ITEM 1. BUSINESS
We are a real estate homebuilder and investor with over 30 years of experience in the real estate industry. During 2004, we delivered 818 homes with an average price of $259,000 per home and 126 single-family lots with an average price of $45,000 per lot. At December 31, 2004, we had 28 residential communities with 4,352 homes or home sites under development in four states and a backlog of signed contracts for 1,238 homes valued in excess of $340 million. As of December 31, 2004, we also had interests in 13,647 rental apartments units in 58 residential communities and 1.3 million square feet of office and retail space, located in 13 states, primarily in Florida, Connecticut, and Texas. For more detailed information about our rental and for-sale communities, please see ITEM 2.
ITEM 2. PROPERTIES
At December 31, 2004, our real estate portfolio had 85 properties, including 58 apartment communities, seven office buildings, ten retail properties, six tracts of land, and four rental apartment communities currently under development. Unconsolidated joint ventures owned 19 of the 85 properties. We also had 15 consolidated and six unconsolidated active for-sale communities and seven consolidated single-family home site developments. Tarragon, or the consolidated or unconsolidated subsidiaries, partnerships, or joint ventures that own the properties, generally have fee simple title to these properties, and most of them are pledged to secure mortgages. For a detailed listing of these mortgages, see the table below entitled “Mortgage Loans Secured by Owned Properties.” We believe our properties are adequately covered by liability and casualty insurance, consistent with industry standards.
The following tables summarize information about our rental apartment and for-sale communities. Tarragon’s ownership interest is presented for communities owned through unconsolidated joint ventures. Dollar amounts are in thousands.
Tarragon Corporation
Communities Summarized by Market
December 31, 2004
(1) Represents one rental community currently in lease-up and in the Homebuilding Division.
TARRAGON CORPORATION
RENTAL APARTMENT COMMUNITIES
DECEMBER 31, 2004
TARRAGON CORPORATION
RENTAL APARTMENT COMMUNITIES
DECEMBER 31, 2004
TARRAGON CORPORATION
RENTAL APARTMENT COMMUNITIES
DECEMBER 31, 2004
(1)
Average monthly rent is defined as total possible rent (actual rent for leased apartments and asking rent for vacant apartments) for the month of December divided by number of units.
(2)
For properties owned by unconsolidated joint ventures, this balance represents the net carrying value on the books of the joint venture.
(3)
These properties are owned by consolidated joint ventures in which we have a 70% ownership interest.
(4)
All of these properties were transferred to the Investment Division from the Homebuilding Division after January 1, 2003. Physical occupancy as of December 31, 2004, for apartment communities in lease up during 2003 or 2004 was as follows:
TARRAGON CORPORATION
PLANNED RENTAL APARTMENT COMMUNITIES
DECEMBER 31, 2004
Our development program includes the construction of the rental communities presented below. We expect to acquire the land in Ocala, Florida, for Deerwood in the first quarter of 2005. 1118 Adams will be an affordable apartment community, and we will utilize capital grants and loans from the New Jersey Housing Finance Agency to pay for 25% of the costs of this project. We plan to use a construction loan and the sale of Federal tax credits to finance the remaining costs of this project. We have a $14.3 million construction loan with a balance of $3.1 million as of December 31, 2004, to finance the construction of Cason Estates. We expect the first apartments in this property to be ready for occupancy in April 2005. We closed a $21.4 million construction loan in January 2005 to finance the construction of Newbury Village. We expect the first apartments in this property to be ready for occupancy in the fourth quarter of 2005. We plan to finance eighty-five percent of the cost of Deerwood with a construction loan. We will use internally generated funds to pay for the remainder of the costs of these properties.
TARRAGON CORPORATION
ACTIVE FOR-SALE COMMUNITIES
DECEMBER 31, 2004
(1)
Number of remaining homes or home sites includes both backlog (homes or home sites sold, not closed) and unsold homes under active development.
(2)
Costs to Complete represent estimated construction costs to complete the projects. In addition to these costs, we anticipate incurring marketing, advertising, selling commissions and closing costs, and interest on mezzanine debt.
(3)
Construction financing available represents funds available from construction loans. For the December 31, 2004, loan balances, please see the table below entitled “Mortgage Loans Secured by Owned Properties.”
(4)
We have a commitment from a bank for a $24.4 million construction loan to finance the development of this project.
(5)
This conversion project was purchased in January 2005 for $47 million.
(6)
In January 2005, we acquired our partners’ interests in these projects.
(7)
We have a $9 million revolving construction loan. As we complete buildings and close sales, we pay down the loan, which makes additional borrowings available.
(8)
We are in discussions with a bank to obtain a $10.9 million acquisition and development loan and a $10 million revolving construction loan to finance the development of this project.
(9)
We are in discussions with a bank to obtain a $24.1 million acquisition and development loan and a $15 million revolving construction loan to finance the development of this project.
(10)
We are in the process of developing our budgets for these projects.
Tarragon’s Development Program includes construction or renovation of the above for-sale communities. Costs to complete in excess of construction financing available will be paid for with internally generated funds.
TARRAGON CORPORATION
MORTGAGE LOANS SECURED BY OWNED PROPERTIES
DECEMBER 31, 2004
(Dollars in thousands)
TARRAGON CORPORATION
MORTGAGE LOANS SECURED BY OWNED PROPERTIES
DECEMBER 31, 2004
(Dollars in thousands)
TARRAGON CORPORATION
MORTGAGE LOANS SECURED BY OWNED PROPERTIES
DECEMBER 31, 2004
(Dollars in thousands)
TARRAGON CORPORATION
MORTGAGE LOANS SECURED BY OWNED PROPERTIES
DECEMBER 31, 2004
(Dollars in thousands)
TARRAGON CORPORATION
MORTGAGE LOANS SECURED BY OWNED PROPERTIES
DECEMBER 31, 2004
(Dollars in thousands)
(A)
Variable rate mortgage.
(B)
Variable rate mortgage subject to cap or ceiling.
(C)
Fixed rate mortgage.
(D)
For loans with variable interest rates, the rate in effect as of December 31, 2004, is presented.
(E)
Represents weighted average interest rate as of December 31, 2004, computed based upon the December 31, 2004, balances.
(F)
These mortgages are presented in Liabilities Related to Assets Held for Sale in the Consolidated Balance Sheet as of December 31, 2004, in ITEM 8. “FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.” This property was sold, and the mortgages paid off in January 2005.
(G)
Includes mortgages secured by eight commercial properties and three tracts of land.
(H)
Includes mortgages secured by one commercial property.
(I)
This is a mezzanine loan provided by Tarragon.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In April 2003, in connection with the condominium conversion of Pine Crest Village at Victoria Park, a contractor for Tarragon may have inadvertently disturbed asbestos-containing materials. Such actions are currently under investigation by the Environmental Protection Agency and may result in civil and/or criminal proceedings under applicable law. The extent of the resulting liability, if any, is unknown at this time. We have incurred legal and other professional fees and costs of relocation of residents in connection with this matter of $448,000 to date. Remediation has been completed at a cost of approximately $795,000.
Tarragon is also a party to various claims and routine litigation arising in the ordinary course of business. We do not believe that the results of these claims and litigation, individually or in the aggregate, will have a material adverse effect on our business, financial position, or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of the fiscal year covered by this report, no matter was submitted to a vote of security holders.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is listed on the NASDAQ National Market System under the symbol “TARR.” The following table sets forth the high and low bid quotations of our common stock reported by the NASDAQ system for the periods indicated. Over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down, or commissions, and may not necessarily represent actual transactions. The quotations have been restated to give effect to three-for-two stock splits effective February 14, 2003, and February 10, 2005, and a five-for-four stock split effective January 15, 2004.
According to the transfer agent’s records, at March 7, 2005, our common stock was held by approximately 4,803 holders, including beneficial holders. On March 14, 2005, the closing price of our common stock was $23.50.
No cash dividends were paid to common stockholders in 2004 and 2003. In 2000, the Board of Directors discontinued cash dividends on Tarragon’s common stock. In January 2003, the Board of Directors approved a three-for-two stock split effective February 14, 2003. In December 2003, the Board of Directors approved a five-for-four stock split effective January 15, 2004. In January 2005, the Board of Directors approved a three-for-two stock split effective February 10, 2005.
Securities Authorized for Issuance Under Equity Compensation Plans
We have three stock-based equity compensation plans that have been approved by our stockholders. See NOTE 8. “STOCK BASED AWARDS” for descriptions of the plans, the number of shares of common stock to be issued upon the exercise of outstanding stock options and stock appreciation rights, the weighted-average exercise price of outstanding stock options and stock appreciation rights, and the number of shares of common stock remaining for future issuance under the plans. We have no compensation plans which were adopted without the approval of our stockholders.
Sale of Unregistered Securities
On September 16, 2004, we completed the sale of $50 million principal amount of 8% Senior Convertible Notes Due 2009 (the “Notes”) to Lazard, Frères & Co., LLC (“Lazard”) as the Initial Purchaser under a Purchase Agreement dated September 9, 2004 (the “Purchase Agreement”). Lazard resold the Notes to persons reasonably believed to be “Qualified Institutional Buyers” (as defined in Rule 144A under the Securities Act of 1933, as amended the “Securities Act”). The amount of Notes sold included $10 million principal amount of Notes issued pursuant to an over-allotment option granted to the Initial Purchaser that was exercised. The Notes are general, senior, unsecured obligations of Tarragon, bear interest at the rate of 8% per annum and are convertible into Tarragon Common Stock at an initial conversion rate of 81.6993 shares per $1,000 in principal
amount of Notes (equal to a conversion price of $12.24 per share of Tarragon Common Stock on a post-split basis), subject to adjustment in certain instances. We sold the Notes to the Initial Purchaser at a 6% discount which resulted in net proceeds to Tarragon of $47 million.
On November 19, 2004, as a “follow on” offering to the original sale, we sold an additional $12 million of the Notes to Lazard as Initial Purchaser, who resold the Notes to persons reasonably believed to be Qualified Institutional Buyers. We sold the Notes to the Initial Purchaser at a 1.5% premium plus accrued interest. After the Initial Purchaser’s fee, net proceeds to Tarragon were $11.9 million.
If the full principal amount of Notes of $62 million were converted, shares of Tarragon Common Stock issued and outstanding would increase by 3,376,906 (5,065,359 as adjusted to give effect to the February 2005 three-for-two stock split), or approximately 22% of the shares of Common Stock of Tarragon issued and outstanding as of December 31, 2004 (adjusted for the three for two split effective at February 10, 2005).
Prior to September 16, 2007, the Notes are not redeemable. After that date until maturity, we have the right, but not the obligation, upon certain notice, to redeem the Notes (in whole or in part) for cash at a redemption price of $1,000 original amount of Note, plus accrued and unpaid interest if the closing price of Tarragon’s Common Stock equals or exceeds 150% of the then applicable conversion price for 20 out of 30 consecutive trading days. The Notes may also be subject to a “put option” by the Holders if a fundamental change occurs, as that term is defined in the Note Indenture. The Notes were sold pursuant to and in reliance upon Rule 144A. The Notes and the Common Stock issuable upon conversion of the Notes are now covered by Registration Statement No. 333-1211258 declared effective by the Commission on January 24, 2005. Tarragon will not receive any proceeds from the sale by the named selling security holders of the Notes or the shares of Common Stock issuable upon conversion of the Notes pursuant to such Registration Statement.
As of March 4, 2005, no shares of Common Stock had been issued upon conversion of the Notes and no presentation for such conversion had been made.
Purchases of Equity Securities
Tarragon’s Board of Directors authorized the repurchase of up to 1 million shares of its common stock under a share repurchase program implemented in September 2001. In March 2004, the Board of Directors authorized the repurchase of up to an additional 500,000 shares. The share repurchase program has no expiration date. Through December 31, 2004, we had repurchased 790,009 shares of our common stock pursuant to this repurchase program. The following table presents shares repurchased during the three months ended December 31, 2004.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Please read the following information along with the Consolidated Financial Statements and Notes and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Form 10-K. Dollar amounts are in thousands, except per share amounts.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Please read this discussion along with the Consolidated Financial Statements and Notes found at ITEM 8. “FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.” Dollar amounts in tables are in thousands.
Forward-Looking Statements
This Annual Report on Form 10-K contains forward-looking statements that are based on our current expectations, estimates, forecasts, and projections about the industries in which we operate, our beliefs, and assumptions that we have made based on our current knowledge. In addition, other written or oral statements that constitute forward-looking statements may be made by or on behalf of us. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” and/or variations of such words and similar expressions are intended to identify our forward-looking statements. These statements are not guarantees of future performance and involve many risks, uncertainties, and assumptions that are difficult to predict. Therefore, actual outcomes and results may be materially different from what is expressed or forecast in our forward-looking statements. Except as required under the federal securities laws and the rules and regulations of the SEC, we do not have any intention or obligation to update publicly any forward-looking statements, whether as a result of new information, future events, or otherwise.
The risks, uncertainties, and assumptions that are involved in our forward-looking statements include:
• general industry, economic, and market conditions particularly with regard to apartment property occupancy, rental growth rates, prevailing rental rates, and competition in the markets where our rental properties are concentrated;
• the effects of fluctuating interest rates, and the pricing and availability of mortgage financing;
• our substantial indebtedness and high leverage which could adversely affect our financial health and prevent us from fulfilling our debt service obligations;
• our ability to generate sufficient cash flow to meet our debt service obligations;
• an increase in competition for tenants and home purchasers or a decrease in demand by tenants and home purchasers;
• the adoption, on the national, state, or local level, of more restrictive laws and governmental regulations, including more restrictive zoning, land use, or environmental regulations and increased real estate taxes;
• opposition from local community or political groups with respect to development or construction at a particular site;
• construction delays or cost overruns, either of which may increase project development costs;
• our ability to obtain zoning, occupancy, and other required governmental permits and authorizations;
• our ability to sell our older, under-performing properties when necessary for cash flow purposes;
• our ability to identify and secure additional apartment properties and sites that meet our criteria for future acquisition or development; and
• all of the other risk factors discussed under the heading “Risks Related to Tarragon” in ITEM 1. “BUSINESS.”
These are representative of the risks, uncertainties, and assumptions that could cause actual outcomes and results to differ materially from what is expressed or forecast in forward-looking statements. In addition, such statements could be affected by local, national, and world economic conditions and political events, including the global economic slowdown and fluctuations in interest and currency exchange rates. For a further description of the risks, uncertainties, and assumptions that could cause actual results to differ materially from our forward-looking statements, see “Risk Related to Tarragon” in ITEM 1. “BUSINESS.”
