ITEM 1. BUSINESS
Transcontinental Realty Investors, Inc. ("TCI"), 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.
TCI's real estate at December 31, 2002, consisted of 128 properties held for investment, one partnership property and 11 properties held for sale In 2002, TCI purchased 16 properties held for investment. TCI's mortgage notes receivable portfolio at December 31, 2002, consisted of 13 mortgage loans. TCI's real estate and mortgage notes receivable portfolios are more fully discussed in ITEM 2.
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, 2002, 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, which were primarily obtained through foreclosure of the collateral securing mortgage notes receivable, 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, 2002, none of TCI's properties, mortgage notes receivable or investment in partnerships exceeded 10% of total assets. At December 31, 2002, 86% of TCI's assets consisted of properties held for investment, 3% consisted of properties held for sale, 3% consisted of mortgage notes and interest receivable and 2% consisted of investments in partnerships. The remaining 6% 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, 2002, 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, 2002, TCI held mortgage notes receivable secured by apartments and commercial properties in the Southwest and Midwest regions of the continental United States, as shown more specifically in the table under "Mortgage Loans" below.
Geographic Regions
TCI has divided the continental United States into the following geographic regions.
[GEOGRAPHIC REGION MAP]
Northeast region comprised of the states of Connecticut, Delaware, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island and Vermont, and the District of Columbia. TCI owns a commercial property in this region.
Southeast region comprised of the states of Alabama, Florida, Georgia, Mississippi, North Carolina, South Carolina, Tennessee and Virginia. TCI owns five apartments and 18 commercial properties in this region.
Southwest region comprised of the states of Arizona, Arkansas, Louisiana, New Mexico, Oklahoma and Texas. TCI owns 47 apartments and 18 commercial properties in this region.
Midwest region comprised of the states of Illinois, Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Missouri, Nebraska, North Dakota, Ohio, South Dakota, West Virginia and Wisconsin. TCI owns two apartments, for commercial properties and three hotels in this region.
Mountain region comprised of the states of Colorado, Idaho, Montana, Nevada, Utah and Wyoming. TCI owns three commercial properties in this region.
Pacific region comprised of the states of California, Oregon and Washington. TCI owns a hotel and two commercial properties in this region.
Excluded from the above are 34 parcels of unimproved land and one hotel in Wroclaw, Poland, as described below.
Real Estate
At December 31, 2002, approximately 92% 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 nonleveraged basis. TCI's real estate portfolio consists of properties held for investment, investments in partnerships and properties held for sale (which were primarily obtained through foreclosure of the collateral securing mortgage notes receivable).
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 and criteria for selecting new real estate investments and for obtaining financing without a vote of stockholders.
TCI's real estate portfolio consists of 140 owned properties. Of the 140 properties, 12 apartments were sold to partnerships controlled by Metra Capital, LLC ("Metra"). See NOTE 6. "NOTES AND INTEREST PAYABLE." Because the Metra sales transaction was accounted for as a finance transaction, TCI continues to account for the 12 properties as owned properties.
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 such higher risk projects.
At December 31, 2002, TCI had the following properties under construction:
In 2002, TCI completed the 252 unit Limestone Ranch in Lewisville, Texas, the 284 unit Falcon Lakes Apartments in Arlington, Texas, the 190 unit Tivoli Apartments in Dallas, Texas, the 80 unit Waters Edge IV Apartments in Gulfport, Mississippi and the 165 room Hotel Akademia in Wroclaw, Poland.
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 34 parcels of unimproved land, as described below) at December 31, 2002.
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 34 parcels of unimproved land, two parcels for a total of 21.23 acres in the Southeast region, one parcel of 25 acres in the Pacific region and 31 parcels for a total of 996.65 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.
A summary of activity in TCI's owned real estate portfolio during 2002 is as follows:
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, 2002, 2001 and 2000, for apartments and commercial properties and average occupancy during 2002, 2001 and 2000 for hotels:
- -------- * Property was purchased in 2001 or 2002. ** Property was under construction. (1) Includes the 2301 Valley Branch, Dominion, Eagle Crest, Folsom, Hollywood Casino, Manhatten, Mira Lago, Pac Trust and Solco-Valley Ranch land parcels.
Occupancy presented here and throughout this ITEM 2. is without reference to whether leases in effect are at, below or above market rates.
In 2002, TCI purchased the following properties:
- -------- (1) Land purchased for apartment construction. (2) Property received from ARI, a related party, for payment of debt. (3) Assumed debt. (4) Weighted average. The Centura Tower is encumbered by two loans, one for $28.7 million at 10.5% and the other for $15.0 million at 17.9%. (5) Property exchanged with American Realty Investors, Inc. ("ARI"), a related party, for the Plaza on Bachman Creek Retail Center and the reduction of $600,000 in affiliate receivables.
In 2002, TCI sold the following properties:
- -------- (1) Excludes a $920,000 deferred gain from seller financing. See NOTE 3. "NOTES AND INTEREST RECEIVABLE." (2) Property was exchanged with ARI, a related party, for the Oak Tree Village Shopping Center and two parcels of land; the Rasor land parcel and Lakeshore Villas land parcel.
In 2002, TCI financed/refinanced the following property:
- -------- (1) The Echo Valley Apartments are under construction. The $1.6 million debt incurred was to fund construction to date. The total construction funding for the project is $12.7 million. (2) In April 2002, TCI sold 12 residential properties to partnerships controlled by Metra Capital, LLC ("Metra"). These properties include: the 75 unit Apple Lane Apartments in Lawrence, Kansas; the 195 unit Arbor Point Apartments in Odessa, Texas; the 264 unit Fairway View Estates Apartments in El Paso, Texas; the 152 unit Fairways Apartments in Longview, Texas; the 166 unit Fountain Lake Apartments in Texas City, Texas; the 172 unit Fountains of Waterford Apartments in Midland, Texas; the 122 unit Harper's Ferry Apartments in Lafayette, Louisiana; the 108 unit Oak Park IV Apartments in Clute, Texas; the 131 unit Quail Oaks Apartments in Balch Springs, Texas; the 300 unit Sunchase Apartments in Odessa, Texas; the 180 unit Timbers Apartments in Tyler, Texas; and the 112 unit Willow Creek Apartments in El Paso, Texas. (3) Variable interest rate. (4) The Verandas at City View Apartments are under construction. The $2.8 million debt incurred was to fund construction to date. The total construction funding for the project is $19.4 million. (5) The mortgage is cross-collateralized with the 29,000 sq. ft. Addison Hanger II in Addison, Texas. (6) The mortgages are cross-collateralized.
Properties Held for Sale. Set forth below are TCI's properties held for sale.
Partnership Properties. TCI accounts for partnership properties using the equity method. Set forth below are the properties owned by partnerships, the average annual rental rate for commercial properties, and occupancy rates at December 31, 2002, 2001 and 2000:
TCI is a 30% general partner in Sacramento Nine ("SAC 9"), which owns the Prospect Park #29 Office Building.
Provision for asset impairment was $2.6 million in 2002. TCI recorded asset impairments of $2.6 million, representing the write down of certain operating properties to current estimated fair value. These assets include the following properties:
The Red Cross land was under contract to sell 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 is in current negotiations to refinance the Plantation Apartments. Lenders will refinance the property at between 80% and 90% of the value of the property. Currently, the loans are in the range of $2.0 million and $2.4 million.
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. BCM, in its capacity as a mortgage servicer, 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, 2002, consisted of two apartments, six office buildings, a shopping center, and unimproved land. 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, 2002, TCI's mortgage notes receivable portfolio included nine mortgage loans with an aggregate principal balance of $16.5 million secured by income-producing real estate located in the Midwest, Southeast and Southwest regions of the continental United States, three mortgage loans with an aggregate principal balance of $11.8 million secured by unimproved land in the Pacific and Southwest regions of the continental United States and one loan with a principal balance of $100,000 secured by a partnership interest. At December 31, 2002, 3% of TCI's assets were invested in notes and interest receivable.
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, 2002. 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 2002 is as follows:
During 2002, $11.9 million was collected in full payment of seven mortgage notes and $4.3 million in principal payments were received on other mortgage notes. At December 31, 2002, 1% of TCI's assets were invested in mortgage notes secured by non-income producing real estate, comprised of a first lien mortgage note secured by 36 acres of unimproved land in Palm Desert, California, a second lien mortgage note secured by 1,714 acres of unimproved land in Tarrant County, Texas, a second lien on 21.6 acres of unimproved land in Tarrant County, Texas, and a loan secured by a partnership interest.
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 that it originates to other lenders.
In July 2001, TCI funded a $1.7 million mortgage loan secured by a first lien on 44.6 acres of unimproved land in Fort Worth, Texas, and a 100% interest in a partnership. The note receivable bears interest at 16.0% per annum, requires monthly interest only payments and matured in June 2002. In September 2002, TCI received $1.3 million on the note. With this payment, TCI agreed to release the lien on the 44.6 acres substituting a second lien on 21.61 acres of unimproved land in Tarrant County, Texas, from the borrower to secure the remaining $689,000 in debt. TCI has extended the maturity to November 2002. As of March 2003, management continued efforts to collect the remaining balance.
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% of TCI's assets. At December 31, 2001, 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 as well as events that affected previously funded junior mortgage loans during 2002.
In March 2001, TCI funded a $3.5 million mortgage loan secured by a second lien on a retail center in Montgomery County, Texas. In June 2001, an additional $1.5 million was funded. The note receivable bore interest at 16.0% per annum, required monthly interest only payments of $67,000 and matured in September 2001. In October 2001, TCI extended the loan until February 2002, receiving $100,000 as an extension fee. In December 2001, TCI received a $1.5 million principal payment. In February 2002, TCI sold a $2.0 million senior participation interest in the loan to IORI, a related party. TCI and IORI received 43% and 57%, respectively, of the remaining principal and interest payments. Also in February 2002, TCI extended the loan until April 2002, receiving $23,000 as an extension fee. In April 2002, the loan was extended until July 2002. In July 2002, the loan was extended until September 2002. In August 2002, the loan was paid off, including accrued but unpaid interest.
In June 2001, in conjunction with the sale of 275 unit McCallum Glen Apartments in Dallas, Texas, TCI funded a $1.5 million mortgage loan secured by a second lien on the apartments. The note receivable bore interest at 10% per annum, required monthly interest only payments and matured in June 2003. In May 2002, the loan was paid off. TCI agreed to a 5% discount on the note and recognized a loss of $75,000 from the note. TCI also recognized a previously deferred gain on $1.5 million on the sale of the property.
In July 2001, TCI agreed to fund a $4.4 million line of credit secured by a second lien on 1,714.16 acres of unimproved land in Tarrant County, Texas. The note receivable bears interest at 15% per annum, requires monthly interest only payments beginning in September 2001 and matures in July 2003. In March 2002, TCI received a $1.8 million principal payment. As of March 2003, TCI has funded $2.4 million of the line of credit.
In August 2001, TCI agreed to fund up to $5.6 million loan 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 2003, TCI has funded a total of $4.3 million. On January 23, 2003, TCI agreed to extend the maturity date until May 1, 2003. The agreement requires interest to accrue at the default rate of 18%.
