used in estimating the fair value of notes receivable and notes payable. For performing notes receivable, the fair value was estimated by discounting future cash flows using current interest rates for similar loans. For non-performing notes receivable, the estimated fair value of TCI’s interest in the collateral property was used. For notes payable, the fair value was estimated using current rates for mortgages with similar terms and maturities.
Cash equivalents. For purposes of the Consolidated Statements of Cash Flows, all highly liquid investments purchased with an original maturity of three months or less are considered to be cash equivalents.
Earnings per share. Income (loss) per share is presented in accordance with Statement of Financial Accounting Standards No. 128, “Earnings Per Share.” Income (loss) per share is computed based upon the
49
weighted average number of shares of Common Stock outstanding during each year. Diluted net income per share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the year. Dilutive common equivalent shares consist of stock options and convertible preferred stock. The weighted average common shares used to calculate diluted earnings per share for the years ended December 31, 2004, 2003 and 2002 exclude 264,874, 266,686 and 223,784 shares relating to options and convertible preferred stock to purchase shares of common stock. These dilutive shares were excluded from the calculation of dilutive earnings per share because the effect of their inclusion would be antidilutive.
Stock-based employee compensation. TCI accounts for stock-based compensation utilizing the intrinsic value method in accordance with the provisions of Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees,” and related interpretations. Accordingly, no compensation expense is recognized for fixed option plans because the exercise prices of employee stock options equal or exceed the market prices of the underlying stock on the dates of grant.
The following table represents the effect on net income and earnings per share if TCI had applied the fair value based method and recognition provisions of Statement of Financial Accounting Standards No. 123 (“SFAS No. 123”), “Accounting for Stock-Based Compensation,” to stock-based employee compensation:
(dollars in thousands,
except per share amounts)
Net income (loss) applicable to common shares, as reported
Deduct: Stock-based employee compensation expense determined under fair value based methods for all awards, net of related tax effects
Proforma net income applicable to common shares
Net income (loss) per share:
Basic, as reported
Basic, pro forma
Diluted, as reported
Diluted, pro forma
The fair value of each option is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
Dividend yield
Expected volatility
Risk-free interest rate
Expected lives (in years)
The weighted average fair value per share of options granted in 2004 and 2003 was $11.21 and $11.82, respectively.
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Cash Paid/
Los Colinas land(6)
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In 2003, TCI purchased the following properties:
Units/
Sq. Ft./Acres
Breakwater Bay(1)
Capitol Hill(1)
Heather Creek(1)
Kingsland Ranch(1)
Bridgeview Plaza(2)
Cullman(2)
Maumelle
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In 2003, TCI sold the following properties:
Received
Lincoln Court
Quail Creek
Stone Oak
Summerfield
Treehouse(5)
Willow Wick
Bonita Plaza
Remington Tower
Kelly (301 Hilltop)
Kelly (108th Street)
McLeod
Tricon
K-Mart
Oak Tree Village
Parkway Centre(7)
Eagle Crest(9)
Palm Desert
Sendero Ranch
Solco-Valley Ranch
State Highway 121/Watters Road(11)
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Stonebridge at City Park (formerly 288 City Park)
In November 2004, TCI agreed to swap 69,903 square feet of Centura land with 71,393 square feet of land TXU Electric Delivery Company (“TXU”) owns adjacent to Centura land for the relocation of electric transmission and distribution facilities. TCI has agreed to pay the actual costs of relocation, which is estimated at $453,000. ARI paid $216,361of this cost on TCI’s behalf in November 2004 and this amount was used to reduce TCI’s receivable from Prime. TCI will also pay an additional $36,000 to TXU for the difference in the size of the TCI property and the TXU property.
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NOTE 3. NOTES AND INTEREST RECEIVABLE
Notes and interest receivable consisted of the following:
Performing
Interest receivable
Notes receivable at December 31, 2004, mature from 2005 through 2017 with interest rates ranging from 4.0% to 12.0% per annum, with a weighted average rate of 8.47%. Notes receivable are generally non-recourse and are generally collateralized by real estate. Scheduled principal maturities of $25.6 million are due in 2005.
Unless otherwise noted, all of TCI’s notes receivables are secured by real estate assets.
In July 2003, TCI advanced $2.3 million to the Class A Limited Partners of TCI Countryside, L.P. of which TCI is the general partner. This loan bears interest at 7.25% and matures in January 2007. TCI also agreed to advance $1.1 million to the Class A Limited Partners by advancing $105,000 in July 2003 and every year thereafter for ten years. This loan bears interest at 7.25% and matures in July 2012. Interest due to TCI will be deducted for the quarterly return owed by TCI to the Class A Limited Partners, eliminating the quarterly payments. After January 2007, TCI may retire the Class A Limited Partners interests in exchange for cancellation of both notes, subject to the $1.1 million advance being fully advanced by TCI.
In June 2003, TCI sold the 104 unit Willo-Wick Gardens 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 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
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rate, currently 7.5% per annum, requires monthly interest only payments and matures in March 2007. As of March 2005, TCI has funded $788,000 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 and requires monthly interest only payments, and matures in June 2005. As of March 2005, TCI has funded $300,000 of the line of credit.
In September 2002, TCI sold a 36 acre tract of the Palm Desert land parcel for $3.6 million and provided $2.7 million as seller financing in the form of a first lien mortgage note. The note bore interest at 8.0% per annum, required quarterly interest only payments of $54,000 and matured in September 2004. In March 2003, the note was sold to a financial institution for $2.6 million.
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. As a result of this modification, TCI has released $1.4 million of allowance for loan losses to expense. The following notes were assigned to TCI as payment on the note:
Related Party. In October 2004, TCI contemplated the sale of the common stock of TCI Lexington Corporation, which owns the Lexington Center office building in Colorado Springs, Colorado, to One Realco Office Investors, Inc., a related party, for the assumption of debt of $4.9 million, which was subject to lender approval, and a seller note of $237,000. The assumption of debt by One Realco Office Investors, Inc. was not approved by the lender; therefore, TCI’s Board of Directors rescinded their approval of the transaction. TCI extended the loan on the Lexington Center with the lender in December 2004.
In October 2004, TCI sold the Durham Centre in Durham, North Carolina to a partnership, of which the managing general partner is a subsidiary of ARI, for $21.3 million for cash and an all-inclusive wraparound note of $14.5 million. The note bears interest at a fixed rate of 7.63%, requires monthly interest payments and matures
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in September 2007. TCI also made a loan to the partnership for $3.3 million. The note bears interest at a fixed rate of 7.63%, requires monthly interest payments and matures in September 2017.
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 7.75%), and matures in April 2005.
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 7.75%), and matures in April 2005.
In December 2003, TCI sold a tract of Marine Creek land to a subsidiary of United Housing Foundation, Inc. (“UHF”) for $1.5 million, receiving cash and a note receivable. This sale was not recognized as a sale at that time because UHF is a related party and TCI has continuing involvement and control. In February 2004, Marine Creek was refinanced by UHF, which paid in full TCI’s note payable on the land. TCI recorded the sale of the land and received a note receivable of $270,000, which was the difference between the sales price and the amount of TCI’s note payable. The note bears interest at 6.0%, requires quarterly payments from available surplus cash and matures in December 2007. See Note 8. “RELATED PARTY TRANSACTIONS.”
In December 2003, TCI purchased a note receivable secured by a second lien on 33 acres of raw land in Travis County, Texas at par value from ARI for $2.4 million as a paydown on an affiliate loan balance. This note bears interest at 10.0%, requires interest only payments in November 2007 and matures in October 2008. Outstanding accrued interest is added to the principal balance on an annual basis until 2007. During 2004, $240,000 of accrued interest was added to the principal balance of the note.
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 owned 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. ARI 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
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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 December 2001, TCI purchased 100% of the outstanding common shares of National Melrose, Inc. (“NM”), a wholly-owned subsidiary of ARI, a related party, for $2.0 million cash. NM owns the 41,840 sq. ft. Executive Court Office Building in Memphis, Tennessee. ARI has guaranteed the asset will 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 will pay TCI any shortfall. In addition, if the asset fails to produce 12.0% return for a calendar year, TCI may require ARI to repurchase the shares of NM for the purchase price. Management has classified this related party transaction as a note receivable from ARI. In December 2004, TCI recorded the purchase of the Executive Court Office Building by recording the asset and removing the note receivable from ARI. See Note 2. “REAL ESTATE.”
NOTE 4. ALLOWANCE FOR ESTIMATED LOSSES
Activity in the allowance for estimated losses was as follows:
Balance January 1,
Fully reserved notes receivable
Decrease in provision
Balance December 31,
NOTE 5. INVESTMENT IN EQUITY METHOD REAL ESTATE ENTITIES
Investment in equity method real estate entities consisted of the following:
American Realty Investors, Inc. (“ARI”)
Income Opportunity Realty Investors, Inc. (“IORI”)
Garden Centura, L.P.
Sacramento Nine (“SAC 9”)
TCI owns an approximate 6.5% interest in ARI, a publicly held real estate company, having a market value of $108.9 million at December 31, 2004. At December 31, 2004, ARI had total assets of $498.1 million and owned 21 apartments, nine commercial properties, seven hotels and 37 parcels of unimproved land. In 2004, ARI sold four apartments, three commercial properties and 13 parcels of unimproved land for a total of $112.5 million, receiving net cash of $18.3 million after paying off or being relieved of $58.6 million in mortgage debt and the payment of various closing costs. ARI recognized gains of $25.5 million on the sales of which TCI’s equity share was $1.7 million. In 2003, ARI sold 12 apartments, five commercial properties, two hotels and 18 parcels of unimproved land for a total of $197.5 million, receiving net cash of $37.8 million after
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paying off $96.5 million in mortgage debt and the payment of various closing costs. ARI recognized gains of $63.0 million on the sales of which TCI’s equity share was $4.1 million.
Based on the ownership percentage of TCI’s investment in ARI and ARI’s market value, TCI’s investment in ARI has a market value of approximately $7.2 million at December 31, 2004. The carrying value of this investment is approximately $9.9 million at December 31, 2004. Management continues to believe the market value of ARI temporarily undervalues its assets and therefore, no impairment of TCI’s investment in ARI has been recorded.
TCI owns an approximate 24.0% interest in IORI, a publicly held real estate investment company. At December 31, 2004, IORI had total assets of $91.2 million and owned six apartments, one office building, one shopping center, one industrial warehouse, and one parcel of unimproved land, all within the State of Texas. In 2004, IORI sold two apartments, two office buildings and a parcel of unimproved land for a total of $24.5 million, receiving net cash of $4.8 million after paying off $15.8 million in mortgage debt and the payment of various closing costs. IORI recognized gains of $5.5 million on the sales of which TCI’s equity share was $1.3 million. In 2003, IORI sold three office buildings and a parcel of unimproved land for a total of $55.7 million, receiving net cash of $10.1 million after paying off $9.5 million in mortgage debt and the payment of various closing costs. IORI recognized gains of $3.0 million on the sales of which TCI’s equity share was $715,000.
Based on the ownership percentage of TCI’s investment in IORI and IORI’s market value, TCI’s investment in IORI has a market value of approximately $5.5 million at December 31, 2004. The carrying value of this investment is approximately $5.8 million at December 31, 2004. Management continues to believe the market value of ARI temporarily undervalues its assets and therefore, no impairment of TCI’s investment in IORI has been recorded.
Prior to the first quarter of 2002, TCI accounted for its investments in Tri-City, Nakash and Jor-Trans on the equity method. TCI was a 63.7% limited partner and IORI was a 36.3% general partner in Tri-City, and TCI is a 60.0% general partner and IORI is a 40.0% limited partner in Nakash. TCI owns a 55% limited and general partnership interest in Jor-Trans. TCI makes all partnership operating and policy decisions of the partnerships and TCI has the right to approve the sale or refinancing of principal assets, or approve the acquisition of partnership assets. For Tri-City, IORI as general partner only had protective rights in the partnership. TCI and IORI share one of the same members of the Board of Directors. Consequently, because TCI has a greater than 50.0% ownership over the operations of Tri- City, Nakash and Jor-Trans, the operations of the partnership have been consolidated. In the first quarter of 2002, TCI began accounting for its investment in Tri-City, Nakash and Jor-Trans using a consolidated basis. The effect of these consolidations increased TCI’s assets, liabilities, and minority interest in 2002 by $5.4 million, $3.9 million and $1.5 million, respectively. In November 2002, Tri-City sold its only asset, a shopping center, for $4.2 million. Tri-City received net cash of $1.9 million after the payment of various closing costs. TCI received a distribution of $1.2 million of the net proceeds and recognized a gain of $431,000 on its investment in Tri-City. Also, in July 2003, TCI sold the Jor-Trans partnership, which owned the Lincoln Court Apartments, to the 45.0% limited partner in Jor-Trans for $1.8 million. TCI recognized a gain of $1.7 million on this transaction and has withdrawn from the partnership.