Business Overview
General
We are a real estate homebuilder and investor with over 30 years of experience in the real estate industry. We operate two distinct businesses:
• the Homebuilding Division, which develops, renovates, builds, and markets homes in high-density, urban locations and in master-planned communities; and
• the Investment Division, which owns, develops, and operates residential and commercial rental properties, including almost 5,000 rental apartments we developed. We plan to divest a substantial portion of the Investment Division in 2005 and use the proceeds to expand Homebuilding operation, reduce debt and repurchase common stock.
Homebuilding Division. Over the past seven years, we have substantially increased our investment in homebuilding and development. We have devoted significant resources to our Homebuilding Division in terms of financial investment and human capital. For the year ended December 31, 2004, approximately 69% of our corporate and property general and administrative expenses was attributable to the Homebuilding Division. Because of the long lead time for large projects in urban areas, we are just starting to recognize revenues from some of our earliest projects, which began in 2000. We measure the performance of the Homebuilding Division primarily by gross profit from home sales of its for-sale communities.
Investment Division. Over the past several years funds generated by the operation, sale, or refinancing of properties in the investment portfolio have primarily been applied to finance our homebuilding and development activities. We measure the performance of the Investment Division primarily by net operating income (rental revenue less property operating expenses) of both consolidated and unconsolidated stabilized rental apartment communities and commercial properties.
Revenue. Our revenue is principally derived from:
• Homebuilding sales, which represent sales of condominium homes, townhomes, and residential lots reported on either the completed contract or percentage-of-completion method of revenue recognition, as appropriate; and
• Rental revenues associated with leases of apartments to residents and office and retail space to commercial tenants.
Expenses. Our expenses principally consist of:
• Costs of homebuilding sales, which include construction costs, costs of construction supervision, marketing, commissions and other selling costs, interest, developer fees, and architectural and engineering fees;
• Property operating expenses, which are costs associated with operating, leasing, and maintaining rental apartment communities and office and retail properties, including payroll and benefit expenses of site-level employees;
• Depreciation of rental apartment communities and office and retail properties; and
• General and administrative expenses, a significant portion of which consists of compensation and benefits and other personnel-related costs.
Other income and expenses. Other income and expenses include:
• Interest expense related to mortgages and other debt;
• Equity in income or losses of partnerships and joint ventures, which represents our share of the net income or net loss of unconsolidated partnerships and joint ventures and may include income from distributions received from those entities in excess of our share of their income when we have recovered our investment in them. The source of such distributions is generally proceeds from sales or financings of properties;
• Gain on sales of real estate, which generally consists of gain from sales of assets in our Investment Division; and
• Minority interests in consolidated partnerships and joint ventures, which consists of our partners’ share of gross profit from homebuilding sales or net income or net loss resulting from rental operations and the return on a preferred interest in Tarragon Development Company, LLC, which owns interests in nine rental apartment communities.
Outlook
Our Homebuilding Division has experienced rapid growth over the last few years. We believe the urban homebuilding business will continue to present growth opportunities due to several factors:
• Scarcity of suburban land for development and increased restrictions and controls on growth in many areas, channeling a larger share of new construction into urban areas;
• Demographic trends of increased immigration, smaller households, and later marriages tend to favor demand in urban as opposed to other areas; and
• The recent investment performance of residential real estate and the availability and low cost of mortgage financing resulting in greater demand for home ownership rather than renting.
We continue to evaluate investment opportunities for additions to our investment portfolio only in Connecticut. In May 2004, we acquired a 158-unit rental apartment community in New Haven, Connecticut. In February 2005, we acquired 510 apartments in three communities in Manchester and West Haven, Connecticut. The Homebuilding Division is also developing a 180-unit rental apartment community in Meriden, Connecticut, which, upon completion and stabilization, is expected to be transferred to the Investment portfolio. The Homebuilding Division also has three other rental communities in various stages of development which will be sold at or prior to completion:
• 90 affordable apartments in Hoboken, New Jersey, being built under the low-income housing tax credit program;
Pursuant to a plan approved by our Board of Directors in March 2005, we plan to divest a substantial portion of the Investment Division in 2005. Therefore revenues, expenses, and cash flows from rental operations are expected to decline significantly in 2005 and 2006.
Factors Affecting Comparability of Results of Operations
Application of FIN 46R. One factor that may affect the comparability of our results is the application of the Financial Accounting Standards Board’s (“FASB”) Interpretation 46-R, “Consolidation of Variable Interest Entities,” or “FIN 46R.” On January 1, 2004, we adopted the provisions of FIN 46R for our partnerships and joint ventures formed before February 1, 2003. As a result of the application of FIN 46R, we have consolidated ten of our joint ventures, seven of which were previously unconsolidated, including the partnership that holds the Las Olas River House development. The consolidation of these ten entities increased our total consolidated assets by $336.9 million and total liabilities by $244.8 million as of December 31, 2004. Gross revenue for the year ended December 31, 2004, included homebuilding sales of $51.9 million and rental revenue of $12.2 million produced by these ten newly consolidated entities.
Segment Results. Another factor affecting the comparability of our results of operations is that the segment results for our Investment and Homebuilding Divisions include both revenues generated by consolidated entities and those generated by unconsolidated entities. Therefore, the revenues reflected in the segment results are not fully comparable with our consolidated results.
Distributions in Excess of Investment in Unconsolidated Entities. Distributions in excess of investment in our unconsolidated entities are primarily related to distributions by those entities of non- recourse refinancing or property sale proceeds where we have recovered our investment in those entities. If such an unconsolidated entity becomes consolidated, we will no longer recognize the receipt of cash in excess of our share of income from that entity as income.
Accounting for Inter-Segment Property Transfers. Prior to January 1, 2004, when a property was transferred from our Investment Division to our Homebuilding Division (such as in connection with a condominium conversion), we recorded in our segment results an intercompany sale at the estimated fair value of that property at the time of the sale, which could differ from the property’s carrying value at the time. The calculation of the cost of sales related to a subsequent sale of that property (or condominium units) by our Homebuilding Division would then be based on that estimated fair value. The same was true for a transfer of a property from our Homebuilding Division to our Investment Division, with the depreciation expense associated with the transferred property being based on the fair value at the time of transfer rather than the carrying value. Gains on transfers of assets between segments do not represent gains recognizable in accordance with GAAP and, accordingly, are eliminated for purposes of consolidated reporting. Beginning with the first quarter of 2004, we began recording each inter-segment property transfer at the property’s carrying value. Nevertheless, since we still own a number of properties that were transferred prior to January 1, 2004, our segment results will continue to include depreciation expense and cost of homebuilding sales based on these intercompany transfers at the properties’ fair values for some future periods.
Percentage-of-Completion Revenue Recognition. The percentage-of-completion method of revenue recognition applies to mid-rise and high-rise condominium developments, where construction typically takes eighteen months or more, including our Las Olas River House, Alta Mar, XII Hundred Grand and XIII Hundred Grand projects. Because this method of revenue recognition requires us to recognize revenues from sales of units prior to the closing of such sales, the timing of revenues generated by projects using the percentage-of-completion
method may not be comparable to the timing of revenues generated by projects using the closing method. Furthermore, we will recognize a significant portion of the revenues from unit sales at a percentage-of- completion project prior to our receiving cash in excess of deposits in respect of such unit sales. See “Critical Accounting Policies and Estimates-Revenue Recognition.”
Rental Properties in “Lease-up.” Rental properties that have not yet been stabilized typically have lower rental revenues and net operating income than rental properties that are stabilized. Trends in our results of operations may be masked or distorted in a period in which we have a number of properties in lease-up. However, once a property has been stabilized, the results for that property for a period in which it is stabilized will likely be markedly better than the results for that property during lease-up, which may also mask or distort trends in our results of operations. Where possible, when we make comparisons between periods, we segregate the results of properties that were in lease-up in either or both of the two periods to better illustrate the trends in our results of operations.
Consolidated Results of Operations
2004 Compared to 2003
For the year ended December 31, 2004, total consolidated revenue was $311 million, compared to revenue reported for the corresponding period in 2003 of $131.6 million. This increase is mostly attributable to the increase in homebuilding sales, which, for the year ended December 31, 2004, included sales at our Las Olas River House, Tuscany on the Intracoastal, Alta Mar, Waterstreet at Celebration, Pine Crest Village I and II, and Venetian Bay Village I, II and III projects of $220.5 million. Sales at our Pine Crest Village I, 5600 Collins Avenue, and Venetian Bay Village I projects were a significant portion of our sales for the year ended December 31, 2003, but are now essentially completed. Homebuilding sales and gross profit have become more significant components of our results of operations as more of our for-sale projects have begun to close sales or are nearing completion. We expect this trend to continue as projects in our pipeline begin to generate revenue. See the tables that summarize homebuilding sales and present our backlog of homes sold, not closed, below under “Homebuilding Division.” The application of FIN 46R affected comparability of homebuilding revenue for 2003 and 2004 because Las Olas River House was unconsolidated in 2003, when it reported $97.6 million in homebuilding sale revenue and was consolidated for the year ended December 31, 2004, pursuant to the provisions of FIN 46R when it reported $51.9 million in homebuilding sale revenue.
Rental revenue increased $15.2 million, or 20%, for the year ended December 31, 2004, as compared to the same period of 2003. As presented below under “Operating Results of Consolidated Rental Properties,” four rental apartment communities consolidated in January 2004 as a result of our adoption of the provisions of FIN 46R contributed an increase of $12.2 million. Rental apartment communities in lease-up during one or both periods presented contributed an increase in rental revenue of $1.9 million.
Income from continuing operations was $32.8 million for the year ended December 31, 2004, compared to income from continuing operations of $6.8 million for the year ended December 31, 2003. Gross profit from homebuilding sales resulted in an increase of $35.3 million. Equity in income of partnerships and joint ventures decreased $946,000 chiefly due to $16.3 million recognized in 2003 as our share of the gross profit on home sales of Las Olas River House which was consolidated in January 2004 as a result of our adoption of the provisions of FIN 46R. This decrease is offset by our share of gross profit totaling $12.8 million recognized in 2004 on home sales of XII Hundred Grand and XIII Hundred Grand.
In December 2004, we recognized impairment losses of $733,000 and $400,000 to write down the carrying values of 820 Land and Lakeview Mall, respectively, to their estimated fair values.
During the year ended December 31, 2004, we recognized gains on sale of real estate totaling $18.4 million including those presented in discontinued operations in accordance with SFAS No. 144. During the
corresponding period of 2003, gains on sale, including those presented in discontinued operations, were $24.3 million. During 2004, we also sold our interest in Ninth Street Development, which has development rights for land in Hoboken, New Jersey, for $2.2 million and recognized a gain of $1.7 million. See “Sales of Consolidated Properties.”
Operating Results of Consolidated Rental Properties. At December 31, 2004, our consolidated apartment communities included 9,779 operating rental apartments (excluding 416 units in assets held for sale and presented in discontinued operations), and our consolidated commercial properties had an aggregate 1.3 million square feet. The following tables summarizes aggregate property level revenues and expenses for all of our consolidated rental properties for the years ended December 31, 2004 and 2003:
The results of operations of our consolidated rental properties were affected during the periods presented above by:
• the consolidation of four apartment communities in January 2004 in connection with the adoption of the provisions of FIN 46R;
• the acquisition of one apartment community in 2004;
• the effect of three apartment communities undergoing conversion to condominiums for sale; and
• the results of operations of properties in lease-up.
The following tables illustrate the effects of these items on the various components of the results of operations of our consolidated rental properties for the years ended December 31, 2004 and 2003:
(a)
Includes four apartment communities owned by joint ventures consolidated on January 1, 2004, in connection with the adoption of the provisions of FIN 46R.
(b)
Includes two recently completed properties in lease-up during one or both periods presented.
(c)
This decrease in interest expense is the result of prepayment penalties totaling $3.1 million and $241,000 of deferred financing expenses written off upon the early payoff of two mortgages secured by Pine Crest Apartments in the first quarter of 2003. The mortgages were paid off in connection with the closing of a $25 million loan to finance the condominium conversion of this property.
(d)
This decrease in depreciation expense is primarily due to $1.1 million recorded in the second quarter of 2003 upon the reclassification of two properties to real estate held for investment for the period during which they were classified as held for sale.
Equity in Income of Unconsolidated Partnerships and Joint Ventures. The following table summarizes the components of equity in income of unconsolidated partnerships and joint ventures for the years ended December 31, 2004 and 2003:
Income from homebuilding operations in 2003 was reported by Las Olas River House. Due to the application of FIN 46R, Las Olas was consolidated in January 2004. Homebuilding operations for 2004 were reported by The Grande, a condominium conversion project acquired in September 2004 by Delaney Square, LLC, and XII Hundred Grand and XIII Hundred Grand, two of our Hoboken, New Jersey, projects.
Four rental apartment communities held by variable interest entities were consolidated in 2004 pursuant to FIN 46R. Equity in income of unconsolidated partnerships and joint ventures for 2003 included a loss of $1.4 million, which represented Tarragon’s share of the losses reported by these entities during the period the recently completed properties owned by these entities were in lease-up. In 2003, rental revenues for these properties were $9.9 million, and property operating expenses were $6 million.
Discontinued operations include the operations and gain on sale of Prospect Park, the only property of the Sacramento Nine joint venture, which was sold in December 2004.
When we compute equity in income of partnerships and joint ventures, we eliminate intercompany items, including management fees the joint ventures pay us or interest on advances we have made to joint ventures.
Distributions in excess of investment are primarily related to distributions of financing proceeds of joint ventures in which we have recovered our investment. In these situations, the joint ventures’ debt is non-recourse to Tarragon, and Tarragon has not committed to fund any cash flow deficits of the joint ventures. Income from distributions in excess of investment decreased by $3.3 million for the year ended December 31, 2004 as compared to the same period of 2003. In 2003, Ansonia Apartments, L.P., and Ansonia Liberty, L.L.C., made distributions of proceeds from refinancings totaling $7.6 million. In 2004, Ansonia Apartments, L.P., made distributions of proceeds from financings of $4.4 million.
In the fourth quarter of 2004, Larchmont Associates, L.P., entered into a contract to sell Arbor Glen Apartments. Estimated net proceeds from the sale were not sufficient for Tarragon to recover its investment in Larchmont, which included $1.3 million of advances made during 2004. Accordingly, we recorded a $1.2
million impairment charge to write down the carrying value of our investment to our share of the estimated net sale proceeds in the fourth quarter of 2004.
General and Administrative Expenses. Corporate general and administrative expenses increased $3.2 million for 2004 compared to 2003 primarily due to personnel additions and compensation increases relating to increased homebuilding activities. Please see the discussion below under “Homebuilding Division.” Additionally, we had a $600,000 increase in accounting and consulting fees related to compliance with Rule 404 of the Sarbanes-Oxley Act.