In December 2000, TCI funded a $3.0 million mortgage loan secured by a second lien on four office buildings in San Antonio, Texas. The note receivable bore interest at 16.0% per annum, required monthly interest only payments of $40,000 and matured in June 2001. The note was extended until November 2001 with a $750,000 loan principal paydown. With this paydown, the note was renegotiated to replace the existing collateral with new collateral consisting of a 120,000 sq. ft. office building and industrial warehouse in Carrollton, Texas. The note bore interest at 16.0% per annum, required monthly payments of interest only and matured in May 2002. In July 2002, the note was paid off, including accrued but unpaid interest.
In October 2001, TCI funded a $4.0 million loan secured by a 375,152 sq.ft. office building in St. Louis, Missouri. The note receivable bore interest at 9.0% per annum, required monthly interest only payments of $30,000 and matured in February 2002. In February 2002, TCI extended the loan maturity to February 2003. In August 2002, the note was paid off including accrued but unpaid interest.
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% annual return of the purchase price for a period of three years from the purchase date. If the asset fails to produce the 12% annual return, ARI shall pay TCI any shortfall. In addition, if the asset fails to produce the 12% 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% 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 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 6.0% per annum, requires monthly interest only payments of $14,667 and matures in March 2007. As of March 2003, TCI has funded $264,000 of the additional line of credit.
Also in January 2002, a mortgage loan with a principal balance of $608,000 was paid off, including accrued but unpaid interest. With the payoff of the note, TCI recognized a previously deferred gain on the sale of the property of $608,000.
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 that these assets shall produce at least a 12% return annually of the purchase price for a period of three years from the purchase date. If the assets fail to produce the 12% return, ARI shall pay TCI any shortfall. In addition, if the assets fail to produce the 12% 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% 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.
Also in April 2002, a mortgage loan with a principal balance of $155,000 was paid off, including accrued but unpaid interest.
In July 2002, the Woodsong Apartments were sold. ARI received $2.6 million from the proceeds as payment of principal and accrued but unpaid interest on the note receivable. The funds were received by ARI and the affiliate receivable balance was increased.
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 2003, TCI has funded $175,000 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 bears interest at 8.0% per annum, requires quarterly interest only payments of $54,000 and matures in September 2004. In March 2003, the note was sold to a financial institution for $2.6 million.
Partnership mortgage loans. TCI owns a 60% general partner interest and IORI owns a 40% 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.
ITEM 3. LEGAL PROCEEDINGS
Olive Litigation
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").
On January 27, 1997, the parties entered into an Amendment to the Modification effective January 9, 1997 (the "First Amendment"). The First Amendment provided for the settlement of additional matters raised by plaintiffs' counsel in 1996. The Court issued an order approving the First Amendment on July 3, 1997.
The First Amendment provided that TCI's Board retain a management/compensation consultant or consultants to evaluate the fairness of the BCM advisory contract and any contract of its affiliates with TCI, CMET and IORI, including, but not limited to, the fairness to TCI, CMET and IORI of such contracts relative to other means of administration. In 1998, the Board engaged a management/compensation consultant to perform the evaluation which was completed in September 1998.
In 1999, plaintiffs' counsel asserted that the Board did not comply with the provision requiring such engagement and requested that the Court exercise its retained jurisdiction to determine whether there was a breach of this provision of the First Amendment. In January 2000, the Board engaged another management compensation consultant to perform the required evaluation again. The evaluation was completed in April 2000 and was provided to plaintiffs' counsel. The Board believes that any alleged breach of the First Amendment has been fully remedied by the Board's engagement of this second consultant. Although several status conferences on this matter were held, there has been no court order resolving whether there was any breach of the First Amendment.
In June 2000, plaintiffs' counsel asserted that loans made by TCI to BCM and American Realty Trust, Inc. breached the provision of the Modification. The Board believes that the provisions of the Settlement, Modification and the First Amendment terminated on April 28, 1999. However, the Court has ruled that certain provisions continue to be effective after the termination date. This ruling was appealed by TCI and IORI.
On October 23, 2001, TCI, Income Opportunity Realty Investors, Inc. ("IORI") and American Realty Investors, Inc. ("ARI") jointly announced a preliminary agreement with the plaintiff's legal counsel 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 has been 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. Under the merger, ARI would pay $17.50 cash per TCI share and $19.00 cash per IORI share for the stock held by non-affiliated stockholders. ARI would issue one share of Series G Preferred Stock with a liquidation value of $20.00 per share for each share of TCI Common Stock for stockholders who affirmatively elect to receive ARI preferred stock in lieu of cash. ARI would issue one share of Series H Preferred Stock with a liquidation value of $21.50 per share for each share of IORI Common Stock for stockholders who affirmatively elect to receive ARI preferred stock in lieu of cash. Each share of Series G Preferred Stock would be convertible into 2.5 shares of ARI Common Stock during a 75-day period that commences fifteen days after the date of the first ARI Form 10-Q filing that occurs after the closing of the merger transaction. Upon the acquisition of IORI and TCI shares, TCI and IORI would become wholly-owned subsidiaries of ARI. The transaction was subject to the negotiation of a definitive merger agreement and a vote of the shareholders of all three entities. TCI has the same board as IORI and the same advisor as IORI and ARI. Two of the directors of TCI and IORI also serve as directors for ARI.
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 made to cure a default under the settlement resulting from ARI's failure to timely complete the SEC review process of the registration statement for the proposed mergers with TCI and IORI. 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 fulfills the obligations under the Second Amendment and the Olive Litigation has been dismissed with prejudice. ARI has deferred further action on the mergers.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
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.
As of March 19, 2003, the closing price of TCI's Common Stock as reported in the consolidated reporting system of the NYSE was $17.55 per share.
As of March 19, 2003, TCI's Common Stock was held by 5,234 holders of record.
TCI paid no dividends in 2002 or 2001, and management believes no dividends will be paid in 2003. In December 2000, the Board of Directors determined not to pay a fourth quarter dividend to holders of TCI's Common Stock. The non-payment decision was based on the Board determining that TCI needed to retain cash for acquisitions that were anticipated in 2001 and 2002.
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, 2001, a total of 409,765 shares had been repurchased at a cost of $3.3 million. No shares were repurchased in 2001. In September 2001, the Board approved a private block purchase of 593,200 shares of Common Stock for a total cost of $9.5 million.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table provides information as of December 31, 2002 regarding compensation plans (including individual compensation arrangements) under which equity securities of TCI are authorized for issuance.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
TCI purchased 16 properties for a total of $107.7 million in 2002, 17 properties for a total of $62.5 million in 2001, 18 properties for a total of $103.9 million in 2000, 10 properties for a total of $51.2 million and obtained an additional 64 properties through merger with CMET in 1999, and purchased 22 properties in 1998 for a total of $91.0 million. TCI sold 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, 20 properties in 2000 for a total of $113.5 million, 11 properties in 1999 for a total of $117.4 million, and five properties in 1998 for a total of $31.8 million. See ITEM 2. "PROPERTIES--Real Estate" and ITEM 8. "FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA."
ITEM 7.
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 judgements. TCI's critical accounting policies relate to the evaluation of impairment of long-lived assets and the evaluation of the collectibility of accounts and notes receivable.
If events or changes in circumstances indicate that the carrying value of a rental property to be held and used or land held for development may be impaired, management performs a recoverability analysis based on estimated undiscounted cash flows to be generated from the property in the future. If the analysis indicates that the carrying value is not recoverable from future cash flows the property is written down to estimated fair value and an impairment loss is recognized. If management decides to sell rental properties or land held for development, management evaluates the recoverability of the carrying amounts of the assets. If the evaluation indicates that the carrying value is not recoverable from estimated net sales proceeds, the property is written down to estimated fair value less costs to sell and an impairment loss is recognized within income from continuing operations. TCI's estimates of cash flow and fair values of the properties are based on current market conditions and consider matters such as rental rates and occupancies for comparable properties, recent sales data for comparable properties and, where applicable, contracts or the results of negotiations with purchasers or prospective purchasers. TCI's estimates are subject to revision as market conditions and TCI's assessments of them change. 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.
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, 2002. (Dollars in thousands)
Liquidity and Capital Resources
Cash and cash equivalents were $10.6 million, $10.3 million and $22.3 million at December 31, 2002, 2001 and 2000, 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, the collection of mortgage notes receivable, borrowings and to a lesser extent, distributions from partnerships. Management anticipates that TCI's cash at December 31, 2002, along with cash that will be generated in 2003 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.
Net cash used in operations was $9.1 million in 2002, $895,000 in 2001 and $1.1 million in 2000. The primary factors contributing to TCI's use of cash in its operations are discussed in the following paragraphs.
Cash flow from property operations (rents collected less payments for property operating expenses) was $43.9 million in 2002, $56.0 million in 2001, and $56.6 million in 2000. Of the decrease in property cash flow from 2001 to 2002, $4.3 million and $6.3 million was due to the sale of 16 commercial properties and 24 apartments, respectively in 2002 and 2001, $628,000, $646,000 and $821,000 was due to the lower occupancies at TCI's commercial, apartment and hotel properties, respectively, $125,000 was due to increases in property taxes at TCI's land properties, $453,000 was due to the purchase of 13 land parcels in 2002 and 2001, and $275,000 was due to the completion of the hotel in Poland. These decreases were offset by increases of $1.3 million, and $1.5 million from the purchase of two commercial properties and five apartments, respectively in 2002 and 2001. In 2001, decreases in cash flow of $8.6 million were due to the sale of 29 apartments in 2001 and 2000, and $2.7 million was due to the sale of eight commercial properties and one industrial warehouse in the Kelly portfolio in 2001 and 2000. These decreases were offset by increases in cash flow from property operations of which $900,000 and $2.7 million were from the purchase of 10 existing apartments and seven commercial properties in 2001 and 2000, and $2.5 million and $4.5 million were due to increases in rents at TCI's apartments and commercial properties, respectively. Management believes that this trend of decreased cash flow from property operations will continue as a result of TCI's selling of income producing properties to meet its cash requirements.
Interest collected was $3.2 million in 2002, $1.6 million in 2001, and $1.0 million in 2000. These increases were due to TCI funding seven loans in 2002, eight loans in 2001 and two loans in the fourth quarter in 2000. Interest collected is expected to decrease in 2003 due to the payoff of seven loans in 2002.
Interest paid was $41.4 million in 2002, $39.5 million in 2001 and $45.1 million in 2000. Of the increase in interest paid from 2001 to 2002, $1.4 million, $51,000 and $1.3 million was due to the refinancing of 12 land parcels, 3 commercial and 17 apartment properties, respectively in 2002 and 2001, $631,000, $3.6 million, $2.7 million was due to the purchase of 13 land parcels, 2 commercial properties and 5 apartments, respectively in 2002 and 2001, and $259,000 was due to default interest payments at TCI's Chicago hotels. These increases were offset by decreases of $2.2 million and $4.3 million due to the sale of 16 commercial properties and 24 apartments, respectively in 2002 and 2001, and $212,000, $1.1 million and $229,000 was due to principal paydowns and lower variable interest rates at TCI's land, commercial and apartment properties, respectively. In 2001, decreases of $6.8 million was due to the sale of 40 properties subject to debt in 2001 and 2000, $1.3 million was due to lower variable interest rates, and $1.5 million was due to principal paydowns. These decreases were offset by increases of $3.8 million due to the purchase of 18 properties subject to debt in 2001 and 2000 and $200,000 was due to the refinancing of 14 properties in 2001 and 2000. Interest paid will continue to decrease as TCI sells properties subject to debt.