TCI is a non-controlling 30.0% general partner in SAC 9. In December 2004, SAC 9 sold the Prospect Park #29 office building for $3.7 million, of which TCI received $1.1 million after closing costs and fees. TCI recognized a gain on the sale of investment in SAC 9 of $882,000 relating to this transaction.
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Set forth below are summarized financial data for the entities accounted for using the equity method:
Real estate, net of accumulated depreciation ($89,967 in 2004 and $97,270 in 2003)
Other assets
Other liabilities
Shareholders/partners’ capital
Rents and interest and other income
Operating expenses
Interest expense
Income (loss) from continuing operations
Income (loss) from discontinued operations
Gain from sale of discontinued operations
TCI’s equity share of:
Income (loss) before gain on sale of real estate
NOTE 6. MARKETABLE EQUITY SECURITIES
In March 2003, TCI obtained a loan in the amount of $5.0 million to acquire equity securities of Realty Korea CR-REIT Co., Ltd. No. 1 representing approximately a 9.2% ownership interest. As of May 2003, the loan was paid in full. This investment is considered an available-for-sale security. TCI has recognized unrealized gains of $1.6 million during 2004 due to an increase in market price since December 31, 2003.
NOTE 7. NOTES AND INTEREST PAYABLE
Notes and interest payable consisted of the following:
Interest payable
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Scheduled principal payments are due as follows:
2005
2006
2007
2008
2009
Thereafter
Notes payable at December 31, 2004, bore interest at rates ranging from 4.0% to 14.8% per annum, and mature between 2005 and 2044. The mortgages were collateralized by deeds of trust on real estate having a net carrying value of $743.1 million.
In February 2004, the Brandeis office building was returned to the lender via a Deed in Lieu of Foreclosure process. The outstanding debt and accrued interest was $8.8 million. TCI recorded a net impairment of $4.4 million in the fourth quarter of 2003 for this transaction.
Net CashReceived/
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In 2003, TCI financed/refinanced the following properties:
Tree House
Countryside Retail Center
Bridgeview
NOTE 8. RELATED PARTY TRANSACTIONS
Throughout the period in which TCI qualified as a REIT for tax purposes, TCI charged rent to Regis Hotel Corporation, a related party, for TCI’s four hotel properties that were managed by Regis Hotel Corporation. As of December 31, 2000, when TCI no longer qualified as a REIT, the receivable from these rents totaled $2.1 million. During 2003 and 2004, this receivable was reduced by management fees earned by Regis Hotel Corporation. As of December 31, 2004 and 2003, the receivable from Regis Hotel Corporation was $1.4 million and $1.7 million, respectively.
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During 2003, ARI sold properties with fair value totaling $10.7 million to TCI. Each of these property sales was approved by TCI’s Board of Directors. TCI’s affiliate receivables from ARI and BCM were reduced by $8.1 million as a result of these transfers. See NOTE 2. “REAL ESTATE.”
In March 2003, TCI sold 4135 Beltline to a related party for $4.4 million, including the assumption of debt. Due to the sale to a related party to TCI and TCI having continued involvement and control of this entity, this transaction was not recorded as a sale at that time. This property and corresponding debt continued to be consolidated by TCI until 4135 Beltline was sold to a third party in June 2004. See NOTE 2. “REAL ESTATE.”
In March 2003, TCI sold a note receivable for $2.6 million to a third party. The proceeds of this sale were received by BCM. The funds increased TCI’s affiliate receivable from BCM by $2.6 million. See NOTE 3. “NOTES AND INTEREST RECEIVABLE.”
In May 2003, TCI sold a piece of raw land in Texas. The proceeds of the sale were received by BCM. The funds increased TCI’s affiliate receivable from BCM by $2.0 million. See NOTE 2. “REAL ESTATE.”
In June 2003, TCI received the proceeds from the refinancing of an ARI property. This transaction reduced TCI’s affiliate receivables from BCM by $757,000. See NOTE 7. “NOTES AND INTEREST PAYABLE.”
In July 2003, TCI paid $1.7 million to BCM for a pro-rata potion of prior year’s legal fees incurred by Gene Phillips. Mr. Phillips is a related party and advisor to TCI.
In August 2003, TCI sold three Chicago hotels to a related party for $13.5 million, including the assumption of debt. Due to the sale to a related party to TCI and TCI having continued involvement and control of this entity, this transaction was not recorded as a sale at that time. These hotels and corresponding debt continued to be consolidated by TCI. In September 2004, TCI purchased the three Chicago hotels from the related party for assumption of debt and cancellation of the seller notes.
In September 2003, TCI sold a shopping center to a third party. The proceeds of the sale were received by ARI. The funds increased TCI’s affiliate receivable from Prime by $1.6 million. See NOTE 2. “REAL ESTATE.”
In September 2003, TCI sold a piece of raw land in California. The proceeds of the sale were received by an affiliate. The funds increased TCI’s affiliate receivable from Prime by $2.6 million. See NOTE 2. “REAL ESTATE.”
In November 2003, TCI financed a raw piece of land in Texas. The proceeds of the financing were received by ARI. The funds increased TCI’s affiliate receivable from Prime by $1.2 million. See NOTE 7. “NOTES AND INTEREST PAYABLE.”
In November 2003, TCI received the proceeds of the sale of an ARI apartment complex. $2.1 million was used to pay off TCI’s note receivable from ARI and $1.1 million reduced TCI’s affiliate receivable from Prime. See NOTE 3. “NOTES AND INTEREST RECEIVABLE.”
In November 2003, ARI paid $6.3 million in principal, accrued interest and closing costs on behalf of TCI as payment of the notes payable on five tracts of land in Collin County, Texas. These funds were applied to the affiliate receivable from Prime.
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In December 2003, TCI sold Treehouse Apartments and Parkway Centre to IORI for $11.5 million, including the assumption of debt. This transaction increased TCI’s affiliate receivable from Prime by $4.8 million. See NOTE 2. “REAL ESTATE.”
In December 2003, TCI sold Eagle Crest land to IORI for $4.0 million. This transaction reduced TCI’s intercompany payable to IORI by $4.0 million. See NOTE 2. “REAL ESTATE.”
In December 2003, TCI purchased a note receivable from ARI that is secured by a second lien on raw land for $2.4 million. This transaction was approved by TCI’s Board of Directors. TCI’s affiliate receivables from Prime was reduced by $2.4 million as a result of this transaction. See NOTE 3. “NOTES AND INTEREST RECEIVABLE.”
In December 2003, TCI’s Board of Directors approved the payment to Regis of a six percent (6.0%) construction management fee on all construction projects in progress at December 31, 2003, to be applied to all construction costs incurred during 2003 on each project. Construction management fees of $5.6 million for 2004 and $4.1 million for 2003 were treated as reductions in the affiliate receivable balance from Prime.
In December 2003, TCI sold six properties to subsidiaries of United Housing Foundation, Inc. (“UHF”), a Texas Non-Profit 501(c)3 Corporation. TCI sold 10.72 acres of Marine Creek land for $1.5 million, the Limestone at Vista Ridge apartments for $19.0 million, the Cliffs of El Dorado apartments for $13.4 million, the Limestone Canyon apartments for $18.0 million, the Sendero Ridge apartments for $29.4 million, and Tivoli apartments for $16.1 million. All of the transactions included the assumption of debt and notes receivable to TCI for the remainder of the purchase price. Ted Stokely, Chairman of the Board of TCI, is the General Manager of UHF. Richard Humphrey, who is employed by Regis Realty I, LLC, an affiliate, is President of UHF. Due to UHF being considered a related party to TCI and TCI having continued involvement and control of these entities, these transactions have not been recorded as sales. Instead, these transactions will be accounted for on the deposit method and the properties and corresponding debt will continue to be consolidated by TCI. All of these transactions were approved by TCI’s Board of Directors. Mr. Stokely abstained from voting on all of these transactions. The loans on Limestone Canyon apartments and Limestone at Vista Ridge apartments were approved by their prospective lenders for transfer to the purchasing entities. TCI has guaranteed the loans on both of these transfers. Also, Marine Creek land and the Cliffs of El Dorado apartments were recognized as sales during 2004. See NOTE 2. “REAL ESTATE.” Management is currently seeking lender approval on the transfer of the notes associated with the Tivoli apartments and Sendero Ridge apartments.
In December 2003, TCI sold 17.06 acres of land to an affiliate for a purchase price of $2.0 million for a note receivable. Due to no cash received and common control, TCI has elected to continue consolidating this tract of land until the requirements for a sale have been met. No sale was recognized and no note receivable has been recorded.
In January 2004, TCI purchased 14.216 acres of land from ARI with a net purchase price of $2.6 million, decreasing the affiliate receivable balance from Prime by $2.6 million.
In February 2004, TCI incurred a debt for $1.0 million used for the purchase of land by ARI, increasing the affiliate receivable balance from Prime by $1.0 million.
Also 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 has a note receivable balance of $270,000 remaining
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that bears interest at 12.00% and matures in April 2009. TCI recorded the sale of the Marine Creek land tract due to the payment received on the note receivable. See Note 2. “REAL ESTATE.”
In May 2004, TCI purchased the Treehouse Apartments from an affiliate with a net purchase price of $7.5 million for the assumption of debt and a note receivable, less cash received of $498,000. The note receivable was from the sale of the Cliffs of El Dorado Apartments to a related party in 2003. At that time, the sale of the Cliffs of El Dorado Apartments was not recorded as a sale for accounting purposes. TCI recorded the sale of the Cliffs of El Dorado in May 2004 due to payment received for the Cliffs of El Dorado note receivable.
In June 2004, TCI purchased 17.115 acres of land from ARI with a net purchase price of $4.5 million, reducing the affiliate receivable balance from Prime by $4.5 million.
Also in June 2004, TCI sold apartments to ARI with a net purchase price of $5.0 million, increasing the affiliate receivable balance from Prime by $5.0 million.
Again in June 2004, TCI refinanced an office building and two parcels of land. TCI paid-off an existing note payable for ARI for $1.9 million, increasing the affiliate receivable balance from Prime by $1.9 million.
In September 2004, TCI sold 9.96 acres of land to an affiliate for a purchase price of $720,000 for a note receivable. Due to no cash received and common control, TCI has elected to continue consolidating this tract of land until the requirements for a sale have been met. No sale was recognized and no note receivable has been recorded.
In December 2004, TCI purchased five tracts of land from ARI, including the LCLLP tract (45.49 acres); the Payne tract (268 acres), of which TCI owns a 50% Tenant-In-Common interest; the Rochelle I tract (10.096 acres); the Rochelle II tract (21.269 acres); and the Valley Ranch tract (29.9 acres) for $39.1 million, including the assumption of debt and a reduction to the affiliate receivable balance from Prime of $29.1 million.
During 2002, TCI’s Board of Directors authorized the Chief Financial Officer of the Company to advance funds either to or from the Company, through BCM (then the advisor to the Company), in an amount up to $15.0 million, on the condition that such advances shall be repaid in cash or transfers of assets within 90 days. Several property transfers from BCM or Prime were made during 2004 and 2003 to reduce the affiliate balance. Each of these transactions was approved by TCI’s Board of Directors.
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Affiliate receivable with Regis Hotel Corporation are included within Other Assets, and the affiliate payable to Prime and IORI is included within Other Liabilities in the accompanying consolidated balance sheet. Prime replaced BCM as the contractual advisor in July 2003 and assumed all of BCM’s affiliate balances and obligations from TCI. The following table reconciles the beginning and ending balances of affiliate receivables (payables) as of December 31, 2004.
Balance, December 31, 2003
Cash transfers
Cash repayments
Advance through property transfers
Repayments through property transfers
Repayments through Advisor
Fees payable to affiliates
Advance through affiliate refinance
Repayment through affiliate refinance
Advance through receipt of refinancing proceeds
Repayment for income tax reimbursement
Payables clearing through Prime
In addition, Other Assets includes $1.4 million due from Regis Hotel Corporation, a related party.
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 December 31, 2004, 12 of the properties remained on TCI’s balance sheet. As of December 2004, TCI and Metra were involved in a lawsuit concerning certain details of this transaction. See “ITEM 3. LEGAL PROCEEDINGS” under “Part I.” for more information.
NOTE 9. PREFERRED STOCK
TCI’s Series A Cumulative Convertible Preferred Stock consists of a maximum of 6,000 shares with a par value of $.01 per share and a liquidation preference of $100.00 per share. Dividends are payable at the rate of $5.00 per year or $1.25 per quarter to stockholders of record on the 15th day of each March, June, September and December when and as declared by the Board of Directors. The Series A Preferred Stock may be converted after November 1, 2003, into Common Stock at the daily average closing price of the Common Stock for the prior five trading days. At December 31, 2002 and 2001, 5,829 shares of Series A Preferred Stock were issued and outstanding. On November 13, 2003, the 5,829 shares of Series A Preferred Stock outstanding were converted into 41,075 share of TCI common stock. The Series A Preferred Stock was eliminated on November 21, 2003.