We have also added personnel in our property management group, which has resulted in an increase in property general and administrative expenses of $667,000 for 2004 compared to 2003. Our property management team oversees the Investment Division properties and the initial lease-up of newly constructed rental apartment communities, provides our developers with real time market data, and provides property management services to rental apartment communities acquired for the purpose of converting them to condominiums.
Corporate Interest. Corporate interest increased $1.5 million for 2004 compared to 2003 primarily due to interest expense incurred as a result of the issuance of senior convertible notes. We expect this interest expense to increase by $4.2 million in 2005.
Sales of Consolidated Properties
The following table summarizes sales of consolidated properties during the last three years (in thousands). Except for the sales of Forest Ridge land in 2004, a portion of Northwest O’Hare Office Building in 2003, and Palm Grove Apartments in 2002, the gains on sale were presented in discontinued operations in accordance with SFAS No. 144.
2003 Compared to 2002
Total consolidated revenue increased $32.1 million, or 32%, for the year ended December 31, 2003, compared to the year ended December 31, 2002. Of this increase, $30.1 million was attributable to an increase in homebuilding sales, primarily due to $45.2 million of sales at our Pine Crest Village I and Venetian Bay Village I projects, offset by a decrease in sales at our 5600 Collins Avenue project of $19.9 million. 5600 Collins Avenue was our only homebuilding project with revenue from sales during 2002.
We reported an increase in consolidated rental revenue of $1.7 million, or 2%, from 2002 to 2003. As discussed below in “Operating Results of Consolidated Rental Properties,” this increase mostly resulted from properties that were in lease-up during one or both years.
Income from continuing operations was $6.8 million in 2003 compared to a loss from continuing operations of $967,000 in 2002. Gross profit from homebuilding sales, primarily from sales at our Pine Crest and Venetian Bay projects, increased by $12.5 million from a loss of $2.7 million in 2002. The loss in 2002 was due to a write-down of our 5600 Collins project, as discussed below under “Homebuilding Division.” Additionally, equity in income of partnerships and joint ventures increased $5.8 million due in part to our proportionate share of the gross profit recognized by the partnership holding our Las Olas River House project in the fourth quarter of 2003, partially offset by a decrease resulting from gains on sales of real estate recognized by unconsolidated partnerships and joint ventures in 2002.
Operating Results of Consolidated Rental Properties. At December 31, 2003, our consolidated apartment communities included 7,969 operating rental apartments (excluding 1,424 units sold or held for sale for which operating results are presented in discontinued operations), and our consolidated commercial properties had an aggregate 1.1 million square feet. The following table summarizes aggregate property level revenues and expenses for all of our consolidated properties for the years ended December 31, 2003 and 2002:
The results of operations of our consolidated rental properties were affected during the periods presented above by:
• the sale of one apartment community in 2002;
• the effect of three apartment communities undergoing conversion to condominiums for sale; and
• the results of operations of properties in lease-up.
The following table illustrates the effects of these items on the various components of the results of operations of our consolidated rental properties for 2003 and 2002:
(a)
Includes six recently completed properties in lease-up during one or both periods presented.
(b)
Taking apartments out of service at properties undergoing conversion to condominiums resulted in a $1.1 million decrease in rental revenues and a $256,000 decrease in property operating expenses.
(c)
Prepayment penalties totaling $3.1 million and $241,000 of deferred financing expenses written off upon the prepayment of two mortgages with the proceeds of a $25 million condominium conversion loan contributed to the decrease in interest expense.
(d)
This increase in property operating expenses is related to higher personnel, landscaping, and other costs incurred in connection with leasing efforts to maintain occupancy in highly competitive rental markets. Additionally, property taxes were higher for newly constructed apartment communities whose values have been reassessed after completion. Also, weather-related costs, including utilities and snow removal, and insurance costs were higher.
(e)
This increase in depreciation resulted from resuming depreciation of two apartment communities that had been classified as held for sale upon their reclassification to real estate held for investment in the second quarter of 2003, including an adjustment to record depreciation for the period during which they had been classified as held for sale.
Equity in Income of Unconsolidated Partnerships and Joint Ventures. The following table summarizes the components of equity in income of unconsolidated partnerships and joint ventures for 2002 and 2003:
Homebuilding sales revenue of unconsolidated partnerships and joint ventures was $97.6 million in 2003, while there were no sales in 2002. Las Olas River House began recognizing revenue on its sales using the percentage-of-completion method in the fourth quarter of 2003 after meeting the criteria requiring the use of this method of revenue recognition. We began closing sales in December 2004.
Gain on sale of real estate in 2002 includes a $25.1 million gain on the sale of Devonshire Apartment Owners’ sole property and $2.1 million of gains on sale of three properties owned by Ansonia Apartments, L.P. The reduction in gain recognized for distributions in excess of investment recognized in 2000 relates to Devonshire Apartment Owners. This income was recognized in connection with our transfer of ownership of The Villages at Gateway to the joint venture in July 2000 and represented distribution of financing proceeds in excess of our investment in the joint venture.
Discontinued operations include the net operating results of Stone Creek Associates and the gain on sale of its only property in December 2002, and the net operating results of Sacramento Nine which sold its only property in 2004.
Distributions in excess of investment are primarily related to distributions of financing proceeds of joint ventures in which we have recovered our investment.
In addition, our equity in income of unconsolidated partnerships and joint ventures was affected during the periods presented above by:
The following table presents the effect of these items on the unconsolidated entities’ property level revenues and expenses for 2003 and 2002:
(a) In connection with a change in control, Antelope Pines and Woodcreek Garden were consolidated beginning April 2002. Antelope Pines was sold in December 2004 and Woodcreek Garden was classified as held for sale at December 31, 2004, and their consolidated operating results were presented in discontinued operations.
(b) Includes four apartment communities sold in 2002. Operating results for a fifth property sold are presented in discontinued operations.
(c) Due to a change in control in connection with forming a joint venture, Vintage at Fenwick Plantation was deconsolidated in January 2003. Construction of the property was completed in 2003, and it began leasing in July 2002.
(d) Includes three partnerships with recently completed properties in lease-up during most of 2003.
(e) This increase in property operating expenses is related to higher personnel, landscaping, and other costs incurred in connection with leasing efforts to maintain occupancy in highly competitive rental markets. Additionally, property taxes were higher for newly constructed apartment communities whose values have been reassessed after completion. Also, weather-related costs, including utilities and snow removal, and insurance costs were higher.
(f) The increase in interest expense resulted from new and supplemental financing placed on several properties, including prepayment penalties and the write-off of deferred borrowing costs.
General and Administrative Expenses. Corporate general and administrative expenses increased $3.8 million, or 40%, for 2003 compared to 2002 primarily due to personnel additions and compensation increases as we continued to assemble our homebuilding team. Additionally, we incurred legal and other professional fees and costs of relocating residents of $308,000 in 2003 in connection with a matter relating to the alleged release of asbestos-containing materials at one of our condominium conversion projects. See discussion in ITEM 3. “LEGAL PROCEEDINGS.”
Property general and administrative expenses increased by $628,000, or 20%, for 2003 compared to 2002, primarily due to property management personnel additions and compensation increases.
Homebuilding Division
As stated previously, results for our segments do not distinguish between revenues of consolidated and unconsolidated properties. Therefore, revenue and gross profit or loss from homebuilding sales presented below includes both consolidated and unconsolidated homebuilding projects.
The following table summarizes homebuilding sales (in both units and revenues) and gross profit (both in dollars and as a percentage of sales). Units sold represent units closed except for Las Olas River House, Alta Mar, XII Hundred Grand, and XIII Hundred Grand where we have recorded sales revenue under the percentage-of-completion method. See “ Factors Affecting Comparability of Results of Operations - Percentage-of-Completion Revenue Recognition.”
Home sales were $315.5 million in 2004, up from $153.9 million in 2003 and $26.2 million in 2002. Home sales for 2004 include $155.9 million recognized under the percentage of completion method. Of this, $51.9 million is attributable to Las Olas River House, a luxury, high-rise development in Ft. Lauderdale, Florida. Additionally, $38.5 million is from XII Hundred Grand and $39 million from XIII Hundred Grand, both mid-rise luxury condominium developments in Hoboken, New Jersey. The remaining $26.5 million came from Alta Mar, a mid-rise luxury condominium development in Ft. Myers, Florida. Gross profit net of selling expenses on home sales was 24% for 2004, and 20% in 2003. We reported a loss on home sales of 10% in 2002. Net of minority interests in consolidated home sales and outside partners’ interests in home sales of unconsolidated projects, we reported $57.1 million of income from home sales in 2004 and $25.8 million in 2003. We reported a loss from home sales in 2002 of $2.7 million.
Gross profit on homebuilding sales is based on estimates of total project sales value and total project costs. When estimates of sales value or project costs are revised, gross profit is adjusted in the period of change so that
cumulative project earnings reflect the revised profit estimate. During 2004, we revised our estimate of sales value and development costs for Tuscany on the Intracoastal, resulting in an increase in gross profit of approximately 3.2% from the estimate reported in 2003.
The Homebuilding Division’s gross profit from home sales was reduced by $6.7 million in 2004 and $5.6 million in 2003 for intercompany profit recognized earlier by the Investment Division when Pine Crest Apartments was transferred to the Homebuilding Division.
The Homebuilding Division also reported intercompany sales of $144.7 million in 2003 and $304 million in 2002. These sales represent the transfer of stabilized rental properties to the Investment Division at their then estimated fair values. On an aggregate basis, these estimated fair values exceeded the properties’ carrying values by 15% in 2003 and 18% in 2002. Net of outside partners’ interests in intercompany sales of unconsolidated properties, the Homebuilding Division reported income from intercompany sales of $18.2 million in 2003 and $51.7 million in 2002. Gains on transfers of assets between segments do not represent gains recognizable in accordance with GAAP and, accordingly, are eliminated for purposes of consolidated reporting. Beginning in 2004, we transfer properties between divisions at their cost and no longer report intercompany profits in the segment results.
Rental properties in the Homebuilding Division reported overall net losses from operations of $942,000 in 2004, $6.1 million in 2003, and $3.7 million in 2002. These losses are due to operating, interest, and depreciation expenses exceeding revenues during lease-up prior to stabilization. Previously, we transferred rental properties from the Homebuilding Division to the Investment Division once they are stabilized. We now intend to sell such properties upon or prior to completion and stabilization.
General and administrative expenses of the Homebuilding Division increased 25% in 2004 to $14.3 million, from $11.5 million in 2003, which was up 73% from $6.7 million in 2002, reflecting the increased homebuilding activity.
As of December 31, 2004, as presented in the following table, our backlog of sales was $342.8 million for our 28 for-sale communities under active development.
Investment Division
As stated previously, results for our segments do not distinguish between revenues of consolidated and unconsolidated properties. Therefore, rental revenue and net operating income (rental revenue less property operating expenses) in the following discussion include both consolidated and unconsolidated rental communities. You should read the following discussion along with the Investment Division operating
statements and summary of Investment Division net operating income in NOTE 14. “SEGMENT REPORTING” in the Notes to Consolidated Financial Statements. Net operating income is a supplemental non-GAAP financial measure. A reconciliation of Investment Division net operating income to Investment Division income before tax is presented in the Investment Division operating statements.
The Investment Division reported net operating income of $65.5 million in 2004, $59 million in 2003, and $60.7 million in 2002. Net operating income as a percentage of rental revenue was 48.3% in 2004, $47.5% in 2003, and 49.5% in 2002.
The following table presents net operating income for our 45, same store, Investment Division apartment communities with 9,720 units (consolidated and unconsolidated) and the nine consolidated apartment communities stabilized and moved to the Investment Division during 2002, 2003, or 2004. Prior to their stabilization, the operating results of these nine properties were included in the Homebuilding Division.
Net operating income for our 45 same store stabilized Investment Division apartment communities with 9,720 units increased $1.8 million, or 4.5 % in 2004 compared to 2003, and decreased $1.8 million, or 4.3%, in 2003 compared to 2002. The increase in 2004 was mostly due to an increase in rental revenues: 2% in 2004 compared to 2003. The decrease in 2003 was mostly due to increases in operating expenses, as discussed above: 8.6% in 2003 compared to 2002. Net operating income as a percentage of rental revenue for these properties was 49% in 2004, 47.8% in 2003, and 51% in 2002.
Investment Division gains on sale of real estate, including properties owned through unconsolidated partnerships and joint ventures, were $20.6 million in 2004, $23.8 million in 2003, and $38.4 million in 2002. We sold five consolidated apartment communities in 2004, six consolidated apartment communities in 2003, and three consolidated apartment communities and five unconsolidated apartment communities in 2002. These sales brought decreases in net operating income of $1.4 million in 2004 compared to 2003 and $5.1 million in 2003 compared to 2002. We also sold one unconsolidated commercial property in 2004 and two consolidated commercial properties in 2003. The Investment Division’s gains on sale of real estate have been reduced by $5.8 million in 2003 and $954,000 in 2002 for intercompany profit recognized previously by the Homebuilding Division upon the transfer of stabilized rental properties to the Investment Division. The Investment Division also reported gains on intercompany sales of $5.3 million in 2003, and $12.9 million in 2002. These intercompany sales related to the transfer of properties to the Homebuilding Division for renovation or conversion to condominiums.
Interest expense for the Investment Division increased by $4.4 million, or 12.2%, in 2004 compared to 2003. For the 45 same store stabilized apartment communities, interest expense increased 3.6% from $26.2 million to
$27.1 million. A decrease of $535,000 came from the sale of Investment Division apartment communities during 2004 and 2003. An increase of $2.3 million was related to stabilized apartment communities transferred into the Investment Division.
Investment Division interest expense increased by 1% to $36.4 million in 2003 from $36 million in 2002. The 45 same store stabilized apartment communities reported a $611,000, or 2.4%, increase. A $2.4 million increase was the result of the transfer of stabilized apartment communities into the Investment Division in 2003. A $2.8 million decrease came from the sale of Investment Division apartment communities during 2003 and 2002.
Investment Division depreciation expense was $31.1 million in 2004, $30 million in 2003, and $28.2 million in 2002. The 45 same store stabilized apartment communities reported depreciation expense of $16.8 million in 2004, $18.2 million in 2003, and $16.6 million in 2002. An increase in 2003 and decrease in 2004 of $1 million for same store stabilized apartment communities was the result of resuming depreciation of two properties upon their reclassification from Real Estate Held for Sale to Real Estate Held for Investment. In 2004, an increase of $2.7 million in Investment Division depreciation expense was related to stabilized apartment communities transferred into the Investment Division, and a $984,000 decrease was related to properties sold during 2003 and 2004. In 2003, a $2 million increase came from stabilized apartment communities transferred into the Investment Division.