Advisory and net income fees paid to affiliate was $4.5 million in 2002, $7.9 million in 2001 and $10.5 million in 2000. The decreases were due to a decrease in net income. Advisory and net income fees are expected to decrease as additional properties are sold.
TCI paid incentive fees of $2.9 million to an affiliate in 2001. No such fee was paid in 2002 or 2000. See ITEM 10. "DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT."
General and administrative expenses paid were $8.9 million in 2002, $10.9 million in 2001 and $7.9 million in 2000. The decrease in 2002 was due to decreases in consulting fees, taxes and cost reimbursements. Increases in 2001 of $1.8 million, $615,000, $249,000, and $219,000 were due to increases in consulting fees, legal fees, taxes, and insurance, respectively.
Distributions were received from equity investees operating cash flow of $646,000 in 2001 and $172,000 in 2000. See NOTE 5. "INVESTMENT IN EQUITY METHOD REAL ESTATE ENTITIES."
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.
In 2002, TCI received cash of $12.3 million from the collection of seven mortgage notes receivable, $3.8 million in mortgage receivable principal payments and paydowns, net cash of $176.1 million from new mortgage borrowings and refinancings and an additional $106.1 million from property sales. In 2002, $12.7 million was expended on property purchases, $104.2 million in cash was expended on construction projects, of which $97.4 million was funded by additional borrowings, $7.0 million was expended on capital improvements, and a total of $95.7 million in principal payments were made on mortgage debt.
Also in 2002, TCI made net cash advances to affiliates and related parties of $46.0 million. In repayment of these advances, TCI received $14.5 million in notes receivable, real estate valued at $93.9 million with corresponding debt of $62.2 million assumed at a weighted average interest rate of 12.7% and TCI was credited with $5.3 million against construction supervision and other fees owed by TCI for TCI's apartments under construction. The remaining net cash funding is still due and payable.
In 2001, TCI received cash of $3.7 million from the collection of two mortgage notes receivable, $2.3 million in mortgage receivable principal payments, net cash of $29.1 million from new mortgage borrowings and refinancings and an additional $100.8 million from property sales. In 2001, $19.7 million in cash was expended on property purchases, $24.5 million in cash was expended on construction projects, $9.1 million was expended on capital improvements, and a total of $66.1 million in principal payments were made on mortgage debt.
In 2000, TCI received cash of $20.4 million from the collection of four mortgage notes receivable, $131,000 in mortgage receivable principal payments, net cash of $63.0 million from new mortgage borrowings and refinancings and an additional $80.0 million from property sales. In 2000, $32.5 million in cash was expended on property purchases and a total of $107.5 million in principal payments on mortgage debt.
TCI paid dividends to its Common stockholders totaling $4.7 million or $.54 per share in 2000.
In 2001, TCI repurchased 593,200 shares of Common Stock in a private block purchase for a total cost of $9.5 million.
Scheduled principal payments on notes payable of $209.3 million are due in 2003. For those mortgages that mature in 2003, management intends to either seek to extend the due dates one or more years, or refinance the debt on a long-term basis. Management also intends to sell income producing properties to retire mortgage debt as it becomes due. Management believes it will continue to be successful in obtaining loan extensions or 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
TCI had net income of $4.9 million in 2002, including gains on sale of real estate totaling $43.9 million, $19.8 million in 2001, including gains on sale of real estate totaling $48.9 million, and $29.8 million in 2000, including gains on sale of real estate totaling $50.6 million. Fluctuations in the components of revenues and expense between 2002, 2001 and 2000 are discussed below.
Rents were $109.7 million in 2002, $115.4 million in 2001, and $133.2 million in 2000. Of the decrease in rents from 2001 to 2002, $3.9 million and $10.8 million was due to the sale of six commercial properties and 15 apartments, respectively in 2001, $608,000 and $1.5 million was due to lower occupancies at TCI's apartments and hotels, respectively. These decreases were offset by increases of $3.0 million, and $5.4 million from the purchase of two commercial properties and five apartments, respectively in 2002 and 2001, $1.9 million and $1.0 million was due to the completion of four apartments and one hotel, respectively in 2002, and $623,000 was due to increased rents at TCI's commercial properties. Of the decrease in rents from 2000 to 2001, $3.2 million and $20.4 million was due to the sale of eight commercial properties and 29 apartments, respectively in 2001 and 2000. These decreases were offset by increases of $2.4 million from the purchase of 17 apartments in 2001 and 2000, and $1.9 million was due to increased rents and occupancies at TCI's apartments. In 2000, TCI leased its four U.S. hotels to Regis Hotel Corporation, an affiliate to BCM, at an annual base rent totaling
$503,477 per year plus 30% of the hotel's gross revenues. Beginning January 1, 2001, TCI no longer leased the hotels and recognized revenues based on the operations of the hotels. From this change, rents increased at TCI's hotels by $4.4 million. Rents are expected to decrease in 2003 as TCI selectively sells income producing properties in 2003.
Property operations expenses were $71.0 million in 2002, $68.5 million in 2001, and $74.6 million in 2000. Of the increase in property operations from 2001 to 2002, $435,000, $1.7 million and $3.9 million was due to the purchase of 13 land parcels, two commercial properties and five apartments, respectively in 2002 and 2001, $1.9 million and $1.3 million was due to the completion of four apartments and one hotel, respectively in 2002, and $1.1 million and $1.8 million was due to increases in operating expenses at TCI's commercial properties and apartments, respectively in 2002 and 2001. These increases were offset by decreases of $1.9 million and $6.9 million due to the sale of six commercial properties and 15 apartments, respectively in 2001, and $455,000 was due to the lower operating expenses at TCI's hotels. Of the decrease in property operations from 2000 to 2001, $7.6 million due to the sale of 29 apartments in 2001 and 2000. Property operating expenses are expected to increase as TCI continues to construct apartments in 2003.
Interest and other income was $4.1 million in 2002, $2.9 million in 2001, and $2.4 million in 2000. The increase in 2002 was due to TCI funding seven loans in 2002. The increase in 2001 was primarily due to TCI funding two loans in the fourth quarter of 2000 and eight loans in 2001. Interest income in 2003 is expected to decrease due to the payoff of seven of TCI's loans in 2002.
Prior to the first quarter of 2001, TCI accounted for its investment in ARI, an affiliate, as an available for sale marketable security. In the first quarter of 2001, TCI began accounting for its investment in ARI using the equity method. Equity losses of investees was $3.8 million in 2002, $6.0 million in 2001, and $556,000 in 2000. The losses from equity investees are primarily attributed to increased operating losses for IORI and ARI. Equity losses are expected to increase with decreases in operating income from ARI and IORI as ARI and IORI continue to sell income producing properties.
Interest expense was $38.9 million in 2002, $36.8 million in 2001, and $46.5 million in 2000. Of the increase in interest expense from 2001 to 2002, $838,000, $4.0 million, $2.5 million and $550,000 was due to the purchase of six land parcels, two commercial properties, five apartments and one hotel, respectively subject to debt in 2002 and 2001, $713,000, $56,000 and $1.5 million was due to the financing and refinancing of four land parcels held for investment, three commercial properties and 17 apartments, respectively in 2002, $374,000 was due to an increase in the interest rate at TCI's Chicago hotels from TCI's default in a debt covenant, and $510,000 was due to an interest swap agreement TCI entered into in 2002. These increases were offset by decreases of $1.8 million and $3.3 million due to the sale of six commercial properties and 15 apartments, respectively in 2001, and $121,000, $1.9 million and $271,000 was due to the principal paydowns and lower variable rates at TCI's land, commercial and apartment properties, respectively. Of the decrease in interest from 2000 to 2001, $6.0 million was due to the sale of 29 apartments in 2001 and 2000, $1.4 million was due to the sale of eight commercial properties and one industrial warehouse in the Kelly portfolio in 2001 and 2000, and $289,000 was due to land loan payoffs and principal paydowns in 2001 and 2000. Of the remaining decrease, $263,000 was due to lower variable interest rates at TCI's apartments, $1.3 million was due to lower variable interest rates at TCI's commercial properties and $278,000 was due to lower variable interest rates at TCI's hotels. Interest expense is expected to increase or remain constant as TCI completes construction projects and increases its debt by refinancings.
Depreciation expense was $19.0 million in 2002, and $17.1 million in 2001, and $18.9 million 2000. Of the increase in depreciation expense from 2001 to 2002, $528,000 and $687,000 was due to the purchase of two commercial properties and five apartments, respectively in 2002 and 2001, $255,000 and $187,000 was due to the completion of four apartments and one hotel in 2002, and $1.8 million was due to tenant and building improvements at TCI's commercial properties. These increases were offset by decreases of $673,000 and $907,000 due to the sale of six commercial properties and 15 apartments, respectively in 2001. The decrease in depreciation expense from 2000 to 2001 is primarily due to the sale of 29 apartments in 2001. Depreciation expense is expected to increase or remain constant as TCI completes construction projects during 2003.
Provision for asset impairment was $2.6 million in 2002. TCI recorded asset impairments of $2.6 million, representing the write down of certain operating properties to current estimated fair value. These assets include the following properties:
The Red Cross land was under contract to sell 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 is in current negotiations to refinance the Plantation Apartments. Lenders will refinance the property at between 80% and 90% of the value of the property. Currently, the loans are in the range of $2.0 million and $2.4 million.
Advisory fee expense was $4.5 million in 2002, and $5.3 million in 2001 and 2000. The decrease in 2002, was due to a $1.4 million operating expense refund from BCM. See NOTE 11. "ADVISORY AGREEMENT." This decrease was offset by an increase in advisor fees due to a 20% increase in gross assets, the basis of the fee. Advisory fees are expected to decrease as TCI sells properties.
Net income fee to affiliate was $374,000 in 2002, $1.9 million in 2001, and $2.4 million in 2000. The net income fee is payable to TCI's advisor based on 7.5% of TCI's net income.
Incentive fee to affiliate was $3.2 million in 2001. The incentive fee is payable to TCI's advisor based on 10% of aggregate sales consideration less TCI's cost of all properties sold during the year. No incentive fee was paid in 2000 or 2002.
Realized losses on investments of $3.1 million were recognized in 2001. TCI recognized a previously unrealized loss on ARI's marketable equity securities of $3.1 million in 2001.
General and administrative expenses were $8.8 million in 2002, $11.5 million in 2001, and $8.5 million in 2000. The decrease in 2002, was due to decreases in consulting fees, taxes and cost reimbursements to the advisor. In 2001, increases of $1.8 million, $615,000, $249,000, and $219,000 were due to increases in consulting fees, legal fees, taxes, and insurance, respectively. General and administrative expenses are expected to remain constant or decrease from decreased litigation and consulting fees.
Income from discontinued operations was $41.7 million in 2002, $703,000 in 2001, and $ 447,000 in 2000. Income from discontinued operations relates to 18 properties that TCI sold during 2002, and one parcel of land designated as held for sale. The following table summarizes revenue and expense information for these properties sold and held-for-sale.