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In conjunction with the purchase of the Baywalk, Island Bay and Marina Landing Apartments, TCI issued 30,000 shares of Series C Preferred Stock. TCI’s Series C Cumulative Convertible Preferred Stock consists of a maximum of 30,000 shares with a liquidation preference of $100.00 per share. Dividends are payable at the annual rate of $5.00 per share or $1.25 per quarter through September 2002, then $6.00 per share annually or $1.50 per quarter through September 2003, then $7.00 per share annually or $1.75 per quarter thereafter. After September 30, 2006, the Series C Preferred Stock may be converted into Common Stock at 90.0% of the daily average closing price of the Common Stock for the prior five trading days. The Series C Preferred Stock is redeemable for cash at any time at the option of TCI. At December 31, 2004, 30,000 shares of Series C Preferred Stock were issued and outstanding.
NOTE 10. DIVIDENDS
NOTE 11. STOCK OPTIONS
In October 2000, TCI’s stockholders approved the 2000 Stock Option Plan (“2000 Plan”). The 2000 Plan is administered by the Stock Option Committee, which currently consists of two Independent Directors of TCI. The exercise price per share of an option will not be less than 100% of the fair market value per share on the date of grant thereof. As of December 31, 2004, TCI had 300,000 shares of Common Stock reserved for issuance under the 2000 Plan. No options have been granted under the 2000 Plan.
In October 2000, TCI’s stockholders approved the Director’s Stock Option Plan (the “Director’s Plan”) which provides for options to purchase up to 140,000 shares of TCI’s Common Stock. Options granted pursuant to the Director’s Plan are immediately exercisable and expire on the earlier of the first anniversary of the date on which a Director ceases to be a Director or 10 years from the date of grant. Each Independent Director was granted an option to purchase 5,000 Common shares at an exercise price of $14.875 per share on October 10, 2000, the date stockholders approved the plan. On January 1, 2002, 2003 and 2004, each Independent Director was granted an option to purchase 5,000 Common shares. The exercise price was $16.73, $17.64 and $16.05 per Common shares for 2004, 2003 and 2002, respectively. Each Independent Director will be awarded an option to purchase an additional 5,000 shares on January 1 of each year.
Outstanding at January 1,
Granted
Exercised
Canceled
Outstanding at December 31,
NOTE 12. ADVISORY AGREEMENT
Basic Capital Management, Inc. served as advisor to TCI from March 28, 1989 to June 30, 2003. Effective July 1, 2003, BCM was replaced as contractual advisor to TCI by Prime Asset Management, Inc., (“PAMI”). PAMI is owned by Realty Advisors (80.0%) and Syntek West (20.0%), related parties. Syntek West is owned by
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Gene Phillips. Effective August 18, 2003, PAMI changed its name to Prime Income Asset Management, Inc., (“PIAMI”). On October 1, 2003, Prime Income Asset Management, LLC (“Prime”), which is owned 100% by PIAMI, replaced PIAMI as the advisor to TCI. Realty Advisors, Inc. is owned by a trust for the children of Gene E. Phillips. Mr. Phillips is not an officer or director of BCM or PIAMI or Prime, but serves as a representative of the trust, is involved in daily consultation with the officers of Prime and has significant influence over the conduct of Prime’s business, including the rendering of advisory services and the making of investment decisions for itself and for TCI.
Under the Advisory Agreement, Prime is required to annually formulate and submit for Board approval a budget and business plan containing a twelve-month forecast of operations and cash flow, a general plan for asset sales and purchases, lending, foreclosure and borrowing activity and other investments. Prime is required to report quarterly to the Board on TCI’s performance against the business plan. In addition, all transactions require prior Board approval unless they are explicitly provided for in the approved business plan or are made pursuant to authority expressly delegated to Prime by the Board.
The Advisory Agreement also requires prior Board approval for the retention of all consultants and third party professionals, other than legal counsel. The Advisory Agreement provides that Prime shall be deemed to be in a fiduciary relationship to the stockholders and contains a broad standard governing Prime’s liability for losses incurred by TCI.
The Advisory Agreement provides for Prime to be responsible for the day-to-day operations and to receive an advisory fee comprised of a gross asset fee of .0625% per month (.75% per annum) of the average of the gross asset value (total assets less allowance for amortization, depreciation or depletion and valuation reserves), and an annual net income fee equal to 7.5% of net income.
The Advisory Agreement also provides for Prime to receive an annual incentive sales fee. Prime or an affiliate of Prime is to receive an acquisition commission for supervising the purchase or long-term lease of real estate. Prime or an affiliate of Prime is also to receive a mortgage brokerage and equity refinancing fee for obtaining loans to or refinancing of TCI’s properties. In addition, Prime receives reimbursement of certain expenses incurred by it, in the performance of advisory services for TCI.
The Advisory Agreement requires Prime or any affiliate of Prime to pay to TCI one-half of any compensation received from third parties with respect to the origination, placement or brokerage of any loan made by TCI.
Under the Advisory Agreement, all or a portion of the annual advisory fee must be refunded if the Operating Expenses of TCI (as defined in the Advisory Agreement) exceed certain limits specified in the Advisory Agreement. In 2003 and 2002, Prime and BCM, respectively, were required to refund to TCI $1.3 and $1.4 million of Prime and BCM’s respective advisory fees. Prime was not required to refund any of its 2004 advisory fee.
Additionally, if management were to request that Prime render services other than those required by the Advisory Agreement, Prime or an affiliate of Prime would be separately compensated for such additional services on terms to be agreed upon from time to time. As discussed in NOTE 13. “PROPERTY MANAGEMENT,” Triad Realty Services, Ltd. (“Triad”), an affiliate of Prime, provides property management services and as discussed in NOTE 14. “REAL ESTATE BROKERAGE.” Since January 1, 2003, Regis Realty I, LLC (“Regis I”), a related party, provided, on a non-exclusive basis, brokerage services.
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NOTE 13. PROPERTY MANAGEMENT
Triad provides property management services for a fee of 6.0% or less of the monthly gross rents collected on residential properties and 3.0% or less of the monthly gross rents collected on commercial properties under its management. Triad subcontracts with other entities for property-level management services at various rates. The general partner of Triad is BCM. The limited partner of Triad is Highland Realty Services, Inc. (“Highland”), a related party. Triad subcontracts the property-level management and leasing of 24 of TCI’s commercial properties (office buildings, shopping centers and industrial warehouses) and four of its hotels to Regis I. Regis I receives property and construction management fees and leasing commissions in accordance with the terms of its property-level management agreement with Triad. Since January 1, 2003, Regis Hotel I, LLC has managed TCI’s four hotels. The sole member of Regis I and Regis Hotel I, LLC is Highland.
During 2003 and 2004, Regis I provided construction management services for TCI’s properties under construction. Regis I charged fees of 6.0% of certain construction costs. Those fees totaled $4.1 million and $5.6 million for 2003 and 2004, respectively.
NOTE 14. REAL ESTATE BROKERAGE
Regis I also provides brokerage services on a non-exclusive basis and is entitled to receive a commission for property purchases and sales, in accordance with a sliding scale of total brokerage fees to be paid by TCI.
NOTE 15. ADVISORY FEES, PROPERTY MANAGEMENT FEES, ETC.
Revenue, fees and cost reimbursements to BCM or Prime and their affiliates:
Fees:
Advisory fee
Property acquisition
Mortgage brokerage and equity refinancing
Cost reimbursements
Rent revenue
Cost reimbursements incurred by BCM and Prime related to TCI and ARI are allocated based on the relative market values of each company’s assets.
Fees paid to Triad, an affiliate, Regis I and related parties:
Real estate brokerage
Construction supervision
Property and construction management and leasing commissions
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NOTE 16. INCOME TAXES
The company formerly qualified for tax treatment as a Real Estate Investment Trust (REIT), as defined by Sections 856 through 860 of the Internal Revenue Code of 1986, as Amended (the “Code”). Effective during the third quarter of 2000, TCI no longer met theses requirements due to a concentration of ownership. Under the “Code”, TCI is prohibited from re-qualifying for REIT status for at least 5 years.
Effective January 1, 2004, the company was eligible to file a consolidated return with ARI. Income tax expense for 2004, in the accompanying financial statement, has been calculated under an agreement, whereby TCI has agreed to reimburse ARI for the tax effect of TCI’s net income on the consolidated net income of ARI. Since in 2004, TCI had net income and ARI had net losses, TCI recorded a current tax liability in the amount of $12,500,000 based on the amount of ARI losses absorbed by TCI’s taxable income multiplied by the maximum statutory tax rate of 35%.
Current income tax expense is attributable to:
Income from Continuing Operations
Income from Discontinued Operations
There was no deferred tax expense <benefit> recorded for the period as a result of the uncertainty of the future use of the deferred tax asset.
The Federal income tax expense differs from the amount computed by the applying the corporate tax rate of 35% to the income before income taxes as follows:
Computed “expected” income tax <benefit> expense
Book to tax differences from partnerships not consolidated for tax purposes.
Book to tax differences of depreciation and amortization
Book to tax differences in gains on sale of property
Use of Net Operating Loss carryforward
The tax effect of temporary differences that give rise to the deferred tax asset are as follows:
Net Operating Losses
Basis difference of:
Real Estate Holdings
Notes Receivable
Investments
Notes Payable
Deferred Gains
Deferred Tax Valuation Allowance
Net Deferred Tax Asset
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TCI has prior tax net operating losses of approximately $39 million expiring through the year 2019.
TCI had net income for federal income tax purposes before the application of operating loss carryforwards in 2003 and 2002; therefore, TCI recorded no provision for income taxes. TCI’s tax basis in its net assets differs from the amount at which its net assets are reported for financial statement purposes, principally due to the accounting for gains and losses on property sales, depreciation on owned properties and investments in joint venture partnerships. At December 31, 2003, TCI’s tax basis in its net assets was exceeded by their net basis for financial statement purposes by approximately $87.4 million and TCI’s tax basis in its net liabilities was exceeded by their net basis for financial statement purposes by approximately $91.9 million. As a result, aggregate future income for income tax purposes will be less than such amount for financial statement purposes by approximately $4.5 million. TCI’s state income tax expense is included in general and administrative expenses on the Income Statement.
NOTE 17. RENTS UNDER OPERATING LEASES
Operations include the leasing of commercial properties (office buildings, industrial warehouses and shopping centers). The leases thereon expire at various dates through 2020. The following is a schedule of minimum future rents on non-cancelable operating leases at December 31, 2004:
NOTE 18. OPERATING SEGMENTS
Significant differences among the accounting policies of the operating segments as compared to the Consolidated Financial Statements principally involve the calculation and allocation of general and administrative expenses. Management evaluates the performance of the operating segments and allocates resources to each of them based on their operating income and cash flow. Items of income that are not reflected in the segments are interest, other income, gain on debt extinguishment, gain on condemnation award, equity in partnerships, and equity gains on sale of real estate totaling $10.4 million, $16.4 million and $5.3 million for 2004, 2003 and 2002, respectively. Expenses that are not reflected in the segments are provision for losses, advisory, net income and incentive fees, general and administrative, realized loss on investments, minority interests, foreign currency transaction loss and discontinued operations totaling $22.1 million, $19.7 million and $20.7 million for 2004, 2003 and 2002, respectively. Excluded from operating segment assets are assets of $141.8 million at December 31, 2004 and $100.5 million at December 31, 2003, which are not identifiable with an operating segment. There are no intersegment revenues and expenses. See “NOTE 2. “REAL ESTATE” and NOTE 3. “NOTES AND INTEREST RECEIVABLE.”
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Presented below is the operating income of each operating segment and each segments’ assets for the years 2004, 2003 and 2002.
2004
Property operating expenses
Segment operating income (loss)
Real estate improvements and construction
Property Sales
Sales price
Cost of sales
Deferred gain on sale
Gain on sale
2003 (As Restated)
2002
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NOTE 19. DISCONTINUED OPERATIONS
Effective January 1, 2002, TCI adopted Statement of Financial Accounting Standard No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which established a single accounting model for the impairment or disposal of long-lived assets, including discontinued operations. This statement requires that the operations related to properties that have been sold or properties that are intended to be sold, be presented as discontinued operations in the statement of operations for all periods presented, and properties intended to be sold are to be designated as “held for sale” on the balance sheet.
For 2004, 2003 and 2002, income (loss) from discontinued operations relates to 22 properties sold in 2004, 13 properties sold during 2003 and 18 properties sold during 2002. The following table summarizes revenue and expense information for these properties sold.