General and administrative expenses of the Investment Division increased to $6.4 million in 2004 from $5.4 million in 2003 and $5.9 million in 2002. General and administrative expenses were 4.4% of divisional revenues in 2004, 4.4% in 2003, and 4.8% in 2002.
Twenty-three of our Investment Division rental apartment communities are located in Florida. The hurricanes during 2004 caused relatively minor damage, primarily water intrusion or roof damage and damage to landscaping. We estimate the total cost of repairs to damage and removal and replacement of trees and other landscaping to be approximately $730,000, of which approximately $565,000 has been paid to date. Property maintenance staffs, working in conjunction with contractors, have now largely restored the properties to their pre-storm condition.
Liquidity and Capital Resources
Liquidity
Our principal sources of cash are home sales, rental operations of Investment Division properties, borrowings, and proceeds from the sale of Investment Division properties. As our Homebuilding Division continues to grow, home sales, along with project-related construction loans, will become our primary source of cash. We believe these sources will continue to meet our cash requirements, including debt service, property maintenance and improvements, acquisitions of land for development, development costs for rental apartment and for-sale communities under construction or renovation, projected purchases of existing properties, dividends on preferred stock, and repurchases of common stock under the announced buy back program. Although we expect these sources of cash to be sufficient to fund planned uses of cash, we can make no assurance that the expected home sales and Investment Division property sales and borrowings will be completed as planned.
Mortgages and Other Debt
Senior Convertible Notes. On September 16, 2004, we issued $50 million of 8% Senior Convertible Notes (“The Notes”). On November 19, 2004, we issued an additional $12 million of The Notes. The Notes are general, senior, unsecured obligations of Tarragon, bear interest at the rate of 8% per annum, mature in September 2009, and are convertible into Tarragon Common Stock. Interest is payable semi-annually in March
and September, and the outstanding balance of the Notes is payable at maturity. See NOTE 4. “NOTES AND INTEREST PAYABLE” in the Notes to Consolidated Financial Statements.
Unsecured Credit Facilities. We have a $20 million unsecured line of credit with affiliates of William S. Friedman, our Chief Executive Officer and Chairman of our Board of Directors. Advances under the line of credit bear interest at the lower of 100 basis points over the thirty-day LIBOR or the lowest rate offered in writing to us for an unsecured loan by an institutional lender. Payments of interest only are due on demand but no more frequently than monthly. All outstanding principal and interest are due at maturity in January 2006. As of December 31, 2004, all of these funds were available to us.
We have a $10 million unsecured line of credit with Wachovia Bank. Payment terms are interest only monthly at 200 basis points over the thirty-day LIBOR, with the outstanding balance due at maturity of July 2005. As of December 31, 2004, all of these funds were available to us.
Secured Credit Facilities. We have a $20.2 million revolving line of credit with SouthTrust Bank, an Alabama banking corporation. This loan bears interest at a floating rate equal to the 30-day LIBOR plus 175 basis points. Interest only is payable monthly, with the outstanding principal amount due at maturity in June 2005. It is secured by five properties and shares of our common stock owned by Mr. Friedman and his affiliates. We have agreed to indemnify Mr. Friedman and his affiliates from any loss, cost, or liability associated with their pledge of stock to secure this line of credit. As of December 31, 2004, $19 million was available to us under this line of credit.
We currently have mortgage loans totaling $196.7 million (of which $25 million represents a revolving commitment), secured by a pool of eleven properties, under a secured credit facility with General Electric Capital Corporation (“GECC”) that matures in May 2006. The mortgage loans under this facility are cross-collateralized and cross-defaulted with each other. Under the GECC mortgage facility, we are required to maintain, at all times, a consolidated net worth of not less than $50 million, measured at the end of each quarter, and minimum aggregate unrestricted cash and marketable securities of not less than $10 million in order to be able to incur other debt. Seven of these properties are in a sub-portfolio with an aggregate balance of $124.1 million that bear interest at 173 basis points over LIBOR, payable monthly. If our ratio of net operating income of all of the properties in the entire portfolio to the total debt outstanding in the facility (the “Cash on Cash Ratio”) falls below 8% or our ratio of net operating income of the entire portfolio to the total debt service required under the facility (“Debt Service Coverage Ratio”) falls below 1.2x, the interest rate for these loans will be increased to 198 basis points over the thirty-day LIBOR. The Cash on Cash Ratio, as measured by GECC monthly, has exceeded this threshold, and we believe it will continue to meet or exceed this threshold. Four additional properties have loans with an aggregate balance of $72.6 million that currently bear interest at 190 basis points over the thirty-day LIBOR and require monthly payments of principal and interest computed on a 271/2 -year amortization schedule. If our Cash on Cash Ratio for this sub-portfolio reaches 9% for at least two consecutive quarters, the interest rate on these loans will be reduced to 173 basis points over the thirty-day LIBOR; if our Cash on Cash Ratio for this sub-portfolio reaches 9.75% for at least two consecutive quarters, principal amortization will cease. If the Cash on Cash Ratio for our overall portfolio falls below 8% in any month, payment on the loans on the sub-portfolio of seven properties will change to principal plus interest computed on a 30-year amortization schedule. In addition, we will be required to pay the lender 100% of our net cash flow (after payment of property operating expenses, debt service and impounds) from all of the properties in the portfolio in reduction of the principal balance of the loans, until the portfolio Cash on Cash Ratio is again 8% or greater for two consecutive months. This credit facility has two one-year extension options. The first extension option requires a Cash on Cash Ratio of 10% or greater and a Debt Service Coverage Ratio of 1.25x or greater. The second extension option requires a Cash on Cash Ratio of 10.5% or greater and a Debt Service Coverage Ratio of 1.3x or greater.
Non-recourse Mortgage Debt. As of December 31, 2004, in addition to the GECC mortgage facility, we had an aggregate of $209 million of outstanding non-recourse indebtedness secured by 30 Investment Division assets. The agreements governing this mortgage debt generally do not contain restrictive covenants and are not guaranteed by us or any of our subsidiaries or joint ventures. Of these mortgage loans, $185.9 million bear interest at various fixed rates, and $23.1 million bear interest at various floating rates. As of December 31, 2004, they bore interest at a weighted average rate of 6.1%.
Recourse Mortgage Debt. The following table summarizes the material terms of our recourse mortgage debt (dollars in thousands):
(a)
Represents a guaranty of 5% of the loan amount. The remainder of the loan amount is included in Non-recourse Mortgage Debt above.
(b)
Represents a guaranty of 26% of the loan amount. The remainder of the loan amount is included in Non-recourse Mortgage Debt above.
(c)
This loan has been extended until May 2005.
Construction Loans. In connection with our various homebuilding projects, we obtain construction loans to finance the cost of construction. Generally, one of our subsidiaries or a joint venture will incur the construction loan, and we will guarantee the repayment of the construction loan and/or grant a completion guarantee with respect to the project. In general, we repay outstanding amounts under construction loans on for-sale communities with proceeds from home sales. We refinance construction loans on rental communities with permanent or semi-permanent mortgage financing upon the completion and stabilization of the properties. The following table summarizes the material terms of our construction loans, all of which we have guaranteed (dollars in thousands):
Condominium Conversion Loans. We generally obtain loans to finance the cost of acquiring and/or renovating rental properties to condominium homes. Generally, one of our subsidiaries or a joint venture will incur the loan, and we will guarantee the repayment of the loan. The following table summarizes the material terms of our condominium conversion loans, all of which we have guaranteed (dollars in thousands):
Mezzanine Loans. In connection with our homebuilding projects, we occasionally obtain mezzanine loans to finance part of the cost of construction. Generally, one of our subsidiaries or a joint venture will incur the loan, and we will guarantee the repayment of the loan and/or grant a completion guarantee with respect to the project. We have one mezzanine loan, which we have guaranteed, on our Las Olas River House project with a December 31, 2004, balance of $36.5 million. This loan bears interest at a variable rate, which was 5.90% at December 31, 2004, and matures in March 2005, unless we exercise our option to extend for six months. This loan will be paid off with proceeds from closings of home sales.
Acquisition and Development Loans. In connection with our homebuilding projects, we obtain acquisition and development loans to finance the purchase of land and the development of the infrastructure with the intent to subdivide and sell lots to other homebuilders. Generally, one of our subsidiaries or a joint venture will incur the loan, and we will guarantee the repayment of the loan. The following table summarizes the material terms of our acquisition and development loans, all of which we have guaranteed (dollars in thousands):
Land Loans. When we acquire land for future development or sale, we sometimes finance the acquisitions with land loans. Generally, one of our subsidiaries or a joint venture will incur the loan, and we will guarantee the repayment of the loan. The following table summarizes the material terms of our land loans, all of which we have guaranteed (dollars in thousands):
Other Non-Recourse Debt. We have a loan of $8.4 million due to Aetna secured by interests in our joint ventures with it. The loan matures in November 2010. Aetna receives a sliding percentage ranging from all to 10% of operating cash flow or capital proceeds from the three properties owned by the joint ventures based on the cumulative return received.
Sources and Uses of Cash
The following table presents major sources and uses of cash for the past three years.
Advances to partnerships and joint ventures for homebuilding activities in 2004 included:
• $6 million to Park Avenue Tarragon for purchase of an existing 743-unit apartment community for conversion.
Advances to partnerships and joint ventures for homebuilding activities in 2003 included:
• $15.5 million to Metropolitan Sarasota to purchase land for its 124-unit high-rise, luxury condominium development in Sarasota, Florida.
• $8.3 million to One Las Olas for development costs of its 287-unit high-rise, luxury condominium development in Ft. Lauderdale, Florida.
• $1.8 million to East Las Olas for development costs of its 90-unit mixed-use retail and condominium development in Ft. Lauderdale, Florida.
• $7.8 million to Thirteenth Street Development for development costs related to its two mid-rise, luxury condominium developments with a total of 277 homes in Hoboken, New Jersey.
Cash Flows
2004 Compared to 2003. For the year ended December 31, 2004, our net cash used in operating activities was $60.1 million compared to net cash provided by operating activities of $7.2 million for the year ended December 31, 2003. This decrease is principally related to homebuilding activities. Cash used for the purchase of homebuilding inventory increased $102 million. Homebuilding renovation and development costs paid increased $80 million, while cash received from homebuilding sales increased $141 million. Additionally, we paid interest of $10 million in connection with the refinancing of the mezzanine loan for Las Olas River House during 2004.
For the year ended December 31, 2004, our net cash used in investing activities was $64.8 million compared to $34.4 million for the same period of 2003. During 2004, we acquired one rental apartment community for $15.4 million, the cash portion of which was $4.2 million. We also purchased land for development for $4.5 million. Additionally, in 2004, we acquired the interests of minority partners in one office building and two apartment communities for $11.1 million. In 2003, we sold eight investment properties for net proceeds of $24.2 million, while net proceeds from the sale of real estate during 2004 was $14.7 million from the sale of five investment properties and one parcel of land. Advances to partnerships and joint ventures for development costs decreased $8.2 million in 2004 compared to 2003 partly due to the consolidation of our Las Olas River House project in January 2004 in connection with the adoption of FIN 46R.
For the year ended December 31, 2004, our net cash provided by financing activities increased to $125 million, from $30.8 million for the year ended December 31, 2003. This increase was primarily due to the issuance of $62 million of Senior Convertible Notes during 2004. Proceeds from the debt issuance were used to repay approximately $34.6 million of mortgage debt and $8 million of outstanding lines of credit balances. In 2004, we also borrowed approximately $228 million in construction loans to fund our homebuilding division projects as compared to $45 million in 2003. In 2004, refinancing loans provided $26.1 million as compared to $36.2 million in 2003. Additionally, the exercise of stock options during 2004 provided cash proceeds of $6 million, an increase of $5.7 million over the same period in 2003.
2003 Compared to 2002. For fiscal 2003, our net cash provided by operating activities was $7.2 million, compared to $24.8 million for fiscal 2002. The decrease in 2003 was due primarily to increased homebuilding renovation and development costs and purchases of homebuilding inventory (caused by the ramping-up of our homebuilding and condominium conversion activities), offset by increased cash received from homebuilding sales.
In 2003, our net cash used in investing activities was $34.4 million, compared to $25.0 million used in 2002. This decrease in net cash from investing activities was due primarily to:
• a significant increase in advances to partnerships and joint ventures for development costs, primarily at our Las Olas River House and Hoboken projects;
• advances to Metropolitan Sarasota in connection with acquiring a parcel of land; and
• a significant decline in distributions from sales of partnership and joint venture properties; offset, in part, by
• a significant increase in proceeds from the sale of real estate; and
• lower real estate development costs resulting from reduced rental property development activities.
In 2003, our net cash provided by financing activities was $30.8 million, compared to $9.2 million in 2002. This increase was due primarily to an increase in refinancing activities and increased borrowings in connection with our homebuilding activities.
Contractual Commitments
The following table summarizes information regarding contractual commitments.
Of the loans maturing in 2005, $60.1 million has been repaid as of March 1, 2005 with proceeds from home sales. The maturity of a $7.3 million mortgage was extended to May 2005. Additionally, $35.9 million may be extended for six months, $7.9 million may be extended for one year, and $36.5 million may be extended for eighteen months. Of the loans maturing in 2006, $41.6 million may be extended for one year, and $196.7 million may be extended for two years. An $8 million mortgage maturing in 2007 has a five year extension option. We intend to extend the loans or pay them off largely through refinancings and home sales. We believe we can arrange such new financing as may be needed to repay maturing loans.
The firm contracts to purchase real estate for homebuilding activities include a contract to purchase the Yacht Club on the Intracoastal, a 388-unit apartment community in Hypoluxo, Florida, for $67.3 million. We financed this purchase with a $62.5 million loan. Firm contracts also include a contract to purchase Georgetown at Celebration, a 315-unit apartment community in Celebration, Florida, for $47 million. This acquisition was financed with a $45 million loan. We acquired both of these properties in January 2005 and plan to sell the apartments as condominiums.
Guaranteed debt of unconsolidated partnerships and joint ventures includes $3.5 million that relates to a mortgage that matures in 2006 with a six month extension option and $7.5 million that relates to a mortgage that matures in 2006 with an extension option for one year. We have also guaranteed construction loans totaling $81.5 million on two unconsolidated properties. These loans mature in 2005 and have a balance as of December 31, 2004, of $52.3 million.
Common Stock Repurchase Program
The Board of Directors has authorized a common stock repurchase program. We may continue to repurchase shares of our common stock as long as we believe the fair market value of our net assets per share is substantially greater than the market price of our common stock. We repurchased 144,311 shares of our common stock in open market and negotiated transactions in 2004 at a cost of $2 million. We repurchased 275,443 shares at a cost of $4.2 million in 2003 and 326,982 shares for an aggregate $4.7 million in 2002. As of December 31, 2004, Tarragon had authority to repurchase an additional 709,991 common shares.