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 2002, 2001 and 2000, gains on sale of real estate totaling $43.9 million, $48.9 million and $50.6 million were recognized. See NOTE 2. "REAL ESTATE."
Related Party Transactions
Historically, TCI, ARI, BCM and IORI 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 $88,000 in 2002, $120,000 in 2001 and $70,000 in 2000 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
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 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. See NOTE 2. "REAL ESTATE." 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.
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. See NOTE 2. "REAL ESTATE." 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. 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. The business purpose of the transaction was for TCI to develop apartments on these four tracts of land.
In December 2002, TCI purchased NLP/CH, Ltd. partnership, which owns the Centura land parcel from ARI. See NOTE 2. "REAL ESTATE." 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 adjacent to its Centura Tower office building.
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
For the year 1999, 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.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES REGARDING MARKET RISK
TCI's future operations, cash flow and fair values of financial instruments are partially dependent upon 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 finance 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 2002 was not material. As permitted, management intends to convert a significant portion of those borrowings from variable rates to fixed rates in 2003. If market interest rates for variable rate debt average 100 basis points more in 2003 than they did during 2002, TCI's interest expense would increase, and income would decrease by $1.2 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.
The following table contains only those exposures that existed at December 31, 2002. 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.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
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.
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors of Transcontinental Realty Investors, Inc.
We have audited the accompanying consolidated balance sheets of Transcontinental Realty Investors, Inc. and Subsidiaries as of December 31, 2002 and 2001 and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2002. 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 auditing standards generally accepted in the United States of America. 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 21, 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, 2002 and 2001, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America.
Also, in our opinion, the schedules referred to above present fairly, in all material respects, the information set forth therein.
As discussed in Note 18, in 2002 the Company changed its method of accounting for discontinued operations.
BDO SEIDMAN, LLP
Dallas, Texas March 21, 2003
TRANSCONTINENTAL REALTY INVESTORS, INC.
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these Consolidated Financial Statements.
TRANSCONTINENTAL REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these Consolidated Financial Statements.
TRANSCONTINENTAL REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
The accompanying notes are an integral part of these Consolidated Financial Statements.
TRANSCONTINENTAL REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these Consolidated Financial Statements.
TRANSCONTINENTAL REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS--Continued
The accompanying notes are an integral part of these Consolidated Financial Statements.
TRANSCONTINENTAL REALTY INVESTORS, INC.
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.
Certain balances for 2001 and 2000 have been reclassified to conform to the 2002 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 18. "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 then 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. In April 2002, the FASB issued Statement 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Correction" ("SFAS No. 145"). Statement 4, "Reporting Gains and Losses from Extinguishment of Debt" ("SFAS No. 4"), required that gains and losses from the extinguishment of debt that were included in the determination of net income be aggregated and, if material, classified as an extraordinary item. The provisions of SFAS No. 145 related to the rescission of SFAS No. 4 will require TCI to reclassify prior period items that do not meet the extraordinary classification. The provisions of SFAS No. 145 that relate to the rescission of SFAS No. 4 become effective in fiscal years beginning after May 15, 2002. 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.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which addresses accounting for restructuring and similar costs. SFAS No. 146 supersedes previous accounting guidance, principally Emerging Issues Task Force ("EITF") Issued 94-3. TCI will adopt the provisions of SFAS No. 146 for restructuring activities initiated after December 31, 2002. SFAS No. 146 requires that the liability costs associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF No. 94-3, a liability for an exit cost was recognized at the date of a company's commitment to an exit plan. SFAS No. 146 also established that the liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing future restructuring costs as well as the amount recognized.
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain Financial Institutions--an amendment to FASB No. 72 and 144 and FASB Interpretation No. 9." SFAS No. 147 provides guidance to companies in reporting and disclosing the purchase of certain financial institutions. Management currently believes that the adoption of SFAS No. 147 will not have a material impact on the financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation, Transition and Disclosure, an amendment of FASB No. 123." SFAS No. 148 provides alternative methods of transition for an entity that voluntarily changes to the fair value method of accounting for stock-based employee compensation. It also amends the disclosure provisions of SFAS No. 123 to require prominent disclosure about the effects on reported net income of an entity's accounting policy decisions with respect to stock-based employee compensation. Finally, this statements amends APB Opinion No. 28, "Interim Financial Reporting," to require disclosure about those effects in interim financial information. Management currently believes that the adoption of SFAS No. 148 will not have a material impact on the financial statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others," which disclosures are effective for financial statements issued after December 15, 2002. While the Company has various guarantees included in contracts in the normal course of business, these guarantees would not represent significant commitments or contingent liabilities of the indebtedness of entities outside of the consolidated company.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"), which requires the consolidation of variable interest entities, as defined. FIN 46 is applicable to financial statements to be issued by the Company after 2003; however, disclosures are required currently if TCI expects to consolidate any variable interest entities. TCI does not currently believe that any entities will be consolidated as a result of FIN 46.
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 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 costs of sale. SFAS No. 144 also requires that properties held for sale
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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.
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"). Until the requirements of SFAS No. 66 for full profit recognition have been met, transactions are accounted for using either the deposit, the installment, the 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 nonperforming 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 per share is presented in accordance with Statement of Financial Accounting Standards No. 128, "Earnings Per Share." Income per share is computed based upon the 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, 2001 and 2000 include 301,548 and 25,000 shares, respectively, to reflect the dilutive effect of options and convertible preferred stock to purchase shares of common stock. For the year ended December 31, 2002, 223,784 weighted average 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.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 2. REAL ESTATE
In 2002, TCI purchased the following properties:
- -------- (1) Land purchased for apartment construction. (2) Property received from ARI, a related party, for payment of debt. (3) Assumed debt. (4) Weighted average. The Centura Tower is encumbered by two loans, one for $28.7 million at 10.5% and the other for $15.0 million at 17.9%. (5) Property exchanged with American Realty Investors, Inc. ("ARI"), a related party, for the Plaza on Bachman Creek Retail Center and the reduction of $600,000 in affiliate receivables.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In 2001, TCI purchased the following properties:
- -------- (1) Land purchased for apartment construction. (2) Land was received from ARI, a related party, in exchange for the Glenwood Apartments. (3) Land purchased for hotel construction. (4) The note was refinanced. See NOTE 6. "NOTES AND INTEREST PAYABLE." (5) The note was paid in full at maturity.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In 2002, TCI sold the following properties:
- -------- (1) Excludes a $920,000 deferred gain from seller financing. See NOTE 3. "NOTES AND INTEREST RECEIVABLE." (2) Property was exchanged with ARI, a related party, for the Oak Tree Village Shopping Center and two parcels of land; the Rasor land parcel and Lakeshore Villas land parcel. TCI also reduced the affiliate receivable from ARI by $600,000.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In 2001, TCI sold the following properties:
- -------- (1) Debt assumed by purchaser. (2) The Glenwood Apartments were exchanged with ARI, a related party, for two parcels of land; the 10.5 acre Limestone Ranch and the 8.88 acre Mira Lago. (3) Excludes $1.5 million deferred gain from seller financing. See NOTE 3. "NOTES AND INTEREST RECEIVABLE." (4) Excludes a $608,000 deferred gain from seller financing. See NOTE 3. "NOTES AND INTEREST RECEIVABLE."
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 3. NOTES AND INTEREST RECEIVABLE
Notes and interest receivable consisted of the following:
Interest income is not recognized on nonperforming notes receivable. For the year 2001, unrecognized interest income on nonperforming notes totaled $192,500.
Notes receivable at December 31, 2002, mature from 2003 through 2008 with interest rates ranging from 5.8% to 16.0% per annum, with a weighted average rate of 10.14%. Notes receivable are generally nonrecourse and are generally collateralized by real estate. Scheduled principal maturities of $8.5 million are due in 2003.
In January 2002, a mortgage loan with a principal balance of $608,000 was paid off, including accrued but unpaid interest. With the payoff of the note, TCI recognized a previously deferred gain on the sale of the property of $608,000.
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 rate, currently 6.0% per annum, requires monthly interest only payments of $14,667 and matures in March 2007. As of March 2003, TCI has funded $264,000 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 2003, TCI has funded $175,000 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 bears interest at 8.0% per annum, requires quarterly interest only payments of $54,000 and matures in September 2004. In March 2003, the note was sold to a financial institution for $2.6 million.
In March 2001, TCI funded a $3.5 million mortgage loan secured by a second lien on a retail center in Montgomery County, Texas. In June 2001, an additional $1.5 million was funded. The note receivable bore interest at 16.0% per annum, required monthly interest only payments of $67,000 and matured in September 2001. In October 2001, TCI extended the loan until February 2002, receiving $100,000 as an extension fee. In December 2001, TCI received a $1.5 million principal payment. In February 2002, TCI sold a $2.0 million senior participation interest in the loan to IORI, a related party. TCI and IORI received 43% and 57%, respectively, of the remaining principal and interest payments. Also in February 2002, TCI received $23,000 as an extension fee
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
and the loan was extended until April 2002. In April 2002, the loan was extended until July 2002. In July 2002, the loan was extended until September 2002. In August 2002, the loan was paid off, including accrued but unpaid interest.
In June 2001, in conjunction with the sale of 275 unit McCallum Glen Apartments in Dallas, Texas, TCI funded a $1.5 million mortgage loan secured by a second lien on the apartments. The note receivable bore interest at 10% per annum, required monthly interest only payments and matured in June 2003. In May 2002, the loan was paid off. TCI agreed to a 5% discount on the note and recognized a loss of $75,000 from the note. TCI also recognized a previously deferred gain of $1.5 million on the sale of the property.
In July 2001, TCI agreed to fund a $4.4 million line of credit secured by a second lien on 1,714.16 acres of unimproved land in Tarrant County, Texas. The note receivable bears interest at 16.0% per annum, requires monthly interest only payments beginning in September 2001 and matures in July 2003. In March 2002, TCI received a $1.8 million principal payment. As of March 2003, TCI has funded $2.4 million of the line of credit and the note is classified as nonperforming.
Also in July 2001, TCI funded a $1.7 million mortgage loan secured by a second lien on 44.6 acres of unimproved land in Fort Worth, Texas. The note receivable bears interest at 16.0% per annum, requires monthly payments of accrued interest beginning September 2001 and each month thereafter and matured January 2002. In January 2002, the note was extended until November 2002. As of March 2003, management continued efforts to collect the remaining balance.
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 2003, 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 agreement requires interest to accrue at the default rate of 18%.
In October 2001, TCI funded a $4.0 million loan secured by a second lien on a 375,752 sq. ft. office building in St. Louis, Missouri. The note receivable bore interest at 9.0% per annum, required monthly interest only payments of $30,000 and matured in February 2002. In February 2002, TCI extended the loan maturity to February 2003. In August 2002, the loan was paid off, including accrued but unpaid interest.
In December 2001, TCI provided $608,000 of purchase money financing in conjunction with the sale of the Madison at Bear Creek Apartments in Houston, Texas. The note receivable bore interest at 7% per annum, required payment of the entire outstanding principal and all accrued and unpaid interest in January 2002. The loan was secured by a second lien on the property. The note was paid in full according to the terms in January 2002.