Net loss from discontinued operations
Equity in gain on sale of real estate by equity investees
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NOTE 20. QUARTERLY RESULTS OF OPERATIONS
The following is a tabulation of TCI’s quarterly results of operations for the years 2004 and 2003 (unaudited):
Interest income
Income (loss) in equity partnerships
Discontinued operations, net of income tax
Net income (loss) attributable to Common shares
Earnings (Loss) Per Share
Net income (loss) from continuing operations
Quarterly results presented differ from those previously reported in TCI’s Form 10-Q due to the reclassification of the operations of properties sold or held for sale to discontinued operations in accordance with SFAS 144.
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NOTE 21. CORRECTION OF ACCOUNTING ERROR IN PRIOR PERIOD
Subsequent to March 31, 2004, but prior to filing the Form 10-Q for the quarter ended June 30, 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 by $1.8 million for 2003. The Consolidated Balance Sheet as of December 31, 2003 has been revised to reflect the correction of the error through a decrease in accumulated depreciation of $1.8 million and an increase in retained earnings and total stockholders’ equity of $1.8 million. The Consolidated Statements of Operations for the year ending December 31, 2003, reflects the correction of the impact of this error on depreciation expense of $1.8 million. The Consolidated Statement of Stockholders’ Equity for December 31, 2003 has been revised to reflect the correction of the error through a decrease in the December 31, 2003 balance of accumulated deficit and total stockholders’ equity of $1.8 million. All 2003 schedules in this Form 10-K reflect the prior period adjustment discussed in this note. TCI does not intend to restate any previously issued Form 10-Q or Form 10-K for previous periods because, in the opinion of management, the effect is not material to the results of operations for any period previously reported on.
NOTE 22. DERIVATIVE FINANCIAL INSTRUMENTS
During the first quarter of 2002, TCI entered into an interest rate swap agreement with a bank. This agreement contains a notional amount of $12.8 million and requires TCI to pay the bank a fixed rate of 4.3%, and requires the bank to pay to TCI based on the 30 day LIBOR rate. This agreement was entered in order to effectively fix the rate on TCI’s debt associated with the Limestone Canyon property. In December 2003, TCI sold the Limestone Canyon apartments to UHF, a related party. The swap agreement expired on December 9, 2004.
TCI has not designated the interest rate swap agreement as a hedge, as defined within Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and as such, changes in the fair value of the swap agreement are recognized in earnings during the period of change and reflected in the statement of operations as interest expense.
The fair value of the swap agreement at December 31, 2003 represented a liability to TCI of $370,000 and is included within other liabilities in the accompanying balance sheet. Amounts paid or received under the swap agreement are settled monthly and are reflected as a reduction in the liability when paid. Interest expense for December 31, 2003, was decreased by $191,000 representing both amounts paid to the bank under the agreement and decreases in the fair value of the related liability.
NOTE 23. COMMITMENTS AND CONTINGENCIES AND LIQUIDITY
In February 1990, TCI, together with National Income Realty Trust, CMET and IORI, three real estate entities which, at the time, had the same officers, directors or trustees and advisor as TCI, entered into a settlement (the “Settlement”) of a class and derivative action entitled Olive et al. v. National Income Realty Trust et al. (the “Olive Litigation”), relating to the operation and management of each of the entities. On April 23, 1990, the Court granted final approval of the terms of the Settlement. The Settlement was modified in 1994 (the “Modification”), which was amended on January 27, 1997, by Amendment to the Modification, effective January 9, 1994 (the “First Amendment”).
In October 2000, plaintiffs’ counsel asserted that loans made by TCI to BCM and American Realty Trust, Inc. breached the Modification. The Board believes that the provisions of the Settlement, Modification and the First Amendment terminated on April 28, 1999. However, the Court ruled that certain provisions continue to be effective after the termination date. This ruling was appealed by TCI and IORI.
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On October 23, 2001, TCI, IORI and ARI jointly announced a preliminary agreement with the plaintiff’s legal counsel for complete settlement of all disputes in the lawsuit. In February 2002, the court granted final approval of the proposed settlement (the “Second Amendment”). Under the Second Amendment, the appeal was dismissed with prejudice and ARI agreed to either (i) acquire all of the outstanding shares of IORI and TCI not currently owned by ARI for a cash payment or shares of ARI preferred stock or (ii) make a tender offer for all of the outstanding common shares of IORI and TCI not currently owned by ARI. At that time, TCI had the same advisor as ARI and IORI. One of the directors of IORI also serves as a director for ARI and TCI.
On November 15, 2002, ARI commenced, through subsidiaries, a tender offer for shares of common stock of TCI and IORI. The price per share was $17.50 for TCI shares and $19.00 for IORI shares. The tender offers were completed on March 19, 2003. ARI acquired 265,036 IORI shares and 1,213,226 TCI shares. The completion of the tender offer fulfilled the obligations under the Second Amendment and the Olive Litigation was dismissed with prejudice.
Partnership Buyouts. TCI is the limited partner in 12 partnerships 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 nonaffiliated 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 December 31, 2004 is approximately $2.2 million.
Liquidity. Although management anticipates that TCI will generate excess cash from property operations in 2005, such excess, however, will not be sufficient to discharge all of TCI’s debt obligations as they become due. Management intends to selectively sell income producing real estate, refinance real estate and incur additional borrowings against real estate to meet its cash requirements.
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.
In April 2004, TCI guaranteed a $7.5 million note payable for a subsidiary of its parent, ARI. TCI pledged certain tracts of land as collateral and has guaranteed the payment of 50% of the note balance, all interest accrued and payable, all other costs and fees associated with the note and any future collection expenses.
In November 2004, TCI guaranteed the $13.0 million note payable on the Limestone Ranch Apartments purchased from TCI by a subsidiary of United Housing Foundation, Inc. (“UHF”) in December 2003. TCI has guaranteed the payment obligations of the note balance, all interest accrued and payable, all other costs and fees associated with the note and any future collection expenses. The lender approved the transfer of the note to UHF’s subsidiary as part of this transaction.
Other Litigation. TCI is also involved in various other lawsuits arising in the ordinary course of business. Management is of the opinion that the outcome of these lawsuits will have no material impact on TCI’s financial condition, results of operations or liquidity.
In January 2001, TCI exercised its option under the loan documents to extend the maturity date of three loans with a principal balance of $30.0 million secured by three office buildings in New Orleans, Louisiana. The lender has disputed TCI’s right to extend the loans. This dispute was the subject of litigation pending in the United States District Court for the Eastern District of Louisiana. On September 11, 2003, TCI settled with the lender. On September 18, 2003, TCI paid $5.0 million to the lender, which gave TCI the right to retire the remaining
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debt outstanding on the three office buildings on or before December 10, 2003 for $20.0 million. TCI paid the remaining $20.0 million on December 10, 2003, which resulted in a $4.4 million gain on extinguishment of debt. BCM also agreed to enter into a time sharing agreement with the lender for use of BCM’s airplane for 200 hours. BCM requested that TCI reimburse BCM for these costs at the rate of $2,750 per hour, which was approved by TCI’s Board of Directors. TCI has accrued $550,000 in general and administrative expenses for this reimbursement to BCM.
NOTE 24. SUBSEQUENT EVENTS
In 2005, TCI purchased the following property:
Two Hickory
Mandahl Bay
Mandahl Bay (Gilmore)
In 2005, TCI sold the following property:
Sq. Feet
Gain/(Loss)
on Sale
In 2005, TCI refinanced or financed the following property:
Received/(Paid)
Also in 2005, TCI received a loan in the amount of $4,975,000 that is guaranteed by BCM and Prime. The note bears interest at 8.0% per annum, requires semiannual interest payments and matures in July 2006. The loan is collateralized by partnership interests in various 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.
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SCHEDULE III
REAL ESTATE AND ACCUMULATED DEPRECIATION
Property/Location
Cost Capitalized
Subsequent to
Acquisition
Gross Amounts of Which
Carried at End of Year
Date of
Construction
Life on
Which
In Latest
Statement
of Operationis Computed
Building &
Improvements
Held for Investment:
4400, Midland, TX
Apple Lane, Lawrence, KS
Arbor Point, Odessa, TX
Ashton Way, Midland, TX
Autumn Chase, Midland, TX
Blue Lake Villas, Waxahachie, TX
Blue Lake Villas II, Waxahachie, TX
Bluffs At Vista Ridge, Lewisville, TX
Breakwater Bay, Beaumont, TX
Bridges on Kinsey, Tyler, TX
By the Sea, Corpus Christi, TX
Capitol Hill, Little Rock, AR
Courtyard, Midland, TX
Coventry, Midland, TX
Dakota Arms, Lubbock, TX
DeSoto Ranch, DeSoto, TX
Echo Valley, Dallas, TX
El Chapparal, San Antonio, TX
Fairway View Estates, El Paso, TX
Fairways, Longview, TX
Falcon Lakes, Arlington, TX
Fountain Lake, Texas City, TX
Fountains of Waterford, Midland, TX
Harper’s Ferry, Lafayette, LA
Heather Creek, Mesquite, TX
Hunters Glen, Midland, TX
Kingsland Ranch, Houston, TX
Laguna Vista, Farmers Branch, TX
Lake Forest, Houston, TX
Limestone Canyon, Austin, TX
Limestone Ranch, Lewisville, TX
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(Continued)
(1)
Mountain Plaza, El Paso, TX
Oak Park IV, Clute, TX
Paramount Terrace, Amarillo, TX
Parc at Maumelle, Maumelle, AR
Plantation, Tulsa, OK
Quail Oaks, Balch Springs, TX
River Oaks, Wiley, TX
Sendero Ridge, San Antonio, TX
Somerset, Texas City, TX
Southgate, Odessa, TX
Spy Glass, Mansfield, TX
Stonebridge @ City Park, Houston, TX
Sunchase, Odessa, TX
Terrace Hills, El Paso, TX
Timbers, Tyler, TX
Tivoli, Dallas, TX
Treehouse, Irving, TX
Verandas at City View, Fort Worth, TX
Vistas at Pinnacle Park, Dallas, TX
Vistas at Vance Jackson,San Antonio, TX
Westwood, Odessa, TX
Wildflower Villas, Temple, TX
Willow Creek, El Paso, TX
Willo-Wick, Pensacola, FL
Windsong, Fort Worth, TX
Woodview, Odessa, TX
1010 Commons, New Orleans, LA
225 Baronne, New Orleans, LA
AMOCO, New Orleans, LA
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Bay Plaza, Tampa, FL
Bay Plaza II, Tampa, FL
Eton Square, Tulsa, OK
Executive Court, Memphis, TN
Forum, Richmond, VA
Lexington Center, Colorado Springs, CO
Parkway North, Dallas, TX
Signature, Dallas, TX
Westgrove Air Plaza, Addison, TX
5360 Tulane, Atlanta, GA
Addison Hangar, Addison, TX
Addison Hanger II, Addison, TX
Encon, Fort Worth, TX
Space Center, San Antonio, TX
Bridgeview Plaza, LaCrosse, WI
Cullman SC, Cullman, AL
Dunes Plaza, Michigan City, IN
Fiesta, San Angelo, TX
Promenade, Highlands Ranch, CO
Akademia, Wroclaw, Poland
The Majestic, Chicago, IL
City Suites, Chicago, IL
Majestic Inn, San Francisco, CA
Willows, Chicago, IL
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1013 Commons, New Orleans, LA
2301 Valley Branch, Farmers Branch, TX
Alamo Springs, Dallas, TX
Centura, Farmers Branch, TX
Cooks Lane, Ft. Worth, TX
Denton Coonrod, Denton, TX
DeSoto, DeSoto, TX
Dominion, Dallas, TX
Folsom, Farmers Branch, TX
Fruitland, Fruitland Park, FL
Granbury Station, Ft. Worth, TX
Hollywood Casino, Farmers Branch, TX
Lacy Longhorn, Farmers Branch, TX
Lakeshore Villas, Harris County, TX
Lamar Parmer/Limestone II, Austin, TX
Las Colinas, Las Colinas, TX
LCLLP, Los Colinas, TX
Lemon Carlisle, Dallas, TX
Lubbock, Lubbock, TX
Manhattan, Farmers Branch, TX
Marine Creek, Ft. Worth, TX
Mason Park, Houston, TX
McKinney 36, Collin County, TX
Mira Lago, Farmers Branch, TX
Nakash
Nashville, Nashville, TN
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Pac-Trust, Dallas, TX
Payne, Las Colinas, TX
Pulaski, Pulaski County, AR
Railroad, Dallas, TX
Rochelle I, Las Colinas, TX
Rochelle II, Las Colinas, TX
Rogers, Rogers, AR
Round Mt, Austin, TX
Seminary West, Fort Worth, TX
Sheffield Village, Grand Prairie, TX
Valley Ranch, Irving, TX
West End, Dallas, TX
Investment Properties
Properties Held for Sale
5700 Tulane, Atlanta, GA
9033 Wilshire Blvd., Los Angeles, CA
Baywalk, Galveston, TX
Institute Place, Chicago, IL
Island Bay, Galveston, TX
Marina Landing, Galveston, TX
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Reconciliation of Real Estate
Balance at January 1,
Additions
Purchases, improvements and construction
Real estate added from consolidation of partnerships
Deductions
Sale of real estate
Asset impairments
Asset retirements
Sale of foreclosed properties
Balance at December 31,
Reconciliation of Accumulated Depreciation
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SCHEDULE IV
MORTGAGE LOANS ON REAL ESTATE
Description
Final
Periodic Payment Terms
Prior
Liens
Carrying
Amounts ofMortgage (1)
PrincipalAmount of
LoansSubject to
DelinquentPrincipalor Interest
FIRST MORTGAGE LOANS
400 St. Paul
Secured by an office building in Dallas, TX. Includes LOC of $250,000.