Critical Accounting Policies and Estimates
Accounting estimates are an integral part of the preparation of our consolidated financial statements and our financial reporting process and are based on our current judgments. Certain accounting estimates are particularly sensitive because of their significance to our consolidated financial statements and because of the possibility that future events affecting them may differ from our current judgments. The most significant accounting policies affecting our consolidated financial statements are as follows.
Asset Impairment. GAAP requires a property held for sale to be measured at the lower of its carrying amount or fair value less costs to sell. In instances where a property’s estimated fair value less costs to sell is less than its carrying value at the time of evaluation, we recognize a loss and write down the property’s carrying value to its estimated fair value less costs to sell. We recognize a gain for subsequent increases in fair value less costs to sell, but not in excess of the cumulative loss previously recognized. Our review of properties held for sale generally includes selective site inspections, comparing the property’s current rents to market rents, reviewing the property’s expenses and maintenance requirements, discussions with the property manager, and a review of the surrounding area. We may make adjustments to estimated fair values based on future reviews.
We also evaluate our properties held for investment for impairment whenever events or changes in circumstances indicate that a property’s carrying value may not be recoverable. This evaluation generally consists of reviewing the property’s cash flow and current and projected market conditions, as well as changes in general and local economic conditions. If we conclude that a property has been impaired, we recognize an impairment loss and write down the property’s carrying value to estimated fair value.
Investments in Joint Ventures Accounted for Using the Equity Method. In December 2003, the FASB issued FIN 46R. FIN 46R clarifies the application of Accounting Research Bulletin 51, “Consolidated Financial Statements,” for certain entities that do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support or in which equity investors do not have the characteristics of a controlling financial interest, or “variable interest entities.” Variable interest entities within the scope of FIN 46R are required to be consolidated by their primary beneficiary. The primary beneficiary of a variable interest entity is determined to be the party that absorbs a majority of the entity’s expected losses, receives a majority of its expected returns, or both. We adopted the provisions of FIN 46R in the first quarter of 2004.
We use the equity method to account for investments in partnerships and joint ventures over which we exercise significant influence but do not control or which are not variable interest entities of which we are the primary beneficiary. Under the equity method, our initial investments are increased by our proportionate share of the partnerships’ operating income and additional advances and decreased by our proportionate share of the partnerships’ operating losses and distributions received. Our interest in intercompany transactions is eliminated.
We determine our proportionate share of the profits or losses of the partnerships and joint ventures consistent with the allocation of cash distributions in accordance with the provisions of the American Institute of Certified
Public Accountants’ Statement of Position (“SOP”) 78-9, “Accounting for Investments in Real Estate Ventures.”
We have investments in a number of partnerships or joint ventures in which we hold non-controlling interests or our outside partners have significant participating rights, as defined by the FASB’s Emerging Issues Task Force in its 96-16 Abstract, or important rights, as defined by SOP 78-9 and which we have determined not to be variable interest entities, as defined by FIN 46R. The net effect of not consolidating these joint ventures has been to exclude their assets, liabilities, and gross revenues and expenses from our consolidated financial statements. There has been no effect on reported net income or loss except in instances where we have received distributions from a joint venture in excess of our investment in the joint venture, with the excess recorded as income. In these situations, we have recovered our investment in the joint venture, its indebtedness is non-recourse to us, and we have no obligation to fund any of its cash flow deficits.
Revenue Recognition. We have generally recognized revenue from homebuilding sales at the time of closing under the completed contract method. The related profit is recognized when collectibility of the sale price is reasonably assured and the earnings process is substantially complete. When a sale does not meet the requirements for income recognition, profit is deferred until such requirements are met. For mid- rise and high-rise condominium developments, where construction typically takes eighteen months or more, the percentage-of-completion method is employed. Under this method, once construction is beyond a preliminary stage, buyers are committed to the extent of being unable to require refunds except for non- delivery of the home, a substantial percentage of homes are under firm contracts, the sale prices are deemed collectible, and remaining costs and revenues can be reasonably estimated, revenue is recorded as a portion of the value of non-cancelable sale contracts. Revenue recognized is calculated based upon the percentage of construction costs incurred in relation to total estimated construction costs. Any amounts due under sale contracts, to the extent recognized as revenue, are recorded as contracts receivable.
Rental revenue is recognized on the straight-line method. Lease terms for our apartment communities are generally for one year or less. Lease terms for our commercial properties are generally from three to five years, although they may be shorter or longer. Rental concessions are deferred and amortized on the straight-line method over the lease terms as a reduction to rental revenue. We accrue percentage rentals only after the tenant’s sales have reached the threshold provided for in the lease.
Interest and management fee revenue are recognized when earned. Revenue from long term laundry and cable service contracts is deferred and amortized to income on the straight-line method over the terms of the contracts.
Gains on Sale of Real Estate. Gains on sales of real estate are recognized when and to the extent permitted by SFAS No. 66 - “Accounting for Sales of Real Estate.” Until the requirements of SFAS No. 66 for full profit recognition have been met, transactions are accounted for using the deposit, installment, cost recovery, or financial method, whichever is appropriate.
Recent Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment”. SFAS No. 123(R) replaces SFAS No. 123, “Accounting for Stock-Based Compensation” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS No. 123 established as preferable a fair-value-based method of accounting for share-based payment transactions with employees. However, it permitted companies the option of continuing to apply the guidance in APB No. 25, as along as the footnotes to the financial statements disclosed the proforma effects of implementing the fair-value-based method in a footnote. SFAS No. 123(R) requires that compensation cost relating to share-based payment transactions be recognized in financial statements. The cost will be measured based on the fair value of the equity or liability instruments
issued. SFAS No. 123(R) will be effective as of the first interim or annual reporting period beginning after June 15, 2005 and will apply to all awards granted after the required effective date and to awards modified, repurchased, or cancelled after that date. The cumulative effect of initially applying SFAS No. 123(R), if any, is recognized as of the required effective date. The adoption of SFAS No. 123 (R) will not have a material effect on our consolidated financial statements because we adopted the fair value method of accounting for stock-based awards in the third quarter of 2002.
Environmental Matters
Under federal, state, and local environmental laws, ordinances, and regulations, Tarragon may be liable for removal or remediation costs, as well as other costs (such as fines or injuries to persons and property) where our employees may have arranged for removal, disposal, or treatment of hazardous or toxic substances. In addition, environmental laws impose liability for release of asbestos-containing materials into the air, and third parties can seek recovery from Tarragon for personal injury associated with those materials. We are not aware of any liability relating to these matters that would have a material adverse effect on our business, financial position, or results of operations. However, there is a matter involving the alleged release of asbestos-containing materials at one of our condominium conversion projects, as described in ITEM 3. “LEGAL PROCEEDINGS.” As of this date, we are unable to determine the outcome of this matter and whether it will have a material impact on our financial statements. We have incurred legal and other professional fees and costs of relocating residents in connection with this matter totaling $448,000 to date. Remediation has been completed at a total cost of $795,000.
Estimated Fair Value of Equity of Investment Division
Tarragon also measures its performance by changes in estimated fair value of equity in its Investment Division properties, as presented in the following table.
(1)
Estimated fair values have been determined using the following procedures. For properties with appraisals ordered by lenders in connection with mortgage financing performed within one year, the appraised values are used. For 2002, we estimated the fair value of five properties under contract at such contract prices. Three of these properties were sold in the first quarter of 2003. We estimated the fair values of two properties based on written offers to purchase from third parties. For 2003, we estimated the fair value of one property under contract at its contract sale price. For 2004, we estimated the fair values of four properties under contract at their contract sale prices. One of these properties was sold in January 2005. We estimated the fair values of four properties based on offers to purchase. We estimated the fair values of two properties based on recently canceled contracts for sale. We estimated the fair values of three properties based on analysis performed by brokers marketing the properties for sale. We estimated the fair value of one property acquired in 2004 at its purchase price. For land and all properties under development or construction or in initial lease-up, the historical cost basis net carrying values are used. For all other properties, we engaged Marcus & Millichap, a national real estate investment brokerage company, to perform Broker’s Opinions of Value, and these values are used. Estimated fair values presented do not give effect to income taxes.
(2)
Debt as of December 31, 2004, excludes $62 million of unsecured convertible notes.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk from changes in interest rates that may adversely affect our financial position, results of operations, and cash flows. In seeking to minimize the risks from interest rate fluctuations, we manage such exposure through our regular operating and financing activities. We do not trade or speculate in financial instruments.
At December 31, 2004, we had approximately $529 million of consolidated variable rate debt. The primary base rate is the 30-day LIBOR. Using this balance of debt, a 100 basis point (1%) increase in LIBOR or any other indexes on which the rates are based would reduce our annual pre-tax earnings and cash flows by approximately $5.3 million. On the other hand, a 100 basis point decrease in interest rates would increase our annual pre-tax earnings and cash flows by approximately $5.3 million.
At December 31, 2004, unconsolidated partnerships and joint ventures had approximately $152 million of variable rate debt. A 100 basis point increase in the index on which the rates are based would reduce our annual pre-tax earnings and cash flows by $762,000, based on our interests in profits and losses of those entities. A 100 basis point decrease in the index would increase our pre-tax earnings and cash flows by $762,000.
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ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
All other schedules are omitted because they are not required or are not applicable or because the information required is included in the Consolidated Financial Statements or Notes.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders of
Tarragon Corporation
We have audited the accompanying consolidated balance sheets of Tarragon Corporation and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States of America). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Tarragon Corporation and subsidiaries, as of December 31, 2004 and 2003, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 1 to the consolidated financial statements, the Company adopted, Statements of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets,” and the fair value accounting method of No. 123 “Accounting for Stock-Based Compensation” in 2002 and No. 145 “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections” in 2003, and Financial Accounting Standards Board Interpretation 46-R “Consolidation of Variable Interest Entities” in 2004.
We also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States of America), the effectiveness of Tarragon Corporation’s internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 15, 2005 expressed an unqualified opinion on management’s assessment of, and an adverse opinion on the effective operation of, internal control over financial reporting.
/s/ GRANT THORNTON LLP
Dallas, Texas
March 15, 2005
TARRAGON CORPORATION
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these Consolidated Financial Statements.
TARRAGON CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
The accompanying notes are an integral part of these Consolidated Financial Statements.
TARRAGON CORPORATION
CONSOLIDATED STATEMENTS OF INCOME (Continued)
The accompanying notes are an integral part of these Consolidated Financial Statements.
TARRAGON CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
The accompanying notes are an integral part of these Consolidated Financial Statements.
TARRAGON CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these Consolidated Financial Statements.
TARRAGON CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
The accompanying notes are an integral part of these Consolidated Financial Statements.
TARRAGON CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
The accompanying notes are an integral part of these Consolidated Financial Statements.
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
We are a real estate homebuilder and investor with over 30 years of experience in the real estate industry. We operate two distinct businesses:
• the Homebuilding Division, which develops, renovates, builds, and markets homes in high-density, urban locations and in master-planned communities; and
• the Investment Division, which owns, develops, and operates residential and commercial rental properties, including almost 5,000 rental apartments we developed.
Financial information about our segments can be found in NOTE 14. “SEGMENT REPORTING.”
The accompanying Consolidated Financial Statements of Tarragon Corporation, its subsidiaries, and consolidated partnerships and joint ventures have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”), the most significant of which are described in NOTE 1. “SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.” The preparation of financial statements in accordance with GAAP requires us 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 financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 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 years then ended unless otherwise indicated. Dollar amounts in tables are in thousands, except per share amounts. Certain balances for 2002 and 2003 have been reclassified to conform to the 2004 presentation.
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of consolidation. The Consolidated Financial Statements include the accounts of Tarragon, its subsidiaries, and partnerships and joint ventures (which consist primarily of limited liability companies) it controls. Tarragon is deemed to control partnerships or joint ventures which have no unaffiliated owners or for which Tarragon is designated as the manager and the outside owners are given no participating rights, as defined in the Financial Accounting Standard Board’s (“FASB”) Emerging Issues Task Force’s 96-16 Abstract (“EITF 96-16”), or are given no important rights as defined in the American Institute of Certified Public Accountants’ Statement of Position (“SOP”) 78-9, “Accounting for Investments in Real Estate Ventures.” All significant intercompany transactions and balances have been eliminated.
In December 2003, the Financial Accounting Standards Board issued Interpretation 46-R (“FIN 46R”), “Consolidation of Variable Interest Entities,” an interpretation of Accounting Research Bulletin 51, “Consolidated Financial Statements.” FIN 46R changes the criteria by which one company includes another entity in its consolidated financial statements. FIN 46R requires a variable interest entity (“VIE”) to be consolidated by a company if that company is subject to a majority of the risk of loss from the VIE’s activities or entitled to receive a majority of the entity’s residual returns or both. Additionally, if the holders of equity at risk as a group do not have controlling financial interest, the entity may be defined as a VIE. Once an entity is determined to be a VIE, the primary beneficiary must consolidate the VIE into its financial statements. We adopted the provisions of FIN 46R on January 1, 2004.
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
We have identified ten partnerships and joint ventures, over which we exercise significant influence but do not control, which qualify as VIEs and of which we are the primary beneficiary. These ten entities, seven of which were previously accounted for using the equity method, have been consolidated in accordance with FIN 46R. Their assets and liabilities were recorded at carrying value. The ten entities consist of three limited partnerships and three limited liability companies engaged in homebuilding and one partnership and three limited liability companies which own and operate rental apartment communities with 1,226 units. The consolidation of these ten entities increased assets by $336.9 million as of December 31, 2004. Gross revenue for the year ended December 31, 2004, included homebuilding sales of $51.9 million and rentals of $12.2 million produced by these ten consolidated entities. One Las Olas, Ltd. is the most significant of the VIEs with $166.5 million in assets as of December 31, 2004, and homebuilding sales of $51.9 million for the year ended December 31, 2004. One Las Olas, Ltd. is a limited partnership currently developing Las Olas River House, a luxury high-rise condominium development in Ft. Lauderdale, Florida. The recourse debt of these VIEs of $92.6 million is collateralized by the carrying value of the pledged assets of $246.7 million. Two of these VIEs have mortgages of $53.6 million that are non-recourse to the general assets of Tarragon.
Real estate and depreciation. Real estate held for investment is carried at cost unless an impairment is determined to exist. We periodically evaluate whether events or changes in circumstances indicate that the carrying value of any of our properties held for investment may not be recoverable. This evaluation generally consists of a review of the property’s cash flow and current and projected market conditions, as well as any changes in general and local economic conditions. If an impairment loss exists based on the results of this review, the asset’s carrying value is written down to estimated fair value with a charge against current earnings. In 2004, we recorded an impairment charge to reduce the carrying value of a tract of land in our Homebuilding Division by $733,000 after entering into a contract for sale, reducing its carrying value to equal the sales value. Additionally, we recorded an impairment charge to the carrying value of a shopping center in our Investment Division after determining its value had been impaired. An impairment charge of $400,000 was recorded to reduce its carrying value to its estimated fair value. The fair value was determined using a broker’s opinion of value from a national real estate investment brokerage company.