Also in December 2000, TCI funded a $3.0 million mortgage loan secured by a second lien on four office buildings in San Antonio, Texas. The note receivable bore interest at 16.0% per annum, required monthly payments of interest only and matured in June 2001. In June 2001, the note was extended until November 2001 with a $750,000 loan principal paydown. With the paydown, the note was renegotiated to replace the existing collateral with new collateral consisting of a 120,000 sq.ft. office building and industrial warehouse in Carrollton, Texas. The renegotiated note originally was to mature in May 2002. In February 2002, the maturity date on the loan was extended to July 2002. In July 2002, the loan was paid off, including accrued but unpaid interest.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Related Party. 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% annual return of the purchase price for a period of three years from the purchase date. If the asset fails to produce the 12% annual return, ARI shall pay TCI any shortfall. In addition, if the asset fails to produce the 12% 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% 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 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 that these assets shall produce at least a 12% return annually of the purchase price for a period of three years from the purchase date. If the assets fail to produce the 12% return, ARI shall pay TCI any shortfall. In addition, if the assets fail to produce the 12% 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% 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. The $2.6 million received by ARI is included in other assets on the accompanying balance sheet.
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 that the asset will produce at least a 12% annual return of the purchase price for a period of three years from the purchase date. If the asset fails to produce the 12% annual return, ARI will pay TCI any shortfall. In addition, if the asset fails to produce 12% 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.
NOTE 4. ALLOWANCE FOR ESTIMATED LOSSES
Activity in the allowance for estimated losses was as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 5. INVESTMENT IN EQUITY METHOD REAL ESTATE ENTITIES
Investment in equity method real estate entities consisted of the following:
TCI owns an approximate 6.5% interest in ARI, a publicly held real estate company, having a market value of $92.0 million at December 31, 2001. At December 31, 2002, ARI had total assets of $709.3 million and owned 35 apartments, 14 commercial properties, nine hotels and 41 parcels of unimproved land. In 2002, ARI sold 18 apartments, five commercial properties and 13 parcels of unimproved land for a total of $287.4 million, receiving net cash of $22.2 million after paying off $155.0 million in mortgage debt and the payment of various closing costs. ARI recognized gains of $50.5 million on the sales of which TCI's equity share was $3.3 million. In 2001, ARI sold 17 apartments, one commercial property and 26 parcels of unimproved land for a total of $187.3 million, receiving net cash of $52.4 million after paying off $110.2 million in mortgage debt and the payment of various closing costs. ARI recognized gains of $83.4 million on the sales of which TCI's equity share was $5.3 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 $6.0 million at December 31, 2002. The carrying value of this investment is approximately $9.5 million at December 31, 2002. Management continues to believe that 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, 2002, IORI had total assets of $90.2 million and owned seven apartments in Texas, five office buildings (two in California, two in Texas and one in Virginia) and two parcels of unimproved land in Texas. In 2002, IORI sold two office buildings for a total of $19.2 million, receiving net cash of $8.6 million after paying off $9.3 million in mortgage debt and the payment of various closing costs. IORI recognized gains of $6.8 million on the sales of which TCI's equity share was $1.6 million.
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% general partner and IORI is a 40% 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 have the same Board of Directors and the same executive officers. Consequently, because TCI has a greater than 50% 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 by $5.4 million, $3.9 million and $1.5 million, respectively.
TCI is a non-controlling 30% general partner in SAC 9, which at December 31, 2002 owned an office building in Rancho Cordova, California.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In March 2001, in conjunction with the sale of the 211 unit Park at Colonade Apartments in San Antonio, Texas, TCI received a 23% limited partner interest in the acquiring partnership. TCI is to receive payments of $5,000 monthly from the partnership, a $50,000 distribution in June 2001 which was received and its remaining investment in March 2002. In July 2001, TCI assigned its limited partnership interest to the general partner, receiving a discounted payoff of $490,000. In conjunction with this assignment, TCI recognized a previously deferred gain on the sale of the apartments of $540,000.
Set forth below are summarized financial data for the entities accounted for using the equity method:
NOTE 6. NOTES AND INTEREST PAYABLE
Notes and interest payable consisted of the following:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Scheduled principal payments are due as follows:
Notes payable at December 31, 2002, bore interest at rates ranging from 4.0% to 17.9% per annum, and mature between 2003 and 2044. The mortgages were collateralized by deeds of trust on real estate having a net carrying value of $733.2 million.
In 2002, TCI financed/refinanced the following property:
- -------- (1) The Echo Valley Apartments are under construction. The $1.6 million debt incurred was to fund construction to date. The total construction funding for the project is $12.7 million. (2) In April 2002, TCI sold 12 residential properties to partnerships controlled by Metra Capital, LLC ("Metra"). These properties include: the 75 unit Apple Lane Apartments in Lawrence, Kansas; the 195 unit Arbor Point Apartments in Odessa, Texas; the 264 unit Fairway View Estates Apartments in El Paso, Texas;
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
the 152 unit Fairways Apartments in Longview, Texas; the 166 unit Fountain Lake Apartments in Texas City, Texas; the 172 unit Fountains of Waterford Apartments in Midland, Texas; the 122 unit Harper's Ferry Apartments in Lafayette, Louisiana; the 108 unit Oak Park IV Apartments in Clute, Texas; the 131 unit Quail Oaks Apartments in Balch Springs, Texas; the 300 unit Sunchase Apartments in Odessa, Texas; the 180 unit Timbers Apartments in Tyler, Texas; and the 112 unit Willow Creek Apartments in El Paso, Texas. Innovo Group, Inc. ("Innovo") is a limited partner in the partnerships that purchased the properties. Joseph Mizrachi, a director of ARI, a related party, controls approximately 11.67% of the outstanding common stock of Innovo. Management has determined to account for this sale as a refinancing transaction, in accordance with SFAS No. 66, "Accounting for Sales of Real Estate." TCI will continue to report the assets and the new debt incurred by the Metra partnerships on the TCI financial statements. The sales price for the properties totaled $37.6 million. TCI received net cash of $10.5 million after paying off the existing debt of $18.0 million and various closing costs. The new debt of $30.3 million bears interest at 7.57% per annum, requires monthly interest only payments of $212,000 and matures in May 2012. TCI also received $8.0 million of 8% non-recourse, non-convertible Series A Preferred Stock ("Preferred Shares") of Innovo. (3) Variable interest rate. (4) The Verandas at City View Apartments are under construction. The $2.8 million debt incurred was to fund construction to date. The total construction funding for the project is $19.4 million. (5) The mortgage is cross-collateralized with the 29,000 sq. ft. Addison Hanger II in Addison, Texas. (6) The mortgages are cross-collateralized.
In 2001, TCI financed the following property:
- -------- (1) Variable rate.
NOTE 7. 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 2001 and 2002, this receivable was reduced by management fees earned by Regis Hotel Corporation. As of December 31, 2002 and 2001, the receivable from Regis Hotel Corporation was $1.7 million and $1.9 million, respectively.
During 2002, TCI received $4.0 million in cash from IORI, and has repaid $80,000 to IORI prior to year end.
In February 2002, IORI funded a $2.0 million mortgage loan as a participation agreement with TCI. This note was paid in full during 2002. Of the principal repayments on this note, $1.5 million was deposited in the account of TCI. This amount is included in the affiliate payable balance at December 31, 2002. This transaction is more fully described in Note 3.
In March 2002, TCI sold the Plaza on Bachman Creek shopping center to ARI in exchange for a shopping center and two parcels of land. This transaction was approved by TCI's Board of Directors. See Note 2.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In April 2002, TCI purchased four wholly-owned subsidiaries of ARI, including Garden Woodsong, L.P. ("Woodsong"). This transaction, which is more fully described in Note 3, was treated as a financing, and TCI recorded a $10.0 million note receivable from ARI. $2.5 million of this note was related to Woodsong, which was subsequently sold in July 2002. The affiliate receivable balance from ARI increased by $2.8 million, representing principal and accrued but unpaid interest on the note receivable.
During 2002, ARI sold properties with fair value totaling $46.2 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 $5.0 million and $41.2 million, respectively, as a result of these transfers. For property transfers treated as financings, TCI has recorded notes receivable for the fair values of the properties transferred as an offset to the reductions in the affiliate receivables.
In January 2003, TCI's Board of Directors approved the payment to BCM of a six percent (6%) construction management fee on all construction projects in process at December 31, 2002, to be applied to all construction costs incurred during 2002 on each project. The resulting calculation of $4.6 million was treated as a reduction in the affiliate receivable balance from BCM.
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 were made during 2002 to reduce the affiliate balance. Each of these transactions were approved by TCI's Board of Directors.
Affiliate receivable with BCM, ARI and Regis Hotel Corporation are included within Other Assets, and the affiliate payable to IORI is included within Other Liabilities in the accompanying consolidated balance sheet. The following table reconciles the beginning and ending balances of affiliate receivables (payables) as of December 31, 2002:
In addition, Other Assets includes $1.7 million due from Regis Property Management, a related party.
Returns on Metra Properties. As described in Note 5, TCI sold residential properties during 2002 to partnerships controlled by Metra. The partnership agreement for each of these partnerships states that the Metra Partners, as defined, receive cash flow distributions at least quarterly in an amount sufficient to provide them with a 15 percent cumulative compounded annual rate of return on their invested capital, as well as a cumulative annual amount of 0.50% of the average outstanding balance of the mortgage indebtedness secured by any of these residential properties. These distributions to the Metra Partners have priority over distributions to any of the other partners.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 8. 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.
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% 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, 2002, 30,000 shares of Series C Preferred Stock were issued and outstanding.
NOTE 9. DIVIDENDS
TCI paid dividends on its Common Stock of $4.7 million ($.54 per share) in 2000. TCI reported to the Internal Revenue Service that 100% of the dividends paid in 2000 represented ordinary income.
In December 2000, the Board of Directors determined not to pay a fourth quarter dividend to holders of TCI's Common Stock. The non-payment decision was based on the Board determining that TCI needed to retain cash for acquisitions that were anticipated in 2001 and 2002. No dividends were paid in 2002 or 2001.
NOTE 10. 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, 2002, 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, 2001, 2002 and 2003, each Independent Director was granted an option to purchase 5,000 Common shares. The exercise price was $16.05 and $8.875 per Common shares for 2002 and 2001, respectively. Each Independent Director will be awarded an option to purchase an additional 5,000 shares on January 1 of each year.
TRANSCONTINENTAL REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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:
The weighted average fair value per share of options granted in 2002 and 2001 was $10.51 and $7.60, respectively.
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, 2002:
NOTE 12. ADVISORY AGREEMENT
Basic Capital Management, Inc. ("BCM"), an affiliate, has served as advisor to TCI since March 28, 1989. BCM is indirectly owned by a trust for the children of Gene E. Phillips. Mr. Phillips is not an officer or director of BCM, but serves as a representative of the trust, is involved in daily consultation with the officers of BCM and has significant influence over the conduct of BCM's business, including the rendering of advisory services and the making of investment decisions for itself and for TCI.
Under the Advisory Agreement, BCM 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. BCM 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 BCM by the Board.
TRANSCONTINENTAL REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 BCM shall be deemed to be in a fiduciary relationship to the stockholders and contains a broad standard governing BCM's liability for losses incurred by TCI.