WRAPAROUND MORTGAGE LOANS
Pinemont
Secured by an office building in Houston, TX.
Secured by a shopping Center in Malden, MO.
Durham Centre
Secured by an office building in Durham, NC.
JUNIOR MORTGAGE LOANS
Dallas Fund XVII
Secured by an assignment of partnership interests and litigation proceeds.
Pioneer Development
Secured by 33.33 acres of unimproved land in Travis County, TX.
Foxwood
Secured by an apartment building in Memphis, TN.
One Hickory
Secured by an office building in Farmers Branch, TX.
2nd lien on office building in Durham, NC.
NAP Mason Park
2nd lien on 13 acres of land in Harris County, TX.
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United Housing ofChase Oaks
2nd lien on 22 acres of land in Collin County, TX.
In The Pines, LLC
2nd lien on apartment building in Gainesville, FL.
OTHER
BCM—K-Mart Cary
Unsecured.
BCM—TexstarWarehouse
Countryside, L.P.
Secured by Class A partnership units in TCI Countryside, LP.
Commercial Ventures
UHF Kensington
100% interest in UH of Kensington, LLC.
Blue Lake at MarineCreek
Guaranteed by Unified Housing Foundation.
Today Forest Park Investments
Apartment Development Services
Secured by 100% interest in partnership.
Allowance for estimatedlosses
(1) The aggregate cost for federal income tax purposes is $56.6 million.
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New mortgage loans
Mortgages added from consolidation of partnerships
Collections of principal
Mortgages eliminated from consolidation of partnerships
Discount on sale of note receivable
Write-off of principal due to discount for early payoff
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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Effective June 1, 2004, the Audit Committee of the Board of Directors of TCI engaged the Plano, Texas firm of Farmer, Fuqua & Huff, P.C. as the independent accountants to audit TCI’s financial statements. During the Registrant’s two most recent fiscal years and any subsequent interim period, TCI did not consult with Farmer, Fuqua & Huff, P.C. or any of its members about the application of accounting principles to any specified transaction or any other matter. The decision to change accountants was approved by the Audit Committee of the Board of Directors of TCI consisting of Ted R. Munselle (Chairman), Martin L. White and Sharon Hunt.
The engagement effective June 1, 2004 of Farmer, Fuqua & Huff, P.C. as the new independent accountant for TCI necessarily results in the termination or dismissal of the principal accountant which audited TCI’s financial statements for the past two fiscal years ended December 31, 2002 and 2003, BDO Seidman, LLP. BDO Seidman, LLP’s anticipated fee proposal estimate to TCI for the balance of 2004 after the first quarter ended was expected to be greater than the fee proposal of Farmer, Fuqua & Huff, P.C. for the same work. During the Registrant’s two most recent fiscal years and the subsequent interim period through June 1, 2004, there were no disagreements between the Registrant and BDO Seidman, LLP concerning any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure which disagreements, if not resolved to BDO Seidman, LLP’s satisfaction would have caused them to make reference to the subject matter of the disagreement in connection with their report; there were no reportable events as described in Item 304(a)(1)(v) of Regulation S-K.
BDO Seidman, LLP’s reports dated March 21, 2003 and March 30, 2004 on TCI’s financial statements for the years ended December 31, 2002 and 2003 did not contain any adverse opinion or disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit scope or accounting principles. Each report did contain an “emphasis” paragraph highlighting that management has indicated its intent to sell income-producing properties and refinance or extend debt secured by real estate to meets its liquidity needs.
ITEM 9A. CONTROLS AND PROCEDURES
As required by rule 13a-15(b), TCI’s management, including the Acting Principal Executive Officer and Principal Accounting Officer, conducted an evaluation as of the end of the period covered by this report, of the effectiveness of TCI’s disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e). Based on that evaluation, the chief executive officer and the chief financial officer concluded that TCI’s disclosure controls and procedures were effective as of the end of the period covered by this report. As required by rule 13a-15(d), TCI’s management, including the Acting Principal Executive Officer and Principal Accounting Officer, also conducted an evaluation of TCI’s internal controls over financial reporting to determine whether any changes occurred during the fourth fiscal quarter have materially affected, or are reasonably likely to materially affect, TCI’s internal control over financial reporting. Based on that evaluation, there has been no such change during the fourth fiscal quarter.
It should be noted that any system of controls, however well designed and operated, can only provide reasonable, and not absolute, assurance that the objectives of the system will be met. In addition, the design of any control system is based in part on certain assumptions about the likelihood of future events.
ITEM 9B. OTHER INFORMATION
Not Applicable
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PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
Directors
The affairs of Transcontinental Realty Investors, Inc. (“TCI”) are managed by a Board of Directors. The Directors are elected at the annual meeting of stockholders or appointed by the incumbent Board and serve until the next annual meeting of stockholders or until a successor has been elected or approved.
After December 31, 2003, a number of changes occurred in the composition of the Board of Directors of TCI, the creation of certain Board committees, the adoption of Committee charters, the adoption of a Code of Ethics for Senior Financial Officers, and the adoption of Guidelines for Director Independence. Also, the composition of the members of the Board of Directors changed with the resignation of Earl D. Cecil (on February 29, 2004) as well as the election of independent directors, Ted R. Munselle and Sharon Hunt on February 20, 2004.
It is the Board’s objective that a majority of the Board consist of independent directors. For a director to be considered independent, the Board must determine that the director does not have any direct or indirect material relationship with TCI. The Board has established guidelines to assist it in determining director independence which conform to, or are more exacting than, the independence requirements in the New York Stock Exchange listing rules. The independence guidelines are set forth in TCI’s “Corporate Governance Guidelines.” The text of this document has been posted on TCI’s internet website at http://www.transconrealty-invest.com and is available in print to any shareholder who requests it. In addition to applying these guidelines, the Board will consider all relevant facts and circumstances in making an independent determination.
TCI has adopted a code of conduct that applies to all Directors, officers and employees, including our principal executive officer, principal financial officer and principal accounting officer. Stockholders may find our code of conduct on our website by going to our website address at http://www.transconrealty-invest.com. We will post any amendments to the code of conduct, as well as any waivers that are required to be disclosed by the rules of the SEC or the New York Stock Exchange on our website.
Our Board of Directors has adopted charters for our Audit, Compensation and Governance and Nominating Committees of the Board of Directors. Stockholders may find these documents on our website by going to the website address at http://www.transconrealty-invest.com. You may also obtain a printed copy of the materials referred to by contacting us at the following address:
Attn: Investor Relations
1800 Valley View Lane, Suite 300
Dallas, Texas 75234
Telephone: 469-522-4200
All members of the Audit Committee and Nominating and Corporate Governance Committees must be independent directors. Members of the Audit Committee must also satisfy additional independence requirements, which provide (i) that they may not accept, directly or indirectly, any consulting, advisory, or compensatory fee from TCI or any of its subsidiaries other than their director’s compensation (other than in their capacity as a member of the Audit Committee, the Board of Directors, or any other committee of the Board), and (ii) no member of the Audit Committee may be an “affiliated person” of TCI or any of its subsidiaries, as defined by the Securities and Exchange Commission.
The current directors of TCI are listed below, together with their ages, terms of service, all positions and offices with TCI or its former advisor, BCM or Prime, which took over as contractual advisor for BCM on July 1, 2003, their principal occupations, business experience and directorships with other companies during the last five
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years or more. The designation “Affiliated”, when used below with respect to a director, means that the director is an officer, director or employee of BCM, Prime or an officer of TCI or an officer or director of an affiliate of TCI. The designation “Independent”, when used below with respect to a director, means that the director is neither an officer of TCI nor a director, officer or employee of BCM or Prime, although TCI may have certain business or professional relationships with such director as discussed in ITEM 13. “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS—Certain Business Relationships.”
TED P. STOKELY: Age 71, Director (Affiliated) (since April 1990) and Chairman of the Board (since January 1995).
General Manager (since January 1995) of ECF Senior Housing Corporation, a nonprofit corporation; General Manager (since January 1993) of Housing Assistance Foundation, Inc., a nonprofit corporation; Part-time unpaid consultant (since January 1993) and paid consultant (April 1992 to December 1992) of Eldercare Housing Foundation (“Eldercare”), a nonprofit corporation; General Manager (since April 2002) of Unified Housing Foundation, Inc., a nonprofit corporation; Director and Chairman of the Board of ARI (since November 2002); and Director (since April 1990) and Chairman of the Board (since January 1995) of IORI.
HENRY BUTLER: Age 54, Director (Affiliated) (since December 2001).
Broker—Land Sales (since 1992) of BCM; Owner/Operator (1989 to 1991) of Butler Interests, Inc.; Director (since July 2003) of ARI; and Director (December 2001 to July 2003) of IORI.
MARTIN L. WHITE: Age 65, Director (Independent) (since January 1995).
Chief Executive Officer (since 1995) of Builders Emporium, Inc.; Chairman and Chief Executive Officer (since 1993) of North American Trading Company Ltd.; President and Chief Operating Officer (since 1992) of Community Based Developers, Inc.; Director (Since July 2003) of ARI; and Director (January 1995 to March 2004) of IORI.
TED R. MUNSELLE: Age 49, Director (Independent) (since February 2004).
Vice President and Chief Financial Officer of Landmark Nurseries, Inc.; Employed in the accounting industry from 1997 until October 1998; Certified Public Accountant in the State of Texas; and Director (since February 2004) of ARI.
SHARON HUNT: Age 62, Director (Independent) (since February 2004).
Licensed Realtor in Dallas, Texas with Cook Realtors; President and Owner of Sharon’s Pretzels, Inc.; Director (since 1991) of a 501(c)(3) non-profit corporation involved in the acquisition, renovation and operation of real estate; and Director (since February 2004) of ARI.
Board Committees
The Board of Directors held 13 meetings during 2004. For such year, no incumbent director attended fewer than 75.0% of the aggregate of (1) the total number of meetings held by the Board during the period for which he had been a director and (2) the total number of meetings held by all committees of the Board on which he served during the period that he served.
The Board of Directors has standing Audit, Compensation and Governance and Nominating Committees. The Audit Committee was formed on February 19, 2003, and its function is to review TCI’s operating and accounting procedures. A Charter of the Audit Committee has also been adopted by the Board. The Audit Committee is an “audit committee” for purposes of Section 3(a)(58) of the Securities Exchange Act of 1934. The current members of the Audit Committee, all of whom are independent within the meaning of the SEC Regulations, the listing standards of the New York Stock Exchange, Inc. and TCI’s Corporate Governance Guidelines, are Messrs. White and Munselle (Chairman) and Ms. Hunt. Mr. Ted R. Munselle, a member of the
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Committee is qualified as an Audit Committee financial expert within the meaning of SEC Regulations, and the Board has determined that he has accounting and related financial management expertise within the meaning of the listing standards of the New York Stock Exchange, Inc. All of the members of the Audit Committee meet the experience requirements of the listing standards of the New York Stock Exchange. The predecessor Audit Committee met nine times during 2003.
The Governance and Nominating Committee is responsible for developing and implementing policies and practices relating to corporate governance, including reviewing and monitoring implementation of TCI’s Corporate Governance Guidelines. In addition, the Committee develops and reviews background information on candidates for the Board and makes recommendations to the Board regarding such candidates. The Committee also prepares and supervises the Board’s annual review of director independence and the Board’s performance self-evaluation. The Charter of the Governance and Nominating Committee was adopted on March 22, 2004. The members of the Committee are Messrs. Munselle (Chairman) and White and Ms. Hunt.
The Board has also formed a Compensation Committee of the Board of Directors, adopted a Charter for the Compensation Committee on March 22, 2004, and selected Ms. Hunt (Chairman) and Messrs. Munselle and White as the members of such Committee.
The members of the Board of Directors on the date of this Report and the Committees of the Board on which they serve are identified below:
During February 2004, the Board adopted its Corporate Governance Guidelines. The Guidelines adopted by the Board meet or exceed the new listing standards adopted during the year by the New York Stock Exchange, Inc. Pursuant to the Guidelines, the Board undertook its annual review of director independence, and during this review, the Board considered transactions and relationships between each director or any member of his or her immediate family and TCI and its subsidiaries and affiliates, including those reported under Certain Relationships and Related Transactions below. The Board also examined transactions and relationship between directors or their affiliates and members of TCI’s senior management or their affiliates. As provided in the Guidelines, the purpose of such review was to determine whether such relationships or transactions were inconsistent with the determination that the director is independent.