We capitalize improvements and major rehabilitation projects that increase the value of the respective property and have useful lives greater than one year except for individual expenditures less than $10,000 that are not part of a planned renovation project. Under this policy, during 2004, expenditures of $9.4 million were capitalized, and property replacements of $3.6 million were expensed. Property replacements expensed include, but are not limited to, such items as landscaping, common area improvements, and apartment upgrades. Depreciation is
provided against real estate held for investment by the straight-line method over the estimated useful lives of the assets, as summarized in the following table. Real estate held for sale is not depreciated.
Properties for which firm contracts for sale are in place are reclassified to held for sale. We cease depreciating the properties in the month following their reclassification to held for sale. These properties remain classified as held for sale until sold or until we decide to discontinue marketing efforts.
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
When properties are reclassified from held for sale to held for investment, we resume depreciating them in the month of their reclassification, and depreciation expense is adjusted to record depreciation for the time during which the properties were classified as held for sale. Real estate held for sale is carried at the lower of cost or estimated fair value less estimated costs to sell.
In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” which we adopted January 1, 2002, operating results for assets sold or held for sale are presented as discontinued operations for current and all prior years presented.
Homebuilding inventory. Homebuilding inventory consists of land, condominium conversions, and condominium, townhome, and single-family home site developments. Homebuilding inventory, including capitalized interest and real estate taxes, is carried at the lower of cost or fair value determined by evaluation of individual projects. Whenever events or circumstances indicate that the carrying value of homebuilding inventory may not be recoverable, the related assets are written down to their estimated fair value less selling costs.
Capitalized interest. We capitalize interest on funds used in constructing property from the date of initiation of construction activities through the time the property is ready for leasing or sale. Interest of $14.2 million, $1.7 million, and $850,000 was capitalized during 2004, 2003, and 2002, respectively. Total interest incurred for 2004, 2003, and 2002 was $39.9 million, $25.6 million, and $22.2 million, respectively.
Cash equivalents. We consider all highly liquid debt instruments purchased with maturities of three months or less to be cash equivalents.
Restricted cash. Restricted cash is primarily escrow accounts, generally held by the lenders of certain of our mortgage notes payable, for taxes, insurance, and property repairs and replacements.
Other assets. Other assets consist primarily of notes and interest receivable, tenant accounts receivable, deferred borrowing costs, and prepaid leasing commissions. Deferred borrowing costs are amortized on the straight-line method (which has approximated the effective interest method) over the related loan terms, and such amortization is included in interest expense. Prepaid leasing commissions are amortized to leasing commission expense, included in property operating expenses, on the straight-line method over the related lease terms.
Goodwill. Goodwill was recorded in connection with the acquisitions of Tarragon Realty Advisors and Accord Properties Associates and, until December 31, 2001, was amortized on the straight-line method. We adopted SFAS No.142, “Goodwill and Other Intangible Assets,” on January 1, 2002. SFAS No. 142 requires that goodwill and other intangible assets with indefinite useful lives no longer be amortized but rather carried on the balance sheet as permanent assets. These assets are subject to at least annual assessment for impairment by applying a fair-value-based test.
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Revenue Recognition. Homebuilding sales revenue is typically recognized at the time of closing under the completed contract method. The related profit is recognized when collectibility of the sale price is reasonably assured and the earnings process is substantially complete. When a sale does not meet the requirements for income recognition, profit is deferred until such requirements are met. For mid-rise and high-rise condominium developments, where construction typically takes eighteen months or more, the percentage-of-completion method is employed. Under this method, once construction is beyond a preliminary stage, buyers are committed to the extent of being unable to require refunds except for non-delivery of the home, a substantial percentage of homes are under firm contracts, the sale prices are deemed collectible, and remaining costs and revenues can be reasonably estimated, revenue is recorded as a portion of the value of non-cancelable sale contracts. Revenue recognized is calculated based upon the percentage of construction costs incurred in relation to total estimated construction costs. Any amounts due under sale contracts, to the extent recognized as revenue, are recorded as contracts receivable.
Rental revenue is recognized on the straight-line method. Lease terms for our apartment communities are generally for one year or less. Lease terms for our commercial properties are generally from three to five years, although they may be shorter or longer. Rental concessions are deferred and amortized on the straight-line method over the lease terms as a reduction to rental revenue. We accrue percentage rentals only after the tenants’ sales have reached the threshold provided for in the lease.
Interest and management fee revenue are recognized when earned. Revenue from long term laundry and cable service contracts is deferred and amortized to income on the straight-line method over the terms of the contracts.
Gains on Sale of Real Estate. Gains on sales of real estate are recognized when and to the extent permitted by SFAS No. 66 - “Accounting for Sales of Real Estate.” Until the requirements of SFAS No. 66 for full profit recognition have been met, transactions are accounted for using the deposit, installment, cost recovery, or financing method, whichever is appropriate.
Investments in noncontrolled partnerships and joint ventures. We use the equity method to account for investments in partnerships and joint ventures over which we exercise significant influence but do not control or which are not required to be consolidated under the provisions of FIN46R as discussed above. Under the equity method, our initial investments are increased by our proportionate share of the partnerships’ or joint ventures’ operating income and additional advances and decreased by our proportionate share of the partnerships’ or joint ventures’ operating losses and distributions received. We determine Tarragon’s proportionate share of the profits or losses of the partnerships and joint ventures consistent with the allocation of cash distributions in accordance with the provisions of SOP 78-9. Our interest in intercompany transactions is eliminated.
Stock splits. In January 2005, the Board of Directors approved a three-for-two stock split effective February 10, 2005. In December 2003, the Board of Directors approved a five-for-four stock split effective January 15, 2004. In January 2003, the Board of Directors approved a three-for-two stock split effective February 14, 2003. Weighted average shares of common stock outstanding and stock options outstanding, granted, exercised, and forfeited in NOTE 8. “STOCK-BASED AWARDS” have been restated to give effect to the stock splits.
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Earnings per common share. Earnings per share of common stock is computed based upon the weighted average number of shares outstanding during each year. All share and per share data have been restated to give effect to the three-for-two stock splits on February 14, 2003, and February 10, 2005, and the five-for-four stock split on January 15, 2004. See NOTE 7. “EARNINGS PER COMMON SHARE.”
Fair value of financial instruments. Disclosure about fair value of financial instruments is based on pertinent information available to us as of December 31, 2004 and 2003. Considerable judgment is necessary to interpret market data and develop estimated fair values. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair values. For these reasons, the estimated fair values presented may differ significantly from the actual amounts we may realize or pay.
As of December 31, 2004 and 2003, we estimate that the carrying amounts for cash and cash equivalents and restricted cash approximate fair value because of the short maturities of these instruments. In addition, the carrying amounts of notes receivable and other liabilities approximate fair value. The fair values of notes payable are estimated by discounting future expected cash flows using current rates for loans with similar terms and maturities. See NOTE 4. “NOTES AND INTEREST PAYABLE” for the disclosure of fair values of notes payable.
Extinguishment of Debt. We adopted SFAS No. 145, “Rescission of FASB Statements 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections” on January 1, 2003. Pursuant to this statement, gains or losses on extinguishment of debt are no longer classified as extraordinary unless they meet the unusual in nature and infrequency of occurrence criteria of Accounting Principles Board Opinion No. 30. Items previously classified as extraordinary have been reclassified to conform to the current presentation.
Stock-based awards. In 2002, we adopted the fair value method defined in SFAS No. 123, “Accounting for Stock-Based Compensation,” in accounting for our stock option plans, where previously we applied Accounting Principles Board’s Opinion No. 25 (“APB No. 25”), “Accounting for Stock Issued to Employees,” and related Interpretations. SFAS No. 123 indicates that the fair value method is the preferable method of accounting. In December 2002, the FASB amended SFAS No. 123 by issuing SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure,” which we adopted upon issuance. We elected to apply the fair value method prospectively, which is one of three methods established by SFAS No. 148, for all options granted since the beginning of 2002. Under APB No. 25, compensation costs related to stock options issued pursuant to compensatory plans are measured based on the difference between the quoted market price of the stock at the measurement date (ordinarily the date of grant) and the exercise price and should be charged to expense over the periods during which the grantee performs the related services. Because awards under the plans vest over five years, the cost related to stock-based employee compensation included in the determination of net income for 2004, 2003, and 2002 is less than that which would have been recognized if the fair value based method had been applied to all awards since the original effective date of SFAS No. 123. The following table illustrates the effect on net income and earnings per common share if the fair value based method had been applied to all outstanding and unvested awards in each period. For more information about our stock option plans, see NOTE 8. “STOCK-BASED AWARDS.”
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Marketing costs. Marketing costs, including advertising, incurred in connection with newly constructed rental apartment communities in lease-up are deferred and amortized to property operating expenses over the lease-up term. Marketing costs incurred in connection with for-sale communities are deferred and recorded as cost of sales when sales revenue is recognized. All other advertising costs are recorded to property operating expenses as incurred.
Concentrations of credit risks. We maintain cash equivalents in accounts with financial institutions in excess of the amount insured by the Federal Deposit Insurance Corporation. The Company monitors the financial stability of the depository institutions regularly, and we do not believe excessive risk of depository institution failure exists at December 31, 2004.
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Employee benefit plan. Tarragon has a defined contribution plan covering substantially all of its employees. Tarragon’s contributions are 401(k) matches determined based on 100% of the first 3% and 50% of the next 2% of the employee’s salary deferrals. Total plan expense was $382,000 in 2004, $330,000 in 2003, and $273,000 in 2002 and is included in corporate and property general and administrative expenses in the accompanying Consolidated Statements of Operations.
Income taxes. We recognize deferred tax assets and liabilities based on the difference between the financial statement and income tax bases of assets and liabilities using the enacted statutory tax rate. A valuation allowance is recorded to the extent realization of deferred tax assets is uncertain.
NOTE 2. MINORITY INTERESTS
In February 2000, Tarragon entered into an agreement to acquire the interests of Robert C. Rohdie and certain of his affiliates in ten apartment communities. Simultaneously, he became a member of our Board of Directors and Chief Executive Officer of Tarragon Development Corporation, a wholly-owned subsidiary of Tarragon. Mr. Rohdie, Tarragon’s partner in the development of these projects, contributed his equity interests to Tarragon Development Company, LLC (“TDC”), a newly formed entity, in exchange for a preferred interest in the entity. For five of the ten properties that had been completed as of the date of the agreement, Mr. Rohdie received a preferred interest with a fair value of $5 million. The initial $5 million of purchase consideration was allocated to the five completed properties based upon their relative fair values. In accordance with the terms of the agreement, the purchase of the remaining five properties, which were in various stages of construction or development planning in February 2000, was contingent upon their completion, as defined in the agreement. During 2001, four of the five remaining apartment communities were completed, as defined in the agreement, and Mr. Rohdie received additional preferred interests in TDC with an aggregate fair value approximating $3.8 million. Mr. Rohdie received an additional preferred interest with a fair value of approximately $1.3 million for one final apartment community in May 2003.
Mr. Rohdie’s preferred interest earns a guaranteed return. For 80% of the preferred interest, it is a guaranteed fixed return of 5% for the first two years, increasing by 1% per year until it reaches 10% in year seven. The remaining 20% of the preferred interest is due an amount equal to cash dividends payable, if any, on 668,097 shares (adjusted to give effect to the February 2005 three-for-two stock split) of Tarragon common stock. Mr. Rohdie received distributions of $375,889 in 2002, $577,722 in 2003, and $421,889 in 2004 in payment of his guaranteed return.
Mr. Rohdie can convert his preferred interest in TDC into 668,097 post-split shares of our common stock and preferred stock with a face value of $8 million and a like dividend to his guaranteed fixed return. If we do not have available an issue of preferred stock outstanding at the time of the conversion, or at our discretion, we may pay the cash value of Mr. Rohdie’s preferred interest over three years. Beginning in February 2006, Mr. Rohdie may elect to convert his preferred interest into cash, payable over three years. The cash value that would be payable for the conversion of the preferred interest is equal to the sum of (1) the liquidation preference multiplied by the number of shares of preferred stock payable upon conversion (483,333 shares as of December 31, 2004) and (2) the market value of 668,097 post-split shares of our common stock. As of December 31, 2004, the cash value was $13,768,163.
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 2. MINORITY INTERESTS (Continued)
Tarragon is the sole manager of TDC and makes all decisions regarding the operation, management, or control of its business and therefore consolidates this entity. Mr. Rohdie’s interest in TDC is presented as a minority interest. The guaranteed fixed return payable to Mr. Rohdie is being recorded based on an annual effective yield of 8.53% and is reflected in “Minority interests in income of consolidated partnerships and joint ventures” in the accompanying Consolidated Statements of Operations.
We purchased the preferred interests of the outside partner in Antelope Pines Estates, L.P., and Woodcreek Garden Apartments, L.P., which were presented as minority interests, in July 2004, for $9.5 million. In the fourth quarter of 2004, we entered into contracts to sell Antelope Pines Apartments and Woodcreek Garden Apartments. The sale of Antelope Pines closed in December 2004, and the sale of Woodcreek Garden closed in January 2005. In accordance with SFAS No. 144, the operating results of these properties, along with the gain on sale of Antelope Pines of $10.9 million, have been presented in discontinued operations for all periods presented in the accompanying Consolidated Statements of Operations. Additionally, assets and liabilities associated with Woodcreek Garden have been presented in “Assets held for sale” and “Liabilities related to assets held for sale” in the accompanying December 31, 2004, Consolidated Balance Sheet. See NOTE 13. “ASSETS HELD FOR SALE.”
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS AND JOINT VENTURES
Investments in and advances to partnerships and joint ventures consisted of the following at December 31:
We exercise significant influence over but hold noncontrolling interests in each of the above partnerships or joint ventures or our outside partners have significant participating rights, as defined in the EITF 96-16, or important rights, as defined by SOP 78-9. Therefore, except to the extent consolidation is required by FIN46 (see note (1) above), we account for our investments in these partnerships and joint ventures using the equity method.
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS AND JOINT VENTURES (Continued)
Ansonia Apartments, L.P. Our partner in Ansonia Apartments is Ansonia LLC, the members of which are Robert Rothenberg, Saul Spitz, Eileen Swenson, Richard and Rebecca Frary, and Joel Mael. Messrs. Rothenberg and Spitz and Ms. Swenson became executive officers of Tarragon, and Mr. Rothenberg was appointed to our Board of Directors, in September 2000. Mr. Frary was appointed as a member of our Board of Directors in April 2004. Mr. Frary is also a partner in Ansonia Liberty, L.L.C., and Tarragon Calistoga, L.L.C.