The Advisory Agreement provides for BCM 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 BCM to receive an annual incentive sales fee. BCM or an affiliate of BCM is to receive an acquisition commission for supervising the purchase or long-term lease of real estate. BCM or an affiliate of BCM is to receive a mortgage or mortgage loan. BCM or an affiliate of BCM is also to receive a mortgage brokerage and equity refinancing fee for obtaining loans to or refinancing of TCI's properties. In addition, BCM receives reimbursement of certain expenses incurred by it in the performance of advisory services for TCI.
The Advisory Agreement requires BCM or any affiliate of BCM 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 2002, BCM was required to refund to TCI $1.4 million of BCM's advisory fee. BCM was not required to refund any of its 2000 or 2001 advisory fee.
Additionally, if management were to request that BCM render services other than those required by the Advisory Agreement, BCM or an affiliate of BCM would be separately compensated for such additional services on terms to be agreed upon from time to time. As discussed in NOTE 12. "PROPERTY MANAGEMENT," Triad Realty Services, Ltd. ("Triad"), an affiliate of BCM, provides property management services and as discussed in NOTE 13. "REAL ESTATE BROKERAGE," Regis Realty, Inc. ("Regis"), a related party, provided, on a non-exclusive basis, brokerage services until December 2002. Since January 1, 2003, Regis Realty I, LLC, a related party, provided brokerage services.
NOTE 13. PROPERTY MANAGEMENT
Triad provides property management services for a fee of 5% or less of the monthly gross rents collected on residential properties and 3% 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 subcontracted to Regis, a related party, which is a company owned by Highland, the property-level management and leasing of 45 of TCI's commercial properties, and its five hotels until December 2002. Since January 1, 2003, Regis Realty I, LLC, provided property management services. Regis was and Regis Realty I, LLC 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.
During 2002, Regis provided construction management services for TCI's properties under construction. Regis charged fees of 6% of certain construction costs. Those fees totaled $4.7 million.
TRANSCONTINENTAL REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 14. REAL ESTATE BROKERAGE
Regis also provided brokerage services on a non-exclusive basis until December 2002. Regis was and Regis Realty I, LLC 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 and its affiliates:
Costs incurred by BCM related to TCI, ARI and IORI are allocated based on the relative book values of each company's assets.
Fees paid to Regis, a related party:
NOTE 16. INCOME TAXES
During the third quarter of 2000, due to a concentration of ownership, TCI no longer met the requirements for tax treatment as a Real Estate Investment Trust ("REIT"), as defined in Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the "Code"), under the Code, and is prohibited for re-qualifying for REIT tax status for at least five years.
TCI had a loss for federal income tax purposes (after utilization of operating loss carryforwards) in 2002, 2001 and 2000; therefore, it 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
TRANSCONTINENTAL REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
for gains and losses on property sales, the difference in the allowance for estimated losses, depreciation on owned properties and investments in equity method real estate entities. At December 31, 2002, TCI's tax basis in its net real estate assets exceeded their basis for financial statement purposes by $46.9 million. As a result, aggregate future income for tax purposes will be less than such amount for financial statement purposes. Additionally, TCI had tax net operating loss carryforwards at December 31, 2002, of approximately $42.5 million expiring through the year 2018. The use of such loss carryforwards are subject to certain limitations under the Internal Revenue Code.
At December 31, 2002, TCI had a net deferred tax asset of $28.4 million due to tax deductions available to it in future years. However, as management cannot determine that it is more likely than not that TCI will realize the benefit of the deferred tax asset, a 100% valuation has been established.
NOTE 17. 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, equity in partnerships, and equity gains on sale of real estate totaling $4.5 million, $2.3 million and $6.4 million for 2002, 2001 and 2000, 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 $26.4 million, $24.4 million and $14.6 million for 2002, 2001 and 2000, respectively. Excluded from operating segment assets are assets of $100.3 million at December 31, 2002, and $86.5 million at December 31, 2001, 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."
TRANSCONTINENTAL REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Presented below is the operating income of each operating segment and each segments' assets for the years 2002, 2001 and 2000.
TRANSCONTINENTAL REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 18. 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 2002, 2001 and 2000, income (loss) from discontinued operations relates to 18 properties that TCI sold during 2002. The following table summarizes revenue and expense information for these properties sold.
TRANSCONTINENTAL REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 19. QUARTERLY RESULTS OF OPERATIONS
The following is a tabulation of TCI's quarterly results of operations for the years 2002, 2001 and 2000 (unaudited):
In the first quarter of 2002, gains on sale of real estate totaling $5.4 million were recognized on the sale of the Primrose Apartments, Central Storage Industrial Warehouse, a deferred gain on the sale of Madison at Bear Creek Apartments, and TCI's share of gains recognized by ARI and IORI, equity investees. In the second quarter of 2002, gains on sale of real estate totaling $7.3 million were recognized on the sale of Southgreen Apartments, Jefferson Office Building, NASA Office Building, Windsor Plaza Office Building, a deferred gain on the sale of McCallum Glen Apartments, and TCI's share of gains recognized by ARI. In the third quarter of 2002, gains on sale of real estate totaling $13.7 million were recognized on the sale of 4242 Cedar Springs, Camelot, Country Crossing, Gladstell Forest, and Heritage on the River Apartments, Savings of America Office Building, and TCI's share of gains recognized by ARI. In the fourth quarter of 2002, gains on sale of real estate totaling $14.9 million were recognized on Grove Park and Trails of Windfern Apartments, Plaza Tower Office Building, Chelsea Square Shopping Center, and TCI's share of gains recognized by ARI.
TRANSCONTINENTAL REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In the first quarter of 2001, gains on sale of real estate totaling $6.5 million were recognized on the sale of Heritage Apartments, Forest Ridge Apartments, Park at Colonade Apartments, the Zodiac Warehouse, a portion of the McKinney 36 land parcel, a portion of the Round Mountain land parcel, and TCI's share of gains recognized by ARI, an equity investee. In the second quarter of 2001, gains on sale of real estate totaling $22.3 million were recognized on the sale of Glenwood Apartments, Fontenelle Hills Apartments, Bent Tree Gardens Apartments, McCallum Glen Apartments, Moss Creek lots land parcel, Waterstreet Office Building, Technology Trading Center, Daley Office Building, and TCI's share of gains recognized by ARI. In the third quarter of 2001, gains on sale of real estate totaling $18.8 million were recognized on the sale of Park Lane Apartments, McCallum Crossing Apartments, Carseka Apartments, Sunset Lakes Apartments, Oak Run Apartments, a portion of the Eagle Crest land parcel, Chesapeake Office Building, and TCI's share of gains recognized by ARI. In the fourth quarter of 2001, gains on sale of real estate totaling $6.7 million were recognized on the sale of South Cochran Apartments, Madison at Bear Creek Apartments, Summerstone Apartments, Valley Rim Office Building, a previously deferred gain on the sale of Town and Country Shopping Center, and TCI's share of gains recognized by ARI. See NOTE 2. "REAL ESTATE" and NOTE 5. "INVESTMENT IN EQUITY METHOD REAL ESTATE ENTITIES."
TRANSCONTINENTAL REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In the first quarter of 2000, gains on sale of real estate totaling $9.0 million were recognized on the sale of Hunters Bend Apartments, Westgate of Laurel Apartments and a previous deferred gain on the sale of McKinney land. In the second quarter of 2000, gains on sale of real estate totaling $8.9 million were recognized on the sale of Apple Creek Apartments, Villas at Fairpark Apartments, Chateau Charles Hotel, and TCI's share of gain recognized by IORI, an equity investee. In the third quarter of 2000, gains on sale of real estate totaling $11.8 million were recognized on the sale of Brookfield Corporate Center, Ashley Crest Apartments, a portion of the Allen land, Eagle Rock Apartments, Shady Trail Warehouse, McKinney land, Woodbridge Apartments and Villas at Countryside Apartments. In the fourth quarter of 2000, gains on sale of real estate totaling $21.0 million were recognized on the sale of Shadow Run Apartments, a portion of the Watters Road/Highway 121 land, Parkwood Knoll Apartments, Villa Piedra Apartments, Country Bend Apartments, Fountain Village Apartments and Crescent Place Apartments. See NOTE 2. "REAL ESTATE" and NOTE 5. "INVESTMENT IN EQUITY METHOD REAL ESTATE ENTITIES."
NOTE 20. 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 into in order to effectively fix the rate on TCI's debt associated with the Limestone Canyon property. The swap agreement expires 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.
TRANSCONTINENTAL REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The fair value of the swap agreement at December 31, 2002 represents a liability to the Company of $624,000 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 at December 31, 2002, was increased by $895,000 representing both amounts paid to the bank under the agreement and increases in the fair value of the related liability.
NOTE 21. 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").
On January 27, 1997, the parties entered into an Amendment to the Modification effective January 9, 1997 (the "First Amendment"). The First Amendment provided for the settlement of additional matters raised by plaintiffs' counsel in 1996. The Court issued an order approving the First Amendment on July 3, 1997.
The First Amendment provided that TCI's Board retain a management/compensation consultant or consultants to evaluate the fairness of the BCM advisory contract and any contract of its affiliates with TCI, CMET and IORI, including, but not limited to, the fairness to TCI, CMET and IORI of such contracts relative to other means of administration. In 1998, the Board engaged a management/compensation consultant to perform the evaluation which was completed in September 1998.
In 1999, plaintiffs' counsel asserted that the Board did not comply with the provision requiring such engagement and requested that the Court exercise its retained jurisdiction to determine whether there was a breach of this provision of the First Amendment. In January 2000, the Board engaged another management compensation consultant to perform the required evaluation again. The evaluation was completed in April 2000 and was provided to plaintiffs' counsel. The Board believes that any alleged breach of the First Amendment has been fully remedied by the Board's engagement of this second consultant. Although several status conferences on this matter were held, there has been no court order resolving whether there was any breach of the First Amendment.
In June 2000, plaintiffs' counsel asserted that loans made by TCI to BCM and American Realty Trust, Inc. breached the provision of the Modification. The Board believes that the provisions of the Settlement, Modification and the First Amendment terminated on April 28, 1999. However, the Court has ruled that certain provisions continue to be effective after the termination date. This ruling was appealed by TCI and IORI.
On October 23, 2001, TCI, Income Opportunity Realty Investors, Inc. ("IORI") and American Realty Investors, Inc. ("ARI") jointly announced a preliminary agreement with the plaintiff's legal counsel 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 has been 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. Under the merger, ARI would pay $17.50 cash per TCI share and $19.00 cash per IORI share for the stock held by non-affiliated stockholders. ARI would issue one share of Series G Preferred Stock with a liquidation value of $20.00 per share for each share of TCI Common
TRANSCONTINENTAL REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Stock for stockholders who affirmatively elect to receive ARI preferred stock in lieu of cash. ARI would issue one share of Series H Preferred Stock with a liquidation value of $21.50 per share for each share of IORI Common Stock for stockholders who affirmatively elect to receive ARI preferred stock in lieu of cash. Each share of Series G Preferred Stock would be convertible into 2.5 shares of ARI Common Stock during a 75-day period that commences fifteen days after the date of the first ARI Form 10-Q filing that occurs after the closing of the merger transaction. Upon the acquisition of IORI and TCI shares, TCI and IORI would become wholly-owned subsidiaries of ARI. The transaction was subject to the negotiation of a definitive merger agreement and a vote of the shareholders of all three entities. TCI has the same board as IORI and the same advisor as IORI and ARI. Two of the directors of TCI and IORI also serve as directors for ARI.