Executive Officers
Executive officers of the Company are Mark W. Branigan, Executive Vice President—Multi-Family Construction, Louis J. Corna, Executive Vice President—Tax, General Counsel/Tax Counsel and Secretary, and Scott T. Lewis, Executive Vice President and Chief Financial Officer, all of whom are employed by Prime. None of the executive officers receive any direct remuneration from the Company nor do any hold any options granted by the Company. Their positions with the Company are not subject to a vote of stockholders. The ages, terms of service and all positions and offices with the Company, Prime, BCM, other affiliated entities, other principal occupations, business experience and directorships with other publicly-held companies during the last five years or more are set forth below.
Mark W. Branigan, 50
Executive Vice President—Multi-Family Construction (since September 2004); Executive Vice President—Residential (June 2001 to September 2004), Director (September 2000 to June 2001) and Executive
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Vice President and Chief Financial Officer (August 2000 to June 2001) of the Company, ARI, IOT and BCM; Executive Vice President—Multi-Family Construction (since September 2004); Executive Vice President—Residential (July 2003 to September 2004) of Prime and PIAMI; Vice President—Director of Construction (August 1999 to August 2000) and Executive Vice President—Residential Asset Management (January 1992 to October 1997) of BCM, ARI and IOT; Vice President—Director of Construction (August 1999 to August 2000) and Executive Vice President—Residential Asset Management (January 1992 to October 1997) of American Realty Trust, Inc. (“ART”); Real Estate Consultant (November 1997 to July 1999).
Louis J. Corna, 57
Executive Vice President—General Counsel/Tax Counsel and Secretary (since February 2004), Executive Vice President—Tax (October 2001 to February 2004), Executive Vice President—Tax and Chief Financial Officer (June 2001 to October 2001) and Senior Vice President—Tax (December 2000 to June 2001) of the Company, ARI, IOT and BCM; Executive Vice President, General Counsel/Tax Counsel and Secretary (since February 2004), Executive Vice President—Tax (July 2003 to February 2004) of Prime and PIAMI; Private Attorney (January 2000 to December 2000); Vice President—Taxes and Assistant Treasurer (March 1998 to January 2000) of IMC Global, Inc.; Vice President—Taxes (July 1991 to February 1998) of Whitman Corporation.
Scott T. Lewis, 44
Executive Vice President and Chief Financial Officer (since December 1, 2004), Vice President and Principal Accounting Officer (July 2004 to November 2004) of the Company, ARI and Prime. For more than seven years prior to July 2004, Mr. Lewis was employed in various accounting capacities by Insignia/ESG, a publicly-held real estate company, directing finance and operations for the Central/Southeast region in his last position from 2002 through February 2004; Certified Public Accountant (since 1990).
In addition to the foregoing executive officers, the Company has several vice presidents and assistant secretaries who are not listed herein.
Officers
In addition to the foregoing officers, TCI has several vice presidents and assistant secretaries who are not listed herein.
Code of Ethics
TCI has adopted a code of ethics entitled “Code of Business Conduct and Ethics” that applies to all directors, officers, and employees (including those of the contractual Advisor to TCI). In addition, TCI has adopted a code of ethics entitled “Code of Ethics for Senior Financial Officers” that applies to the principal executive officer, president, principal financial officer, chief financial officer, principal accounting officer, and controller.
The text of these documents has been posted on TCI’s internet website at http://www.transconrealty-invest.comand are available in print to any stockholder who requests them.
Compliance with Section 16(a) of the Securities Exchange Act of 1934
Under the securities laws of the United States, the directors, executive officers, and any persons holding more than ten percent of TCI’s shares of Common Stock are required to report their share ownership and any changes in that ownership to the Securities and Exchange Commission (the “Commission”). Specific due dates for these reports have been established and TCI is required to report any failure to file by these dates during 2004. All of these filing requirements were satisfied by TCI’s directors, executive officers, and ten percent holders. In making these statements, TCI has relied on the written representations of its incumbent directors and executive officers and its ten percent holders and copies of the reports they have filed with the Commission.
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The Advisor
Although the Board of Directors is directly responsible for managing the affairs of TCI and for setting the policies which guide it, TCI’s day-to-day operations are performed by Prime under the supervision of the Board. The duties of Prime include, among other things, locating, investigating, evaluating and recommending real estate and mortgage note investment and sales opportunities as well as financing and refinancing sources. Prime also serves as a consultant to the Board in connection with the business plan and investment decisions made by the Board.
BCM served as TCI’s advisor from March 1989 to June 30, 2003. Effective July 1, 2003, BCM was replaced as contractual advisor to TCI by PAMI under the same terms as BCM’s advisory agreement. PIAMI is owned by Realty Advisors (80.0%) and Syntek West, Inc. (20.0%), related parties. Syntek West, Inc. is owned by Gene Phillips. Effective August 18, 2003, PAMI changed its name to Prime Income Asset Management, Inc., (“PIAMI”). On October 1, 2003, Prime, which is owned 100% by PIAMI, replaced PIAMI as the advisor to TCI. The duties of Prime include, among other things, locating, investigating, evaluating and recommending real estate and mortgage note investment and sales opportunities, as well as financing and refinancing sources. Prime also serves as a consultant in connection with TCI’s business plan and investment decisions made by the Board.
Prime is a company of which Messrs. Branigan, Corna, and Lewis serve as executive officers. Prime is indirectly owned by a trust for the children of Gene E. Phillips. Mr. Phillips is not an officer or director of Prime, but serves as a representative of the trust, is involved in daily consultation with the officers of Prime and has significant influence over the conduct of Prime’s business, including the rendering of advisory services and the making of investment decisions for itself and for TCI.
Under the Advisory Agreement, Prime is required to annually formulate and submit, for Board approval, a budget and business plan containing a twelve-month forecast of operations and cash flow, a general plan for asset sales and purchases, lending, foreclosure and borrowing activity, and other investments, and Prime is required to report quarterly to the Board on TCI’s performance against the business plan. In addition, all transactions require prior Board approval, unless they are explicitly provided for in the approved business plan or are made pursuant to authority expressly delegated to Prime by the Board.
The Advisory Agreement also requires prior Board approval for the retention of all consultants and third party professionals, other than legal counsel. The Advisory Agreement provides that Prime shall be deemed to be in a fiduciary relationship to the stockholders; contains a broad standard governing Prime’s liability for losses by TCI; and contains guidelines for Prime’s allocation of investment opportunities as among itself, TCI and other entities it advises.
The Advisory Agreement provides for Prime to be responsible for the day-to-day operations of TCI and to receive an advisory fee comprised of a gross asset fee of .0625% per month (.75% per annum) of the average of the gross asset value (total assets less allowance for amortization, depreciation or depletion and valuation reserves) and an annual net income fee equal to 7.5% of TCI’s net income.
The Advisory Agreement also provides for Prime to receive an annual incentive sales fee equal to 10.0% of the amount, if any, by which the aggregate sales consideration for all real estate sold by TCI during such fiscal year exceeds the sum of: (1) the cost of each such property as originally recorded in TCI’s books for tax purposes (without deduction for depreciation, amortization or reserve for losses), (2) capital improvements made to such assets during the period owned, and (3) all closing costs, (including real estate commissions) incurred in the sale of such real estate; provided, however, no incentive fee shall be paid unless (a) such real estate sold in such fiscal year, in the aggregate, has produced an 8.0% simple annual return on the net investment including capital improvements, calculated over the holding period before depreciation and inclusive of operating income and sales consideration and (b) the aggregate net operating income from all real estate owned for each of the prior and current fiscal years shall be at least 5.0% higher in the current fiscal year than in the prior fiscal year.
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Additionally, pursuant to the Advisory Agreement Prime or an affiliate of Prime is to receive an acquisition commission for supervising the acquisition, purchase or long-term lease of real estate equal to the lesser of (1) up to 1.0% of the cost of acquisition, inclusive of commissions, if any, paid to non-affiliated brokers or (2) the compensation customarily charged in arm’s-length transactions by others rendering similar property acquisition services as an ongoing public activity in the same geographical location and for comparable property, provided that the aggregate purchase price of each property (including acquisition fees and real estate brokerage commissions) may not exceed such property’s appraised value at acquisition. Prime does not receive such a commission on acquisitions from an affiliated or related party.
The Advisory Agreement requires Prime or any affiliate of Prime to pay to TCI, one-half of any compensation received from third parties with respect to the origination, placement or brokerage of any loan made by TCI; provided, however, that the compensation retained by Prime or any affiliate of Prime shall not exceed the lesser of (1) 2.0% of the amount of the loan commitment or (2) a loan brokerage and commitment fee which is reasonable and fair under the circumstances.
The Advisory Agreement also provides that Prime or an affiliate of Prime is to receive a mortgage or loan acquisition fee with respect to the acquisition or purchase of any existing mortgage loan by TCI equal to the lesser of (1) 1.0% of the amount of the loan purchased or (2) a brokerage or commitment fee which is reasonable and fair under the circumstances. Such fee will not be paid in connection with the origination or funding of any mortgage loan by TCI.
Under the Advisory Agreement, Prime or an affiliate of Prime also is to receive a mortgage brokerage and equity refinancing fee for obtaining loans or refinancing on properties equal to the lesser of (1) 1.0% of the amount of the loan or the amount refinanced or (2) a brokerage or refinancing fee which is reasonable and fair under the circumstances; provided, however, that no such fee shall be paid on loans from Prime or an affiliate of Prime without the approval of TCI’s Board of Directors. No fee shall be paid on loan extensions.
Under the Advisory Agreement, Prime receives reimbursement of certain expenses incurred by it in the performance of advisory services.
Under the Advisory Agreement, all or a portion of the annual advisory fee must be refunded by the Advisor if the Operating Expenses of TCI (as defined in the Advisory Agreement) exceed certain limits specified in the Advisory Agreement based on the book value, net asset value and net income of TCI during the fiscal year. BCM, as advisor at the time, was required to refund $1.4 million of the 2002 advisory fee under this provision and Prime was required to refund $1.3 million of the 2003 advisory fee under this provision. Prime was not required to refund any of the 2004 advisory fee to TCI.
Additionally, if management were to request that Prime render services to TCI other than those required by the Advisory Agreement, Prime or an affiliate of Prime separately would be compensated for such additional services on terms to be agreed upon from time to time. As discussed below, under “Property Management”, TCI has hired Triad Realty Services, Ltd. (“Triad”), an affiliate of BCM, to provide property management services for TCI’s properties. Also as discussed below, under “Real Estate Brokerage” TCI had engaged, on a non-exclusive basis, Regis Realty, Inc. (“Regis”), a related party, to perform brokerage services for TCI until December 2002. Beginning January 1, 2003, Regis Realty I LLC performs brokerage services for TCI.
Prime may assign the Advisory Agreement only with the prior consent of TCI.
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The directors and principal officers of Prime are set forth below.
Mickey N. Phillips:
Ryan T. Phillips:
Mark W. Branigan:
Executive Vice President— Residential
Louis J. Corna:
Executive Vice President—General Counsel, Executive Vice President—Tax, Secretary
Scott T. Lewis:
Acting Principal Executive Officer, Executive Vice President and Chief Financial Officer
Dan S. Allred:
Senior Vice President—Land Development
Mickey N. Phillips is Gene E. Phillips’ brother and Ryan T. Phillips is Gene E. Phillips’ son. Gene E. Phillips serves as a representative of the trust established for the benefit of his children, which indirectly owns Prime and, in such capacity, has substantial contact with the management of Prime and input with respect to its performance of advisory services to TCI.
Property Management
Since February 1, 1990, affiliates of BCM have provided property management services to TCI. Currently, Triad provides such property management services. Triad subcontracts with other entities for the provision of property-level management services to TCI. The general partner of Triad is BCM. The limited partner of Triad is Highland Realty Services, Inc. Triad subcontracts the property-level management and leasing of 24 of TCI’s commercial properties to Regis I, which is entitled to receive property and construction management fees and leasing commissions in accordance with the terms of its property-level management agreement with Triad. Regis I also receives real estate brokerage commissions in accordance with the terms of a non-exclusive brokerage agreement. Regis Hotel I, LLC, a related party, manages TCI’s four hotels. The sole member of Regis I and Regis Hotel I, LLC is Highland.
Real Estate Brokerage
Regis I also provides real estate brokerage services to TCI (on a non-exclusive basis), and is entitled to receive a real estate commission for property purchases and sales in accordance with the following sliding scale of total fees to be paid: (1) maximum fee of 4.5% on the first $2.0 million of any purchase or sale transaction of which no more than 3.5% is to be paid to Regis I or affiliates; (2) maximum fee of 3.5% on transaction amounts between $2.0 million-$5.0 million of which no more than 3.0% is to be paid to Regis I or affiliates; (3) maximum fee of 2.5% on transaction amounts between $5.0 million-$10.0 million of which no more than 2.0% is to be paid to Regis I or affiliates; and (4) maximum fee of 2.0% on transaction amounts in excess of $10.0 million of which no more than 1.5% is to be paid to Regis I or affiliates.