Tarragon’s investment in Ansonia Apartments was fully recovered in 2002 from distributions to the partners of cash proceeds from property sales, mortgage refinancings, supplemental mortgages, and operations. Distributions in excess of our share of Ansonia’s earnings since then have been included in equity in income of partnerships and joint ventures in the accompanying Consolidated Statements of Operations and total $6.3 million, $8.2 million, and $5.3 million, respectively, for the years ended December 31, 2004, 2003, and 2002.
Hoboken joint ventures. In November 2004, we entered into an agreement to purchase a portion of one of our partners’ interests in various joint venture projects in The Upper Grand neighborhood of Hoboken, New Jersey, for an aggregate purchase price of $15 million. Pursuant to this agreement, we paid $10 million in November 2004 and the balance in February 2005 in exchange for assignments of all of Ursa Development Group, Inc.’s interests in the Block 88 and Adams Street developments, 50% of its interests in the Block 99 development, and 25% of its interests in all other Hoboken joint ventures. In connection with this transaction, we acquired control of Adams Street Development and Block 88 Development and began consolidating them in November 2004. The purchase price was allocated among the interests acquired based on the relative fair values of their projects.
Merritt 8 Acquisitions, L.L.C. In September 2004, we purchased our partner’s interest in this entity, which owns Merritt 8 Office Building in Stratford, Connecticut, for $1.5 million. This entity is now wholly-owned by Tarragon and is consolidated for accounting purposes.
One Las Olas, Ltd. One Las Olas owns our Las Olas River House condominium development in Ft. Lauderdale, Florida. At and prior to December 31, 2003, we accounted for this partnership using the equity method. One Las Olas had total assets at December 31, 2003, of $167.7 million and had total revenue of $97.6 million for the year ended December 31, 2003. Our share of its net income for the year ended December 31, 2003, was $16.3 million, which was reported in equity in income of partnerships and joint ventures in the accompanying Consolidated Statement of Operations for the year ended December 31, 2003. In connection with adoption of the provisions of FIN 46R, we began consolidating this partnership on January 1, 2004.
In January 2005, we acquired our partners’ interests in One Las Olas, 100 East Las Olas/East Las Olas, and Metropolitan Sarasota for $13.7 million and 30,000 (45,000 as adjusted for the February 2005 three-for-two stock split) shares of Tarragon common stock.
Loan Guarantees for Unconsolidated Partnerships and Joint Ventures. We have guaranteed $11 million of mortgages on two unconsolidated properties; $3.5 million relates to a mortgage that matures in 2006 and has a six month extension option, and $7.5 million relates to a mortgage that matures in 2006 with an extension option for one year. We have also guaranteed construction loans totaling $81.5 million on two unconsolidated properties. These loans mature in 2005 and have a balance as of December 31, 2004, of $52.3 million. We have recorded liabilities totaling $392,000 in connection with three of these guarantees. Estimated fair values of other guarantees provided since January 1, 2003, are not significant.
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS AND JOINT VENTURES (Continued)
Below are unaudited summarized financial data for our unconsolidated partnerships and joint ventures as of and for the periods indicated.
December 31, 2004
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS AND JOINT VENTURES (Continued)
December 31, 2003
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS AND JOINT VENTURES (Continued)
NOTE 4. NOTES AND INTEREST PAYABLE
Notes and interest payable consisted of the following at December 31:
Notes payable at December 31, 2004, bear interest at fixed rates from 4.53% to 10% per annum and variable rates currently ranging from 4.13% to 6.25% and mature from 2005 through 2027. The mortgage notes are generally nonrecourse, with the exception of construction loans, and are collateralized by deeds of trust on real estate with an aggregate net carrying value of $698 million.
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 4. NOTES AND INTEREST PAYABLE (Continued)
On September 16, 2004, we completed the sale of $50 million principal amount of 8% Senior Convertible Notes Due 2009 (the “Notes”). The Notes are general, senior, unsecured obligations of Tarragon, bear interest at the rate of 8% per annum and are convertible into Tarragon Common Stock at an initial conversion rate of 81.6993 shares per $1,000 in principal amount of Notes (equal to a conversion price of $12.24 per share of Tarragon Common Stock on a post-split basis), subject to adjustment in certain instances. On November 19, 2004, as a “follow on” offering to the original sale, we sold an additional $12 million of the Notes.
Interest is payable semi-annually in March and September, and the principal balance of the Notes is payable at maturity of September 2009. Prior to September 16, 2007, the Notes are not redeemable. After that date until maturity, we have the right, but not the obligation, upon certain notice to redeem the Notes (in whole or in part) for cash at a redemption price of $1,000 original amount of Note, plus accrued and unpaid interest if the closing price of Tarragon’s Common Stock equals or exceeds 150% of the then applicable conversion price for 20 out of 30 consecutive trading days. The Notes may also be subject to a “put option” by the Holders if a fundamental change occurs, as that term is defined in the Note Indenture. The Notes were sold pursuant to and in reliance upon Rule 144A. The Notes and the Common Stock issuable upon conversion of the Notes are now covered by Registration Statement No. 333-1211258 declared effective by the Commission on January 24, 2005. Tarragon will not receive any proceeds from the sale by the named selling security holders of the Notes or the shares of Common Stock issuable upon conversion of the Notes pursuant to such Registration.
Other notes payable consist of an $8.4 million loan secured by interests in joint ventures and outstanding balances and under lines of credit. We have a bank line of credit secured by mortgages on five properties and Tarragon common stock pledged by affiliates of William S. Friedman, our Chief Executive Officer and Chairman of our Board of Directors. See NOTE 9. “RELATED PARTY TRANSACTIONS.” The line of credit matures in June 2005 and was increased from $16.8 million at December 31, 2003 to $20.2 million at December 31, 2004. At December 31, 2004, $19 million was available to us, and there was no outstanding balance under the line of credit. At December 31, 2003, advances of $1.7 million were included in other notes payable, and advances of $5.3 million were included with mortgages on real estate. We had $8.6 million available at December 31, 2003, under this line of credit. Other notes payable at December 31, 2003, also included a fully utilized $2 million bank line of credit that matured August 2004 and was secured by Tarragon common stock pledged by affiliates of Mr. Friedman. We also have an unused $20 million line of credit with affiliates of Mr. Friedman and an unused $10 million line of credit with a bank. The $10 million bank line of credit matures in July 2005. For the terms of the line of credit with affiliates of Mr. Friedman, see NOTE 9. “RELATED PARTY TRANSACTIONS.”
At December 31, 2004, scheduled principal payments on notes payable are due as follows:
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 5. COMMON STOCK REPURCHASE PROGRAM
The Board of Directors has authorized a common stock repurchase program. In 2004, 2003, and 2002, Tarragon repurchased an aggregate of 754,519 shares of its common stock in open market and negotiated transactions at a cost of $10.9 million. Our cumulative cost of common stock repurchases is $42.9 million. As of December 31, 2004, Tarragon had authorization to repurchase an additional 709,991 common shares.
NOTE 6. 10% CUMULATIVE PREFERRED STOCK
The 10% Cumulative Preferred Stock pays a fixed dividend of $1.20 per year and has a liquidation value of $12 per share. Shares may be redeemed at Tarragon’s option at any time after June 30, 2003, at the liquidation value plus a premium of $0.50 per share which declines by $0.10 per share each year thereafter. No mandatory redemption or “sinking fund” is required.
NOTE 7. EARNINGS PER COMMON SHARE
Earnings per common share have been computed based on the weighted average number of shares of common stock outstanding. Following is a reconciliation of earnings per common share and earnings per common share - assuming dilution. The information has been restated to give effect to the three-for-two stock splits in February 2003 and February 2005 and the five-for-four stock split in January 2004.
The convertible preferred interest of minority partner in consolidated joint venture represents the preferred interest of Mr. Rohdie in a joint venture we consolidate (see NOTE 2. “MINORITY INTERESTS.”) His preferred interest became convertible in February 2001. For the year ended December 31, 2002, his interest was convertible into 668,096 shares (as adjusted for January 2005 three-for-two stock split). However, their
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 7. EARNINGS PER COMMON SHARE (Continued)
effect is not reflected in weighted average shares of common stock outstanding - assuming dilution in 2002 because their effect is antidilutive due to a loss from continuing operations allocable to common stockholders.
On a weighted average basis, options to purchase 4,435,494 shares of common stock at a price of $4.07 and 5,446,865 shares at $3.83 per share in 2004 and 2003, respectively, were outstanding during those years. During 2004 and 2003, the exercise prices of all options were less than the market prices of the common stock.
On a weighted average basis, options to purchase 5,165,844 shares at $3.67 per share in 2002 were outstanding during 2002 but were not reflected in the computation of weighted average shares of common stock outstanding - assuming dilution because their effect was antidilutive.
NOTE 8. STOCK-BASED AWARDS
Tarragon has an Independent Director Stock Option Plan (the “Director Plan”), a Share Option and Incentive Plan, and an Omnibus Plan (collectively, the “Option Plans”). Under Tarragon’s Director Plan, Independent Directors receive annual awards of options to purchase up to 2,000 shares of Tarragon common stock on January 1 of each year. The options are immediately exercisable and expire on the earlier of the first anniversary of the date on which the director ceases to serve as a director or ten years from the date of grant.
Under Tarragon’s Share Option and Incentive Plan, incentive stock options have been awarded to officers and employees of Tarragon and its subsidiaries. These stock options vest between one and five years from the date of grant and expire ten years thereafter, unless the optionees’ relationship with Tarragon terminates earlier.
On June 14, 2004, our stockholders approved the adoption of an Omnibus Plan for employee options and stock-based awards. Under this Plan, we have a maximum of two million shares of common stock available for issuance, including an aggregate of one million shares of common stock that are available for issuance of awards other than stock options. The Plan authorizes the award of incentive stock options and non-qualified stock options to our employees, as well as restricted or unrestricted stock awards or stock units; dividend equivalent rights; other stock based awards, including stock appreciation rights payable in stock or cash; and performance based and annual incentive awards.
As of December 31, 2004, shares of common stock available for grant under the Director Plan were 125,022, the Share Option and Incentive Plan were 437,511, and the Omnibus Plan were 1.9 million.
The following table summarizes stock option activity:
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 8. STOCK-BASED AWARDS (Continued)
In 2004, we also granted stock appreciation rights from the Omnibus Plan on 105,300 shares at a weighted average price of $19.69 (shares and price adjusted for the February 2005 three-for-two stock split). These stock appreciation rights have ten-year terms, are limited in appreciation to $15 per share, and may be settled only in common stock of Tarragon. Of these stock appreciation rights, 7,800 with a weighted average exercise price of $19.45 were exercisable at December 31, 2004. The balance of the stock appreciation rights vest over three years from the date of grant. The weighted average grant-date fair value of stock appreciation rights granted in 2004 was $2.52.
The fair value of each option and stock appreciation right is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 8. STOCK-BASED AWARDS (Continued)
The following table summarizes information about the options outstanding at December 31, 2004:
In January 2005, we granted options covering 12,000 shares under the Director Plan, all of which were immediately exercisable. We also granted 201,536 stock appreciation rights under the Omnibus Plan. Also, 52,264 of the options outstanding at December 31, 2004, were exercised in the first two months of 2005.
NOTE 9. RELATED PARTY TRANSACTIONS
With the approval of our Board of Directors, affiliates of William S. Friedman and his wife, Lucy N. Friedman have made a $20 million unsecured line of credit available to us. Advances under the line of credit bear interest at LIBOR plus 1% per annum or the lowest rate at which credit is offered to us by any third party. The line of credit matures in January 2006. We incurred interest on this line of credit of $12,000 in 2004, $2,000 in 2003, and $228,000 in 2002. At December 31, 2004, there was no outstanding balance under the line of credit.
As an accommodation to us, Mr. and Mrs. Friedman and their affiliates have pledged approximately 1.6 million shares of Tarragon common stock to secure a $20.2 million line of credit with a bank. In addition, Mr. Friedman pledged approximately 375,000 shares of Tarragon common stock to secure a $2.0 million line of credit extended to the company by another bank, which was repaid in full and expired by its terms in August 2004. We have agreed to indemnify Mr. and Mrs. Friedman and their affiliates from any loss, cost, or liability associated with these accommodation pledges or the lines of credit. As collateral for our indemnification obligations, we have agreed to pledge shares of our treasury stock to Mr. and Mrs. Friedman and their affiliates.
During 2002, Tarragon received payment in full on notes receivable of $1.6 million and $541,000, respectively, from Robert P. Rothenberg, our President and Chief Operating Officer and a member of the Board of Directors of Tarragon, and Saul Spitz, Executive Vice President of Acquisitions for Tarragon. These loans were made to Messrs. Rothenberg and Spitz in connection with their required contributions to Ansonia Apartments, L.P., in 2001. The notes were paid from the proportionate share of distributions to Messrs. Rothenberg and Spitz from Ansonia. Tarragon recognized interest income totaling $136,000 in 2002 from these two notes.
Prior to 2004, Tarragon provided property management services for rental properties owned by affiliates of Mr. Friedman. Tarragon received property management fees of $15,000 in 2003 and $28,000 in 2002 from these properties. In addition, in 2002, Tarragon received $97,000 for services in refinancing properties owned by affiliates of Mr. Friedman.
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 9. RELATED PARTY TRANSACTIONS (Continued)
Tarragon provides asset and property management services for certain properties owned by partnerships and joint ventures accounted for by the equity method. Tarragon received management fees of $1.5 million in 2004, $1.7 million in 2003, and $1.4 million in 2002 from these properties and recognized as income $374,000, $414,000, and $346,000 for the portion of the fee allocable to our joint venture partners. The remaining portion of the fees was treated as a return of our investment.
In 2003 and 2002, Tarragon recognized as interest income $678,000 and $129,000, respectively, on advances to One Las Olas, Ltd., a partnership that we accounted for on the equity method until January 1, 2004. The income recognized was the portion of the interest allocable to our partners. The remainder of the interest was treated as a reduction of project costs of Las Olas River House. Since the January 1, 2004, consolidation of this partnership, none of the interest on advances is recognized as income in Tarragon’s Consolidated Statement of Operation for the year ended December 31, 2004.
Tarragon recognized income of $61,000 in 2004 and $291,000 in 2003 in connection with development and construction of one of our homebuilding projects in which outside partners hold an interest. The income represents the portion of a manager’s fee allocable to the outside partners’ interest.