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 made to cure a default under the settlement resulting from ARI's failure to timely complete the SEC review process of the registration statement for the proposed mergers with TCI and IORI. 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 fulfills the obligations under the Second Amendment and the Olive Litigation has been dismissed with prejudice. ARI has deferred further action on the mergers.
Partnership Buyouts. TCI is the limited partner in ten partnerships formed to construct 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 nonaffiliated partners, and are set forth in the respective partnership agreements. The total amount of the expected buyouts as of December 31, 2002 is approximately $5.9 million.
Liquidity. Although management anticipates that TCI will generate excess cash from operations in 2003, due to increased rental rates at its properties, such excess, however, will not be sufficient to discharge all of TCI's debt obligations as they mature. Management intends to selectively sell income producing real estate, refinance real estate and incur additional borrowings against real estate to meet its cash requirements.
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.
TCI is currently in default on its loans secured by the three hotels in Chicago. The loans, in the total principal amount of $9.6 million, matured at the end of February 2003 and have been in default since August 2002 due to the hotels not achieving the necessary debt service coverage ratios. Because of the default, the lender began charging default interest at the rate of 12% per annum. TCI has not paid the default interest since September 2002 and is attempting to obtain an extension on the debt.
TCI is currently in default on a $1.0 million loan secured by interests in the partnership which owns the Tivoli Apartments in Dallas, Texas. TCI attempted to negotiate an extension for this loan maturing in December 2002. In January 2003, the lender commenced a lawsuit against TCI to collect the amount.
TCI is currently in default on a $5.3 million loan secured by the Majestic Hotel in San Francisco, California. TCI ceased making monthly payments of principal and interest in May 2002 and attempted to restructure the debt.
TRANSCONTINENTAL REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 is the subject of litigation pending in the United States District Court for the Eastern District of Louisiana.
NOTE 22. SUBSEQUENT EVENTS
In 2003, TCI purchased the following property:
- -------- (1) Property received from a related party for forgiveness of debt.
In 2003, TCI refinanced or financed the following properties:
- -------- (1) Variable rate.
SCHEDULE III
TRANSCONTINENTAL REALTY INVESTORS, INC.
REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 2002
SCHEDULE III (Continued)
TRANSCONTINENTAL REALTY INVESTORS, INC.
REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 2002
SCHEDULE III (Continued)
TRANSCONTINENTAL REALTY INVESTORS, INC.
REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 2002
SCHEDULE III (Continued)
TRANSCONTINENTAL REALTY INVESTORS, INC.
REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 2002
SCHEDULE III (Continued)
TRANSCONTINENTAL REALTY INVESTORS, INC.
REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 2002
SCHEDULE III (Continued)
TRANSCONTINENTAL REALTY INVESTORS, INC.
REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 2002
- -------- (1) The aggregate cost for federal income tax purposes is $863.6 million. (2) Purchase accounting basis adjustment. (3) Writedown of property to estimated net realizable value. (4) Construction period interest and taxes. (5) Forgiveness of debt and cash received deducted from the basis of the property, offset by land acquired in 1992. (6) Cash received for easement deducted from the basis of the property. (7) The Sandison land is collateralized with the Solco Allen and Whisenant land. All of the land in McKinney and Collin County, Texas is cross-collateralized and cross defaulted. (8) Cash received for condemnation of part of property. (9) Sale of portion of property. (10) The Countryside Retail Center is collateralized with the Mimado Building.
SCHEDULE III (Continued)
TRANSCONTINENTAL REALTY INVESTORS, INC.
REAL ESTATE AND ACCUMULATED DEPRECIATION
SCHEDULE IV
TRANSCONTINENTAL REALTY INVESTORS, INC.
MORTGAGE LOANS ON REAL ESTATE December 31, 2002
SCHEDULE IV (Continued)
TRANSCONTINENTAL REALTY INVESTORS, INC.
MORTGAGE LOANS ON REAL ESTATE December 31, 2002
- -------- (1) The aggregate cost for federal income tax purposes is $16.1 million.
TRANSCONTINENTAL REALTY INVESTORS, INC.
MORTGAGE LOANS ON REAL ESTATE
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
-----------------
PART III
ITEM 10.
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.
The Directors of TCI are listed below, together with their ages, terms of service, all positions and offices with TCI or its advisor, Basic Capital Management, Inc. ("BCM"), their principal occupations, business experience and directorships with other companies during the last five 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 or an officer 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, 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 69, Director (Independent) (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 Income Opportunity Realty Investors, Inc. ("IORI").
HENRY BUTLER: Age 52, Director (Affiliated) (since December 2001).
Broker--Land Sales (since 1992) of Basic Capital Management, Inc. ("BCM"); Owner/Operator (1989 to 1991) of Butler Interests, Inc.; and Director (since December 2001) of IORI.
EARL D. CECIL: Age 73, Director (Independent) (since March 2002).
Financial and business consultant (since January 1994); Division Vice President (February 1987 to December 1993) of James Mitchell & Company, a financial services marketing organization; Director (since November 2001) of ARI; and Director (since March 2002) of IORI.
MARTIN L. WHITE: Age 63, 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.; and Director (since January 1995) of IORI.
Board Committees
The Board of Directors held 18 meetings during 2002. For such year, no incumbent Director attended fewer than 75% 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 an Audit Committee, the function of which is to review TCI's operating and accounting procedures. The current members of the Audit Committee, all of whom are Independent Directors, are Messrs. Cecil, Stokely and White. The Audit Committee met four times during 2002.
The Board of Directors does not have Nominating or Compensation Committees.
Executive Officers
The following persons currently serve as executive officers of TCI: Mark Branigan, Executive Vice President--Residential; Louis J. Corna Executive Vice President--Tax; and Ronald E. Kimbrough, Executive Vice President and Chief Financial Officer. Their positions with TCI are not subject to a vote of stockholders. Their ages, terms of service, all positions and offices with TCI or BCM, other principal occupations, business experience and directorships with other companies during the last five years or more are set forth below.
MARK W. BRANIGAN: Age 48, Executive Vice President--Residential (since June 2001), Executive Vice President and Chief Financial Officer (August 2000 to June 2001), Vice President--Director of Construction (August 1999 to August 2000) and Executive Vice President--Residential Asset Management (January 1992 to October 1997).
Executive Vice President--Residential (since June 2001), Executive Vice President and Chief Financial Officer (August 2000 to June 2001), Vice President--Director of Construction (August 1999 to August 2000) and Executive Vice President--Residential Management (January 1992 to October 1997) of BCM, American Realty Trust, Inc. ("ART") and IORI; Executive Vice President and Chief Financial Officer (August 2000 to June 2001) and Director (September 2000 to June 2001) of ARI; and real estate consultant (November 1997 to July 1999).
LOUIS J. CORNA: Age 55, Executive Vice President--Tax (since October 2001), Executive Vice President and Chief Financial Officer (June 2001 to October 2001), and Senior Vice President--Tax (December 2001 to June 2001).
Executive Vice President--Tax (since October 2001), Executive Vice President and Chief Financial Officer (June 2001 to October 2001), and Senior Vice President--Tax (December 2000 to June 2001) of BCM, ARI and IORI; Private Attorney (January 2000 to December 2000); Vice President--Taxes and Assistant Treasurer (March 1998 to January 2000) of IMC Global, Inc.; and Vice President--Taxes (July 1991 to February 1998) of Whitman Corporation.
RONALD E. KIMBROUGH: Age 50, Acting Principal Executive Officer, Executive Vice President and Chief Financial Officer (since January 2002).
Acting Principal Executive Officer, Executive Vice President and Chief Financial Officer (since January 2002) of BCM, ARI and IORI; Controller (from September 2000 to January 2002) of BCM; Vice President and Treasurer (from January 1998 to September 2000) of Syntek West, Inc. and One Realco Corporation; and Consultant (1997).
Officers
Although not an executive officer, Robert A. Waldman currently serves as Senior Vice President, Secretary and General Counsel. His position with TCI is not subject to a vote of stockholders. His age, term of service, all positions and offices with TCI or BCM, other principal occupations, business experience and directorships with other companies during the last five years or more is set forth below.
ROBERT A. WALDMAN: Age 50, Senior Vice President and General Counsel (since January 1995), Vice President (December 1990 to January 1995) and Secretary (December 1993 to February 1997 and since June 1999).
Senior Vice President and General Counsel (since January 1995), Vice President (December 1990 to January 1995) and Secretary (December 1993 to February 1997 and since June 1999) of IORI; Senior Vice President, Secretary and General Counsel (since August 2000) of ARI; Senior Vice President and General Counsel (since January 1995), Vice President (January 1993 to January 1995) and Secretary (since December 1989) of ART; and Senior Vice President and General Counsel (since November 1994), Vice President and Corporate Counsel (November 1989 to November 1994), and Secretary (since November 1989) of BCM.
In addition to the foregoing officers, TCI has several vice presidents and assistant secretaries who are not listed herein.
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 2002. All of these filing requirements were satisfied by TCI's Directors and 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 that they have filed with the Commission.
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 BCM under the supervision of the Board. The duties of BCM 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. BCM also serves as a consultant to the Board in connection with the business plan and investment decisions made by the Board.
BCM has served as TCI's advisor since March 1989. BCM is a company of which Messrs. Branigan, Corna, and Kimbrough serve as executive officers. BCM is indirectly owned by a trust for the children of Gene E. Phillips. Mr. Phillips is not an officer or director of BCM, but serves as a representative of the trust, is involved in daily consultation with the officers of BCM and has significant influence over the conduct of BCM's business, including the rendering of advisory services and the making of investment decisions for itself and for TCI.
Under the Advisory Agreement, BCM 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 BCM 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 BCM 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 BCM shall be deemed to be in a fiduciary relationship to the stockholders; contains a broad standard governing BCM's liability for losses by TCI; and contains guidelines for BCM's allocation of investment opportunities as among itself, TCI and other entities it advises.
The Advisory Agreement provides for BCM 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 BCM to receive an annual incentive sales fee equal to 10% 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% 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% higher in the current fiscal year than in the prior fiscal year.
Additionally, pursuant to the Advisory Agreement BCM or an affiliate of BCM 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% of the cost of acquisition, inclusive of commissions, if any, paid to nonaffiliated 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.
The Advisory Agreement requires BCM or any affiliate of BCM 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 BCM or any affiliate of BCM shall not exceed the lesser of (1) 2% 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 BCM or an affiliate of BCM 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% 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, BCM or an affiliate of BCM 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% 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 BCM or an affiliate of BCM without the approval of TCI's Board of Directors. No fee shall be paid on loan extensions.
Under the Advisory Agreement, BCM 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 was required to refund $1.4 million of the 2002 advisory fee under this provision.
Additionally, if management were to request that BCM render services to TCI other than those required by the Advisory Agreement, BCM or an affiliate of BCM 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.