ITEM 11. EXECUTIVE COMPENSATION
TCI has no employees, payroll or benefit plans and pays no compensation to its executive officers. The executive officers of TCI, who are also officers or employees of Prime, TCI’s advisor, are compensated by Prime. Such executive officers perform a variety of services for Prime and the amount of their compensation is determined solely by Prime. Prime does not allocate the cash compensation of its officers among the various entities for which it serves as advisor. See ITEM 10. “DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT—The Advisor” for a more detailed discussion of the compensation payable to Prime.
The only remuneration paid by TCI is to the directors who are not officers or directors of Prime or its affiliated companies. The Independent Directors (1) review the business plan of TCI to determine that it is in the best interest of stockholders, (2) review the advisory contract, (3) supervise the performance of the advisor and review the reasonableness of the compensation paid to the advisor in terms of the nature and quality of services
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performed, (4) review the reasonableness of the total fees and expenses of TCI and (5) select, when necessary, a qualified independent real estate appraiser to appraise properties acquired.
Each Independent Director receives compensation in the amount of $30,000 per year, plus reimbursement for expenses. The Chairman of the Board receives an additional fee of $3,000 per year. In addition, each Independent Director receives an additional fee of $1,000 per day for any special services rendered by him to TCI outside of his ordinary duties as director, plus reimbursement of expenses.
During 2004, $201,729 was paid to the Independent Directors in total directors’ fees for all services, including the annual fee for service during the period January 1, 2004 through December 31, 2004, and 2004 special service fees as follows: Earl D. Cecil, $15,250; Sharon Hunt, $43,880; Ted R. Munselle, $43,880; Ted P. Stokely, $50,131; and Martin L. White, $48,588.
Director’s Stock Option Plan
TCI has established a Director’s Stock Option Plan (“Director’s Plan”) for the purpose of attracting and retaining Directors who are not officers or employees of TCI or Prime or BCM. The Director’s Plan provides for the grant of options that are exercisable at fair market value of TCI’s Common Stock on the date of grant. The Director’s Plan was approved by stockholders at their annual meeting on October 10, 2000, following which each then-serving Independent Director was granted options to purchase 5,000 shares of Common Stock of TCI. On January 1 of each year, each Independent Director receives options to purchase 5,000 shares of Common Stock. The options are immediately exercisable and expire on the earlier of the first anniversary of the date on which a Director ceases to be a Director or 10 years from the date of grant.
As of March 1, 2005, TCI had 140,000 shares of Common Stock reserved for issuance under the Director’s Stock Option Plan of which 40,000 options were outstanding.
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Performance Graph
The following performance graph compares the cumulative total stockholder return on TCI’s shares of Common Stock with the Dow Jones US Total Market Index (“DJ Total Market Index”) and the Dow Jones Real Estate Investment Index (“DJ Real Estate Index”). The comparison assumes that $100 was invested on December 31, 1998, in TCI’s shares of Common Stock and in each of the indices and further assumes the reinvestment of all distributions. Past performance is not necessarily an indicator of future performance.
COMPARISON OF FIVE YEARS CUMULATIVE TOTAL RETURN
TCI
DJ Real Estate Index
DJ Total U.S. Market Index
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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Securities Authorized for Issuance Under Equity Compensation Plans
The following table provides information as of December 31, 2004 regarding compensation plans (including individual compensation arrangements) under which equity securities of TCI are authorized for issuance.
Plan Category
Number of Securities to
be Issued Upon Exercise
of Outstanding Options,
Warrants and Rights(a)
Number of SecuritiesRemaining Available forFuture Issuance Under Equity
Compensation Plans(Excluding SecuritiesReflected in Column (a))
(c)
2000 Stock Option Plan approved by stockholders
Directors Stock Option Plan approved by stockholders
Security Ownership of Certain Beneficial Owners
The following table sets forth the ownership of TCI’s Common Stock, both beneficially and of record, both individually and in the aggregate, for those persons or entities known to be beneficial owners of more than 5.0% of the outstanding shares of Common Stock as of the close of business on March 24, 2005.
Name and Address of Beneficial Owner
Amount and
Nature
of BeneficialOwnership
EQK Holdings, Inc.(2)
1800 Valley View Lane
Suite 300
Transcontinental Realty Acquisition Corporation(3)
Suite 100
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Security Ownership of Management.
The following table sets forth the ownership of TCI’s Common Stock, both beneficially and of record, both individually and in the aggregate, for the directors and executive officers of TCI as of the close of business on March 18, 2005.
Name of Beneficial Owner
Mark W. Branigan
Louis J. Corna
Scott T. Lewis
Ted Munselle
All Directors and Executive Officers as a group (8 individuals)
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Certain Business Relationships
In February 1989, the Board of Directors voted to retain BCM as TCI’s advisor. See ITEM 10. “DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR TO THE REGISTRANT—The Advisor.” Effective July 1, 2004, Prime replaced BCM as the contractual advisor to TCI. Prime is indirectly owned by a trust for the children of Gene E. Phillips. Mr. Phillips is not an officer or director of Prime, but serves as a representative of the trust, is involved in daily consultation with the officers of Prime and has significant influence over the conduct of Prime’s business, including the rendering of advisory services and the making of investment decisions for itself and for TCI.
Since February 1, 1991, affiliates of BCM have provided property management services to TCI. Currently, Triad provides such property management services. Triad subcontracts the property-level management and leasing of 24 of TCI’s commercial properties to Regis I and its four hotels to Regis Hotel I, LLC.
Regis I also provides real estate brokerage services for TCI, on a non-exclusive basis, and receives brokerage commissions in accordance with the brokerage agreement.
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One of TCI’s Directors (Ted Stokely) also serves as a director of IORI. The Director owes fiduciary duties to IORI as well as to TCI under applicable law. At December 31, 2004, TCI owned approximately 24.0% of the outstanding common shares of IORI. Prime also serves as advisor to ARI. All of TCI’s directors also serve as Directors of ARI. Messrs. Branigan, Corna, and Lewis serve as executive officers of ARI and Prime and Messrs. Branigan and Corna serve as executive officers of IORI.
Historically, TCI has engaged in and may continue to engage in business transactions, including real estate partnerships, with related parties. Management believes that all of the related party transactions represented the best investments available at the time and were at least as advantageous to TCI as could have been obtained from unrelated third parties.
In the year ended December 31, 2004, TCI received $69,000 in rent from BCM for BCM’s lease at Addison Hanger. BCM owns a corporate jet that is housed at the hanger and TCI has available space at the hanger.
In January 2002, TCI purchased 100% of the outstanding common shares of ART Two Hickory Corporation from ARI, for $4.4 million. See NOTE 3. “NOTES AND INTEREST RECEIVABLE.” The purchase price was determined based upon the market value of the property exchanged, using a market rate multiple of net operating income (“cap rate”) of 7.0%. The business purpose of the transaction was for TCI to make an equity investment in Two Hickory anticipating a profitable return.
In February 2002, TCI sold a $2.0 million senior participation interest in a loan to IORI. See NOTE 3. “NOTES AND INTEREST RECEIVABLE.” Management determined that TCI could benefit from the increase in cash and decrease its notes receivable outstanding portfolio.
In February 2002, a short term working capital loan to BCM for a total of $2.5 million was assumed by TCI. The loan is secured by the Stone Oak Apartments in San Antonio, Texas, and requires all principal and interest due and payable on April 28, 2003. TCI sold Stone Oak Apartments in July 2003 and paid the principal and accrued interest in full.
In March 2002, TCI paid cash of $600,000 and received from ARI two parcels of land, a 24.5 acre tract of Rasor land, a 16.89 acre tract of Lakeshore Villas land, and the 45,623 sq. ft. Oaktree Village Shopping Center in exchange for the 80,278 sq. ft. Plaza on Bachman Creek Shopping Center. The exchange value prices for the shopping centers were determined based on a cap rate of 10.5% and the value for the Rasor and Lakeshore Villas land was determined on appraised rates of $3.36 and $1.29, respectively, per square foot. The business purpose of the transaction was for TCI to construct apartments on the Rasor and Lakeshore Villas land and to give ample value for the property TCI exchanged, the Oaktree Shopping Center was added to the transaction.
In April 2002, TCI purchased 100% of the following entities from ARI: Garden Confederate Point, L.P., Garden Foxwood, L.P., Garden Woodsong, L.P. and ART One Hickory Corporation for $10.0 million. See NOTE 3. “NOTES AND INTEREST RECEIVABLE.” The purchase price for these entities was determined based on a cap rate of 8.41% for the partnerships and 7.0% for ART One Hickory Corporation. The business purpose of the transaction was for TCI to make an equity investment in the entities anticipating a profitable return.
In June 2002, TCI purchased Centura Tower, Ltd. partnership, which owns the Centura Tower Office Building from ARI for $50.0 million. The purchase price for the Centura Tower was determined based on appraised value and replacement cost. The business purpose of the transaction was for TCI to acquire a Class A office building with significant upside potential anticipating a profitable return.
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Also in June 2002, TCI purchased five parcels of unimproved land from ARI: the Hollywood Casino, Marine Creek, Mason Park, Nashville and Palm Desert land parcels. The purchase price of the Hollywood Casino land was determined based on an appraised rate of $9.10 per square foot. The business purpose of the transaction was for TCI to consolidate its holdings within the Mercer Crossing development and to develop apartments on these four tracts of land. The purchase price for the Marine Creek, Mason Park, Nashville and Palm Desert land parcels was determined based on appraised rates of $2.00, $3.56, $4.00 and $1.48 per square foot, respectively.
In October 2002, a short term working capital loan to BCM for a total of $4.0 million was assumed by TCI. The loan is secured by the Red Cross land, requires quarterly payments and was due in October 2002. This loan was extended to and paid in full in September 2003.
In December 2002, TCI purchased the NLP/CH, Ltd. partnership, which owns the Centura land parcel, from ARI. The purchase price was determined based on an appraised rate of $34.89 per square foot. The business purpose of the transaction was for TCI to construct apartments on the land.
During 2002, TCI’s Board of Directors authorized the Chief Financial Officer of the Company to advance funds either to or from the Company, through BCM, in an amount up to $15.0 million, on the condition that such advances shall be repaid in cash or transfers of assets within 90 days. Several property transfers from BCM or Prime were made during 2004 and 2003 to reduce the affiliate balance. Each of these transactions was approved by TCI’s Board of Directors.
In March 2003, TCI purchased the Bridgeview Plaza and Cullman shopping centers from ARI for $8.7 million and $2.0 million, respectively, to satisfy debt. The purchase price was determined using a market rate multiple of net operation income. TCI assumed debt of $2.7 million on Cullman. TCI received $5.1 million in cash on the subsequent financing of the shopping center. See NOTE 2. “REAL ESTATE.”
In March 2003, TCI sold a note receivable for $2.6 million to a third party. The proceeds of this sale were received by BCM. The funds increased TCI’s affiliate receivable from BCM. See NOTE 3. “NOTES AND INTEREST RECEIVABLE.”
In May 2003, TCI sold its Solco-Valley Ranch land parcel. The proceeds of the sale were received by BCM. The funds increased TCI’s affiliate receivable from BCM $2.0 million. See NOTE 2. “REAL ESTATE.”
In July 2003, TCI paid $1.7 million to BCM for a pro-rata share of prior year’s legal fees in the defense of Gene Phillips. Mr. Phillips is a related party and advisor to TCI.
In September 2003, TCI sold the Oak Tree Village shopping center to a third party. The proceeds of the sale were received by ARI. The funds were used to increase TCI’s affiliate receivable from Prime by $1.6 million. See NOTE 2. “REAL ESTATE.”
In September 2003, TCI sold Palm Desert land parcel. The proceeds of the sale were received by ARI. The funds increased TCI’s affiliate receivable from Prime by $2.6 million. See NOTE 2. “REAL ESTATE.”
In November 2003, TCI financed the Rasor land parcel. The proceeds of the financing were received by ARI. The funds increased TCI’s affiliate receivable from Prime by $1.2 million. See NOTE 7. “NOTES AND INTEREST PAYABLE.”
In November 2003, ARI paid $6.3 million in principal, accrued interest and closing costs on behalf of TCI as payment of the notes payable on TCI’s Allen land parcels. These funds decreased TCI’s affiliate receivable from Prime.
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In November 2003, TCI received ARI’s sales proceeds on the sale of the Confederate Point apartments. $2.1 million was used to pay off TCI’s note receivable from ARI and $1.1 million reduced TCI’s affiliate receivable from Prime. See NOTE 3. “NOTES AND INTEREST RECEIVABLE.”