BCM may assign the Advisory Agreement only with the prior consent of TCI.
The directors and principal officers of BCM are set forth below.
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 BCM and, in such capacity, has substantial contact with the management of BCM 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 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"), a related party. Triad subcontracted the property-level management and leasing of 45 of TCI's commercial properties to Regis Realty, Inc. ("Regis"), a related party, which was a company owned by Highland, until December 2002. Regis was entitled to receive property and construction management fees and leasing commissions in accordance with the terms of its property-level management agreement with Triad, until December 2002. Regis also was entitled to receive real estate brokerage commissions in accordance with the terms of a non-exclusive brokerage agreement. Since January 1, 2003, Regis Realty I, LLC ("Regis I"), provided these services. Regis I is owned by Highland. Regis Hotel Corporation, a related party, managed TCI's five hotels, until December 2002. Since January 1, 2003, Regis Hotel I, LLC, managed TCI's five hotels. The sole member of Regis I and Regis Hotel I, LLC is Highland.
Real Estate Brokerage
Regis also provided real estate brokerage services to TCI (on a non-exclusive basis), until December 2002. Regis was 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% would be paid to Regis or affiliates; (2) maximum fee of 3.5% on transaction amounts between $2.0 million-$5.0 million of which no more than 3% would be paid to Regis or
affiliates; (3) maximum fee of 2.5% on transaction amounts between $5.0 million-$10.0 million of which no more than 2% would be paid to Regis or affiliates; and (4) maximum fee of 2% on transaction amounts in excess of $10.0 million of which no more than 1.5% would be paid to Regis or affiliates. Beginning January 1, 2003, Regis I provides these services. The sole member of Regis I is Highland.
ITEM 11.
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 BCM, TCI's advisor, are compensated by BCM. Such executive officers perform a variety of services for BCM and the amount of their compensation is determined solely by BCM. BCM 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 BCM.
The only remuneration paid by TCI is to the Directors who are not officers or directors of BCM 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 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 2002, $91,113 was paid to the Independent Directors in total Directors' fees for all services, including the annual fee for service during the period January 1, 2002 through December 31, 2002, and 2002 special service fees as follows: Earl D. Cecil, $25,113; Ted P. Stokely, $34,000; and Martin L. White, $32,000.
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 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 will receive 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, 2003, TCI had 110,000 shares of Common Stock reserved for issuance under the Director's Stock Option Plan of which 15,000 options were outstanding.
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, 1997, 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 [CHART]
TCI DJ Total Market Index DJ Real Estate Index 1997 $100.00 $100.00 $100.00 1998 83.00 124.90 78.88 1999 85.88 153.28 74.69 2000 63.28 139.07 95.24 2001 114.44 122.50 106.49 2002 125.77 95.45 110.35
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
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% of the outstanding shares of Common Stock as of the close of business on March 19, 2003, after completion of the tender offer.
- -------- (1) Percentage is based upon 8,072,594 shares of Common Stock outstanding at March 19, 2003. (2) EQK Holdings, Inc. ("EQK") is a wholly-owned subsidiary of ART, which is a wholly-owned subsidiary of ARI. (3) Transcontinental Realty Acquisition Corporation ("TRAC") is a wholly-owned subsidiary of ARI.
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 19, 2003.
- -------- * Less than 1% (1) Percentage is based upon 8,072,594 shares of Common Stock outstanding at March 19, 2003 and 15,000 shares which may be issued under existing Director Stock Options. (2) Includes 26,475 shares owned by Syntek Asset Management, L.P., 1,166,947 shares owned by BCM. Each of the executive officers of TCI may be deemed to be beneficial owners of such shares by virtue of their positions as executive officers of TCI disclaim such beneficial ownership.
(3) Includes 5,206,067 shares owned by EQK and 1,213,226 shares owned by TRAC. Each of the executive officers of ARI may be deemed to be beneficial owners of such shares by virtue of their positions as executive officers of BCM. The executive officers of TCI disclaim such beneficial ownership. (4) Includes 5,206,067 shares owned by EQK and 1,213,226 shares owned by TRAC. Messrs. Cecil and Stokely may be deemed to be beneficial owners of such shares by virtue of their positions as directors of ARI. Messrs. Cecil and Stokely disclaim such beneficial ownership. (5) Includes 5,000 shares which may be acquired by Mr. Cecil pursuant to the Director Stock Option Plan. (6) Includes 5,000 shares which may be acquired by Mr. Stokely pursuant to the Director Stock Option Plan. (7) Includes 5,000 shares which may be acquired by Mr. White pursuant to the Director Stock Option Plan.
ITEM 13.
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." BCM is indirectly owned by a trust for the children of Gene E. Phillips. Mr. Phillips is not an officer or director of BCM, but serves as a representative of the trust, is involved in daily consultation with the officers of BCM and has significant influence over the conduct of BCM'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. The general partner of Triad is BCM. The limited partner of Triad is Highland, a related party. Triad subcontracted the property-level management and leasing of 45 of TCI's commercial properties, and its five hotels to Regis, a related party, which is a company owned by Highland, until December 2002. Since January 1, 2003, Regis I provided this service.
Regis also provided real estate brokerage services for TCI, on a non-exclusive basis, and receives brokerage commissions in accordance with the brokerage agreement, until December 2002. Since January 1, 2003, Regis I provided this service.
The Directors and officers of TCI also serve as directors and officers of IORI. The Directors owe fiduciary duties to IORI as well as to TCI under applicable law. IORI has the same relationship with BCM as TCI. At December 31, 2002, TCI owned approximately 24.0% of the outstanding common shares of IORI. BCM also serves as advisor to ARI. Messrs. Cecil and Stokely serve also as Directors of ARI. Messrs. Branigan, Corna, and Kimbrough serve as executive officers of ARI.
Related Party Transactions
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.
Operating Relationships
In the year ended December 31, 2002, TCI received $68,000 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.
Property Transactions
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 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. See NOTE 2. "REAL ESTATE."
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. See NOTE 2. "REAL ESTATE." 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.
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. See NOTE 2. "REAL ESTATE." 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. 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. The business purpose of the transaction was for TCI to develop apartments on these four tracts of land.
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 on the Red Cross land, requires quarterly payments and was due in October 2002. See NOTE 6. "NOTES AND INTEREST PAYABLE."
In December 2002, TCI purchased the NLP/CH, Ltd. partnership, which owns the Centura land parcel, from ARI. See NOTE 2. "REAL ESTATE." The purchase price was determined based on an appraised rate of $34.89 per share foot. The business purpose of the transaction was for TCI to construct apartments on the land.
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, 2002, the market value of the IORI common shares was $6.5 million.
At December 31, 2002, 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. BCM also serves as advisor to ARI and at March 19, 2003, ARI owned approximately 64.5% of
TCI's outstanding Common Stock. At December 31, 2002, the market value of the ARI common shares owned by TCI was $6.0 million.
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, requires all principal and interest due and payable on April 28, 2003. See NOTE 22. "SUBSEQUENT EVENTS."
In 2002, TCI paid BCM, its affiliates and related parties $5.9 million in advisory, incentive and net income fees, $753,000 in mortgage brokerage and equity refinancing fees, $58,000 in property acquisition fees, $3.0 million in real estate brokerage commissions and $8.2 million in property and construction management fees and leasing commissions, net of property management fees paid to subcontractors, other than affiliates of BCM. In addition, as provided in the Advisory Agreement, BCM received cost reimbursements of $2.0 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, 2002, TCI had receivables of $6.6 million, $1.8 million and $6.0 million from BCM, GS Realty, and ARI, respectively. Also at December 31, 2002, TCI owed $649,000, $374,000 and $5.3 million to GS Realty, BCM and IORI, respectively. In January 2003, TCI paid the $649,000 due to GS Realty and in March 2003, TCI paid the $374,000 to BCM.
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 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.
ITEM 14. CONTROLS AND PROCEDURES
(a) Within the 90 days prior to the date of this report, TCI carried out an evaluation, under the supervision and with the participation of TCI's management, including TCI's Acting Principal Executive Officer and Principal Accounting Officer, of the effectiveness of the design and operation of TCI's disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon the evaluation, TCI's Acting Principal Executive Officer and Principal Accounting Officer concluded that TCI's disclosure controls and procedures are effective in timely alerting him to material information relating to TCI (including its consolidated subsidiaries) required to be included in TCI's periodic SEC filings.
(b) There have been no significant changes in TCI's internal controls or in other factors that could significantly affect TCI's internal controls subsequent to the date TCI carried out this evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Report:
1. Consolidated Financial Statements
Report of Independent Certified Public Accountants
Consolidated Balance Sheets--December 31, 2002 and 2001
Consolidated Statements of Operations--Years Ended December 31, 2002, 2001 and 2000
Consolidated Statements of Stockholders' Equity--Years Ended December 31, 2002, 2001 and 2000
Consolidated Statements of Cash Flows--Years Ended December 31, 2002, 2001 and 2000
Notes to Consolidated Financial Statements
2. 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 applicable or because the required information is shown in the Consolidated Financial Statements or the Notes thereto.
3. Incorporated Financial Statements
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, 2002).
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, 2002).
4. Exhibits
The following documents are filed as Exhibits to this Report:
(b) Reports on Form 8-K:
None.
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.
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.
Signature Title Date --------- ----- ----
/s/ TED P. STOKELY Chairman of the Board and March 31, 2003 - ----------------------------- Director Ted P. Stokely
/s/ HENRY A. BUTLER Director March 31, 2003 - ----------------------------- Henry A. Butler
/s/ EARL D. CECIL Director March 31, 2003 - ----------------------------- Earl D. Cecil
/s/ MARTIN L. WHITE Director March 31, 2003 - ----------------------------- Martin L. White
/s/ RONALD E. KIMBROUGH Executive Vice President and March 31, 2003 - ----------------------------- Chief Financial Officer Ronald E. Kimbrough (Principal Financial and Accounting Officer and Acting Principal Executive Officer)
CERTIFICATION
I, Ronald E. Kimbrough, Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer and Acting Principal Executive Officer) of Transcontinental Realty Investors, Inc. ("TCI"), certify that:
1. I have reviewed this quarterly report on Form 10-K of TCI;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. I am responsible for establishing and maintaining internal controls and procedures and have:
a. designed such internal controls to insure that material information relating to TCI and its consolidated subsidiaries is made known to me by others within those entities, particularly for the periods presented in this quarterly report;
b. evaluated the effectiveness of TCI's internal controls as of a date within 90 days prior to the filing date of this quarterly report; and
c. presented in this quarterly report my conclusions about the effectiveness of the disclosure controls and procedures based on a date within 90 days prior to the filing date of this quarterly report;
5. I have disclosed to TCI's auditors and Audit Committee of the Board of Directors (or persons fulfilling the equivalent function):
a. all significant deficiencies in the design or operation of internal controls which could adversely affect TCI's ability to record, process, summarize, and report financial data and have identified for TCI's auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or other employees who have a significant role in TCI's internal controls; and
6. I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of my most recent evaluation, including corrective actions with regard to significant deficiencies and material weaknesses.
ANNUAL REPORT ON FORM 10-K
EXHIBIT INDEX
For the Year Ended December 31, 2002