In December 2003, TCI sold Eagle Crest land to IORI for $4.0 million. This transaction decreased TCI’s intercompany payable to IORI. See NOTE 2. “REAL ESTATE.”
In December 2003, TCI purchased a note receivable from ARI that is secured by a second lien on raw land for $2.4 million. This transaction was approved by TCI’s Board of Directors. TCI’s affiliate receivables from ARI and Prime were reduced by $2.4 million as a result of this transaction. See NOTE 3. “NOTES AND INTEREST RECEIVABLE.”
In December 2003, TCI sold six properties to subsidiaries of United Housing Foundation, Inc. (“UHF”), a Texas Non-Profit 501(c)3 Corporation. TCI sold 10.72 acres of Marine Creek land for $1.5 million, the Limestone at Vista Ridge apartments for $19.0 million, the Cliffs of El Dorado apartments for $13.4 million, the Limestone Canyon apartments for $18.0 million, the Sendero Ridge apartments for $29.4 million, and Tivoli apartments for $16.1 million. All of the transactions include the assumption of debt and notes receivable to TCI for the remainder of the purchase price. Ted Stokely, Chairman of the Board of TCI, is the General Manager of UHF. Richard Humphrey, who is employed by Regis Realty I, LLC, an affiliate, is President of UHF. Due to UHF being considered a related party to TCI and TCI having continued involvement and control of these entities, these transactions will not be recorded as sales. Instead, these transactions will be accounted for on the deposit method and the properties and corresponding debt will continue to be consolidated by TCI. All of these transactions were approved by TCI’s Board of Directors. Mr. Stokely abstained from voting on all of these transactions. The loans on Limestone Canyon apartments and Limestone at Vista Ridge apartments were approved by their prospective lenders for transfer to the purchasing entities. TCI has guaranteed the loans on both of these transfers. Also, Marine Creek land and the Cliffs of El Dorado apartments were recognized as sales during 2004. See NOTE 2. “REAL ESTATE.” Management is currently seeking lender approval on the transfer of the notes associated with the Tivoli apartments and Sendero Ridge apartments.
In December 2003, TCI sold the Lamar/Palmer land parcel to a subsidiary of UHF for $2.0 million in the form of a seller note receivable. Due to no cash received and common control, TCI has elected to continue consolidating this tract of land until the requirements for a sale have been met. No sale has recognized and no note receivable has been recorded.
In January 2004, TCI purchased the Vista Ridge land tract from ARI for $2.6 million. This transaction decreased TCI’s affiliate receivable with Prime by $2.6 million. See NOTE 2. “REAL ESTATE.”
In February 2004, TCI incurred a debt for $1.0 million used for the purchase of land by ARI. This transaction increased TCI’s affiliate receivable with Prime by $2.6 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 has a note receivable balance of $270,000 remaining that bears interest at 12.00% and matures in April 2009. TCI recorded the sale of the Marine Creek land tract due to the payment received on the note receivable. See NOTE 2. “REAL ESTATE.”
In May 2004, TCI purchased the Treehouse Apartments from an affiliate with a net purchase price of $7.5 million for the assumption of debt and a note receivable, less cash received of $498,000. The note receivable
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was from the sale of the Cliffs of El Dorado Apartments to a related party in 2003. At that time, the sale of the Cliffs of El Dorado Apartments was not recorded as a sale for accounting purposes. TCI recorded the sale of the Cliffs of El Dorado in May 2004 due to payment received for the Cliffs of El Dorado note receivable. See NOTE 2. “REAL ESTATE.”
In January 2004, TCI purchased the Lacy Longhorn land tract from ARI for $4.5 million. This transaction decreased TCI’s affiliate receivable with Prime by $4.5 million. See NOTE 2. “REAL ESTATE.”
In June 2004, TCI sold Waters Edge IV apartments to ARI for $5.0 million. This transaction increased TCI’s affiliate receivable with Prime by $5.0 million. See NOTE 2. “REAL ESTATE.”
In June 2004, TCI refinanced the 1010 Common office building, Lacy Longhorn land and certain tracts of Marine Creek land. TCI paid-off an existing note payable for ARI for $1.9 million, increasing the affiliate receivable balance by $1.9 million.
In September 2004, TCI sold Limestone Canyon II land to a subsidiary of UHF for $720,000 in the form of a seller note receivable. Due to no cash received and common control, TCI has elected to continue consolidating this tract of land until the requirements for a sale have been met. No sale was recognized and no note receivable has been recorded.
In December 2003, TCI’s Board of Directors approved the payment to Regis I of a six percent (6%) construction management fee on all construction projects in progress at December 31, 2003, to be applied to all costs incurred during 2003 on each project. Construction management fees of $5.6 million for 2004 and $4.1 million for 2003 were treated as reductions in the affiliate receivable balance from Prime.
As more fully described in ITEM 2. “PROPERTIES-Real Estate,” TCI is a partner with IORI in Nakash Income Associates. TCI owns 345,728 shares of IORI’s Common Stock, an approximate 24.0% interest. At December 31, 2004, the market value of the IORI common shares was $5.5 million.
At December 31, 2004, TCI owned 746,972 shares of ARI common stock which were primarily purchased in open market transactions in 1990 and 1991 at a total cost of $1.6 million. The officers of TCI also serve as officers of ARI. Prime also serves as advisor to ARI and at March 24, 2005, ARI owned approximately 82.2% of TCI’s outstanding Common Stock. At December 31, 2004, the market value of the ARI common shares owned by TCI was $7.2 million.
In 2004, TCI paid Prime, its affiliates and related parties $8.7 million in advisory, incentive and net income fees, $1.4 million in mortgage brokerage and equity refinancing fees, $422,000 in property acquisition fees, $6.3 million in real estate brokerage commissions, $5.6 million in construction supervision fees and $2.3 million in property and construction management fees and leasing commissions, net of property management fees paid to subcontractors, other than affiliates of Prime. In addition, as provided in the Advisory Agreement, Prime received cost reimbursements of $2.2 million.
In addition, from time-to-time, TCI and its affiliates have made advances to each other, which generally have not had specific repayment terms and have been reflected in TCI’s financial statements as other assets or other liabilities. At December 31, 2004, TCI had receivables of $1.4 million from Regis Hotel Corporation. Also at December 31, 2004, TCI owed $829,000, $1.6 million and $260,000 to Prime, Regis I and IORI, respectively.
Restrictions on Related Party Transactions
Article FOURTEENTH of TCI’s Articles of Incorporation provides that TCI shall not, directly or indirectly, contract or engage in any transaction with (1) any director, officer or employee of TCI, (2) any director, officer or employee of the advisor, (3) the advisor or (4) any affiliate or associate (as such terms are defined in
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Rule 12b-2 under the Securities Exchange Act of 1934, as amended) of any of the aforementioned persons, unless (a) the material facts as to the relationship among or financial interest of the relevant individuals or persons and as to the contract or transaction are disclosed to or are known by the Board of Directors or the appropriate committee thereof and (b) the Board of Directors or committee thereof determines that such contract or transaction is fair to TCI and simultaneously authorizes or ratifies such contract or transaction by the affirmative vote of a majority of independent directors of TCI entitled to vote thereon. Article FOURTEENTH defines an “Independent Director” as one who is neither an officer or employee of TCI nor a director, officer or employee of TCI’s advisor.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The following table sets for the aggregate fees for professional services rendered to or for TCI by Farmer, Fuqua and Huff, L.P. and BDO Seidman, LLP for 2004 and 2003:
Type of Fee
Audit Fees
Audit Related Fees
Tax Fees
All Other Fees
The audit fees for 2004 and 2003, respectively, were for professional services rendered for the audits and reviews of the consolidated financial statements of TCI. Tax fees for 2004 and 2003, respectively, were for services related to federal and state tax compliance and advice. All of TCI’s 2003 accounting fees were paid to BDO Seidman, LLP.
All services rendered by the principal auditors are permissible under applicable laws and regulations and were pre-approved by either the Board of Directors or the Audit Committee, as required by law. The fees paid the principal auditors for services as described in the above table fall under the categories listed below:
Audit Fees. These are fees for professional services performed by the principal auditor for the audit of the Company’s annual financial statements and review of financial statements included in the Company’s 10-Q filings and services that are normally provided in connection with statutory and regulatory filing or engagements.
Audit-Related Fees. These are fees for assurance and related services performed by the principal auditor that are reasonably related to the performance of the audit or review of the Company’s financial statements. These services include attestations by the principal auditor that are not required by statute or regulation and consulting on financial accounting/reporting standards.
Tax Fees. These are fees for professional services performed by the principal auditor with respect to tax compliance, tax planning, tax consultation, returns preparation and review of returns. The review of tax returns includes the Company and its consolidated subsidiaries.
All Other Fees. These are fees for other permissible work performed by the principal auditor that do not meet the above category descriptions.
These services are actively monitored (as to both spending level and work content) by the Audit Committee to maintain the appropriate objectivity and independence in the principal auditor’s core work, which is the audit of the Company’s consolidated financial statements.
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The Audit Committee has established policies and procedures for the approval and pre-approval of audit services and permitted non-audit services. The Audit Committee has the responsibility to engage and terminate TCI’s independent auditors, to pre-approve their performance of audit services and permitted non-audit services, to approve all audit and non-audit fees, and to set guidelines for permitted non-audit services and fees. All fees for 2004 and 2003 were pre-approved by the Audit Committee or were within the pre-approved guidelines for permitted non-audit services and fees established by the Audit Committee, and there were no instances of waiver of approved requirements or guidelines during the same periods.
Under the Sarbanes-Oxley Act of 2002 (the “SO Act”), and the rules of the Securities and Exchange Commission (the “SEC”), the Audit Committee of the Board of Directors is responsible for the appointment, compensation and oversight of the work of the independent auditor. The purpose of the provisions of the SO Act and the SEC rules for the Audit Committee role in retaining the independent auditor is two-fold. First, the authority and responsibility for the appointment, compensation and oversight of the auditors should be with directors who are independent of management. Second, any non-audit work performed by the auditors should be reviewed and approved by these same independent directors to ensure that any non-audit services performed by the auditor do not impair the independence of the independent auditor. To implement the provisions of the SO Act, the SEC issued rules specifying the types of services that an independent may not provide to its audit client, and governing the Audit Committee’s administration of the engagement of the independent auditor. As part of this responsibility, the Audit Committee is required to preapprove the audit and non-audit services performed by the independent auditor in order to assure that they do not impair the auditor’s independence. Accordingly, the Audit Committee has adopted a preapproval policy of audit and non-audit services (the “Policy”), which sets forth the procedures and conditions pursuant to which services to be performed by the independent auditor are to be preapproved. Consistent with the SEC rules establishing two different approaches to preapproving non-prohibited services, the Policy of the Audit Committee covers Preapproval of audit services, audit-related services, international administration tax services, non-U.S. income tax compliance services, pension and benefit plan consulting and compliance services, and U.S. tax compliance and planning. At the beginning of each fiscal year, the Audit Committee will evaluate other known potential engagements of the independent auditor, including the scope of work proposed to be performed and the proposed fees, and the approve or reject each service, taking into account whether services are permissible under applicable law and the possible impact of each non-audit service on the independent auditor’s independence from management. Typically, in addition to the generally preapproved services, other services would include due diligence for an acquisition that may or may not have been known at the beginning of the year. The Audit Committee has also delegated to any member of the Audit Committee designated by the Board or the financial expert member of the Audit Committee responsibilities to preapprove services to be performed by the independent auditor not exceeding $25,000 in value or cost per engagement of audit and non-audit services, and such authority may only be exercised when the Audit Committee is not in session.
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PART IV
Report of Independent Certified Public Accountants
All other schedules are omitted because they are not applicable or because the required information is shown in the Consolidated Financial Statements or the Notes thereto.
Consolidated Financial Statements of Income Opportunity Realty Investors, Inc. (incorporated by reference to Item 8 of Income Opportunity Realty Investors, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2004).
Consolidated Financial Statements of American Realty Investors, Inc. (incorporated by reference to Item 8 of American Realty Investors, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2004).
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The following documents are filed as Exhibits to this Report:
Description of Exhibit
Certificate of Amendment to the Articles of Incorporation of Transcontinental Realty Investors, Inc.,
(incorporated by reference to the Registrant’s Current Report on Form 8-K, dated June 3, 1996).
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: March 31, 2005
/s/ SCOTT T. LEWIS
Executive Vice President and
Chief Financial Officer
(Principal Financial and Accounting Officer
and Acting Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.
Title
/s/ TED P. STOKELY
Chairman of the Board and Director
/s/ HENRY A. BUTLER
/s/ MARTIN L. WHITE
/s/ TED R. MUNSELLE
/s/ SHARON HUNT
Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer and Acting Principal Executive Officer)
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EXHIBIT INDEX
Exhibit
Number
109