NOTE 10. INCOME TAXES
In 2004, the provision for income taxes includes current federal taxes of $1.3 million, current state taxes of $600,000, deferred federal taxes of $11.6 million, and deferred state taxes of $1.5 million. No current or deferred income tax expense was recognized in 2003 or 2002 due to the application of net operating loss carryforwards. A reconciliation of computed income taxes to actual income taxes follows:
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 10. INCOME TAXES (Continued)
The following table discloses the components of the deferred tax amounts at December 31, 2004 and 2003:
At December 31, 2004, Tarragon had Federal net operating loss carryforwards of approximately $6.2 million expiring between 2005 and 2021.
In 2004, Tarragon’s provision for income taxes is net of the reversal of a valuation allowance against net deferred tax assets of $9.8 million. The valuation allowance from December 31, 2003, was reversed during the second quarter of 2004 as it was determined that realization of Tarragon’s deferred tax asset was more likely than not.
NOTE 11. RENTALS UNDER OPERATING LEASES
Tarragon’s rental operations include the leasing of office buildings and shopping centers subject to leases with terms greater than one year. The leases thereon expire at various dates through 2020. The following is a schedule of future minimum rentals on non-cancelable operating leases as of December 31, 2004:
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 12. COMMITMENTS AND CONTINGENCIES
Tarragon is not aware of any liability relating to federal, state, and local environmental laws, ordinances, and regulations that would have a material adverse effect on our business, financial position, or results of operations. In April 2003, in connection with the condominium conversion of Pine Crest Village at Victoria Park, a contractor for Tarragon may have inadvertently disturbed asbestos-containing materials. Such actions are currently under investigation by the Environmental Protection Agency and may result in civil and/or criminal proceedings under applicable law. The extent of any resulting liability is unknown at this time. We have incurred legal and other professional fees and costs of relocating residents in connection with this matter totaling $448,000 to date. Remediation has been completed at a total cost of $795,000.
In December 2004, Tarragon was notified by its general liability insurer that it was withdrawing coverage for Orlando Central Park Tarragon, LLC, one of our subsidiaries, in connection with a negligence action pending in state court in Florida for personal injuries and damages allegedly suffered by the plaintiff as a result of the use of an insecticide at the property. The extent of the property owner’s liability for the plaintiff’s claims is unknown at this time.
Tarragon is also party to various claims and routine litigation arising in the ordinary course of business. We do not believe that the results of such claims and litigation, individually or in the aggregate, will have a material adverse effect on our business, financial position, or results of operations.
The following is a schedule of future minimum lease payments due on a ground lease in Paramus, New Jersey, that expires in 2061, and on leases for office space occupied by Tarragon that expire in 2009. Under terms of the ground lease, the minimum lease payments increase by 10% every fifth year. Tarragon has the right to acquire the land on expiration of the lease at 70% of its fair market value as determined at that time.
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 13. ASSETS HELD FOR SALE
Assets held for sale and liabilities related to assets held for sale in the accompanying Consolidated Balance Sheets include the following:
The December 31, 2004, amounts include balances related to an apartment community under contract for sale at December 31, 2004, and sold in January 2005. At December 31, 2003, we had no assets classified as held for sale.
In accordance with Statement of Financial Accounting Standards No. 144, operating results for properties for which we implemented plans of disposal after the adoption of this pronouncement have been reported in discontinued operations. Discontinued operations for the years ended December 31, 2004, 2003 and 2002, include the operations of fourteen properties sold since the beginning of 2002 and one property held for sale as of December 31, 2004, which were previously reported in the Investment Division. The results of these operations were as follows:
In March 2005, our Board of Directors approved a plan to sell substantially all of our Investment Division properties. The properties subject to our plan of disposition will be classified as Assets Held for Sale as of March 31, 2005, and their results of operations will be presented in discontinued operations in 2005.
NOTE 14. SEGMENT REPORTING
Our business is divided into two principal segments - homebuilding and the operation of our investment portfolio. Our Homebuilding Division has become the main focus of our business in terms of financial and human capital. Our activities in the Homebuilding Division encompass condominium conversions of existing apartment communities, the development of town homes, carriage homes, and new, mid-rise or high-rise
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 14. SEGMENT REPORTING (Continued)
condominiums for sale to residents, the sale of single-family home sites to homebuilders, and development of new investment properties, primarily apartment communities, which, upon stabilization, become part of our investment portfolio. From the beginning of 2002 until the fourth quarter of 2003, we reported development of for-sale housing and development of new rental properties separately. We now view these activities as consistent with the objectives of the Homebuilding Division and report them together.
Our investment portfolio of stabilized apartment communities and commercial properties is the largest segment in terms of assets. Funds generated by the operation, sale, or refinancing of properties in the investment portfolio support our overhead and finance our homebuilding activities. We reclassify rental properties from the Homebuilding Division to the Investment Division once they have achieved stabilized operations, as defined below. We reclassify properties from the Investment Division to the Homebuilding Division if we have initiated renovation, reposition, or condominium conversion activities.
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 14. SEGMENT REPORTING (Continued)
Homebuilding. For-sale assets in this division include luxury mid-rise and high-rise condominiums and townhouses under development and existing apartment communities under conversion to condominiums. They also include single-family home sites for sale to homebuilders. Communities under development and/or being marketed for sale at December 31, 2004, include the following.
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 14. SEGMENT REPORTING (Continued)
Also included in the Homebuilding Division are rental communities under development or in initial lease-up, existing rental communities under renovation or reposition, and land held for development or sale. Apartments under development or in lease-up or under reposition include 658 consolidated units and 90 units owned through consolidated partnerships and joint ventures.
We measure the performance of our Homebuilding Division primarily by gross profit from home sales. Intercompany sales, which represent the transfer of properties from the Homebuilding Division to the Investment Division, are also included in the following operating statements for the Homebuilding Division.
The sale prices for these properties were their estimated fair market values as of the date of transfer, and the cost of sales was their net carrying values as of the same date. Gains on transfers of assets between segments do not represent gains recognizable in accordance with GAAP and, accordingly, are eliminated for purposes of consolidated reporting. Beginning in 2004, properties are transferred between divisions at cost, and we do not report intercompany sales.
Investment. This division includes properties with stabilized operations. We consider a property stabilized when development or renovation is substantially complete and recurring operating income exceeds operating expenses and debt service. Prior to 2003, we defined stabilized properties as completed properties with stabilized market rate occupancy at market rents for comparable product in the property’s market and which are subject to neither renovation nor repositioning. The Investment Division has 9,563 consolidated stabilized apartments and 3,868 stabilized apartments owned through unconsolidated partnerships and joint ventures. It also has consolidated commercial properties with 1.3 million square feet and commercial properties owned through unconsolidated partnerships and joint ventures with 62,229 square feet.
We use net operating income to measure the performance of our Investment Division. Net operating income is defined as rental revenue less property operating expenses (excluding depreciation). We believe net operating income is an important supplemental measure of operating performance of our investment properties because it provides a measure of the core operations of the properties. Additionally, we believe that net operating income, as defined, is a widely accepted measure of comparative operating performance in the real estate investment community. We believe that net income is the most directly comparable GAAP measure to net operating income. The operating statements for the Investment Division present reconciliations of Investment Division net operating income to Investment Division net income.
We allocate our general and administrative expenses between the segments based on the functions of the corporate departments. We allocate other corporate items, including interest income, management fee and other revenue, minority interests in income of consolidated partnerships and joint ventures, litigation settlement, and insurance and other claims that are not directly associated with one of our divisions in the same proportions as general and administrative expenses are allocated. Income taxes are not allocated between the divisions.
Following are operating statements and balance sheets for our two divisions and net operating income for our Investment Division. In our segment operating statements, we do not distinguish between consolidated and unconsolidated properties. We have provided a reconciliation of segment revenues to consolidated revenue following the operating statements, balance sheets, and summary of investment division net operating income.
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 14. SEGMENT REPORTING (Continued)
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 14. SEGMENT REPORTING (Continued)
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 14. SEGMENT REPORTING (Continued)
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 14. SEGMENT REPORTING (Continued)
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 14. SEGMENT REPORTING (Continued)
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 15. QUARTERLY RESULTS OF OPERATIONS
The following is a tabulation of the quarterly results of operations for the years ended December 31, 2004 and 2003 (unaudited). The quarterly results of operations have been restated to present the operating results of 12 properties sold in 2004 and 2003 and one property held for sale at December 31, 2004, in discontinued operations in accordance with SFAS No. 144.
In the fourth quarter of 2004, we made an adjustment to correct deferred tax liabilities, which increased income tax expense by approximately $2.1 million.
TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 15. QUARTERLY RESULTS OF OPERATIONS (Continued)
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders of
Tarragon Corporation
In connection with our audits of the consolidated financial statements of Tarragon Corporation and Subsidiaries referred to in our report dated March 15, 2005, which is included in Part IV of this Form 10-K, we have also audited Schedules II and III for each of the three years in the period ended December 31, 2004. In our opinion, these schedules present fairly, in all material respects in relation to the financial statements taken as a whole, the information required to be set forth therein.
/s/ GRANT THORNTON LLP
Dallas, Texas
March 15, 2005
SCHEDULE II
TARRAGON CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
FOR THE THREE YEARS ENDED DECEMBER 31, 2004
(Dollars in Thousands)
(A) Utilization of carryforwards
SCHEDULE III
TARRAGON CORPORATION
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2004
(Dollars in Thousands)
SCHEDULE III
TARRAGON CORPORATION
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2004
(Dollars in Thousands)
SCHEDULE III
TARRAGON CORPORATION
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2004
(Dollars in Thousands)
SCHEDULE III
TARRAGON CORPORATION
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2004
(Dollars in Thousands)
(A)
Includes property improvements, impairment charges, and amounts written off in connection with sales of portions of certain properties.
(B)
Construction of this property began in November 2004.
(C)
These properties are under construction and are expected to be completed in 2005.
(D)
Mortgage is collateralized by both Desert Winds and Silver Creek.
(E)
The loan is collateralized by both portions of this property. This property was sold, and the loan repaid, in February 2005.
(F)
This property was pledged as additional collateral for the $1.5 million loan on the 820 land in Ft. Worth, TX.
SCHEDULE III
(Continued)
TARRAGON CORPORATION
REAL ESTATE AND ACCUMULATED DEPRECIATION
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTINGAND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and our principal financial officer, as appropriate, to allow timely decisions regarding required disclosures. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Our management, with the participation of our principal executive officer and our principal financial officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2004, and has concluded they were ineffective as of December 31, 2004. This conclusion was based on the identification of a control deficiency in our internal control over financial reporting that constitutes a material weakness as discussed below in management’s report on internal control over financial reporting.
There was no change in our internal control over financial reporting that occurred during the quarter ended December 31, 2004, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. In connection with our evaluation and testing activities outlined above, management identified a control deficiency in its internal controls over financial reporting as of December 31, 2004, which constitutes a “material weakness” within the meaning of the Public Company Accounting Oversight Board Auditing Standard No. 2. The material weakness relates to the company’s accounting for income taxes. The year-end closing processes resulted in untimely identification of adjustments to the deferred tax liabilities. As a result, an error was discovered that affected the second quarter 2004 provision for income taxes. Management undertook exhaustive efforts to obtain relevant tax and accounting records to support the deferred tax assets and liabilities as of December 31, 2004, and believes that the financial statements are properly stated in accordance with generally accepted accounting principles. Management intends to evaluate the need for additional resources dedicated to accounting for income taxes.
Based on the material weakness described above, management has concluded that internal control over financial reporting was ineffective at December 31, 2004.
Our management's assessment of the effectiveness of our internal control over financial reporting as of December 31, 2004 has been audited by Grant Thornton LLP, an independent registered public accounting firm, as stated in their report which is included herein.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders of
Tarragon Corporation
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Tarragon Corporation (Company) did not maintain effective internal control over financial reporting as of December 31, 2004, because of the effect of the material weakness identified in management’s assessment, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Tarragon’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States of America). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weakness has been identified and included in management’s assessment:
The year-end closing processes resulted in untimely identification of adjustments to the deferred tax liabilities. As a result, an error was discovered that affected the second quarter 2004 provision for income taxes.
The aforementioned material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2004 consolidated financial statements, and this report does not affect our report dated March 15, 2005, which expressed an unqualified opinion on those financial statements.
In our opinion, management’s assessment that Tarragon did not maintain effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also in our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, Tarragon has not maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
/s/ GRANT THORNTON LLP
Dallas, Texas
March 15, 2005
PART III
The information required by Part III has been omitted from this report. We will file a definitive proxy statement with the SEC pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report. Certain information to be included in the proxy statement is incorporated by reference into this report. Only those sections of the proxy statement which specifically address Items 10 through 14 below are incorporated by reference. Such incorporation does not include the performance graph included in the proxy statement.
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
We have adopted a code of conduct that applies to all Directors, officers and employees, including our principal executive officer, principal financial officer and principal accounting officer. You can find our code of conduct on our website by going to our website address at http://www.tarragoncorp.com and clicking on the link for “Investor Relations,” followed by “Governance Documents” to the link entitled “Code of Business Conduct and Ethics.” We will post any amendments to the code of conduct, as well as any waivers that are required to be disclosed by the rules of the SEC or the NASDAQ Stock Market on our website.
Our Board of Directors has adopted charters for Audit, Executive Compensation and Corporate Governance and Nominating Committees of the Board of Directors. You can find these documents on our website by going to our website address at http://www.tarragoncorp.com and clicking on the link for “Investor Relations,” followed by “Governance Documents,” and clicking on the appropriate link.
You can also obtain a printed copy of the materials referred to above by contacting us at the following address:
Tarragon Corporation
Attn: Investor Relations
1775 Broadway, 23rd Floor
New York, New York 10019
Telephone: 212-949-5000
The Audit Committee of our Board of Directors is an “audit committee” for purposes of Section 3(a)(58) of the Securities Exchange Act of 1934. The members of that Committee are Lawrence G. Schafran (Chairman), Raymond V.J. Schrag and Willie K. Davis.
Apart from certain information concerning our executive officers which is set forth in Part I of this Report, the other information required by this Item is incorporated by reference to the applicable information in our Proxy Statement to be filed with the SEC in connection with our Annual Meeting of Stockholders to be held in June 2005.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to our proxy statement to be filed with the SEC in connection with our annual meeting of stockholders to be held in June 2005.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference to our proxy statement to be filed with the SEC in connection with our annual meeting of stockholders to be held in June 2005.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference to our proxy statement to be filed with the SEC in connection with our annual meeting of stockholders to be held in June 2005.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item is incorporated by reference to our proxy statement to be filed with the SEC in connection with our annual meeting of stockholders to be held in June 2005.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
The following documents are filed as part of this Report:
1. Consolidated Financial Statements
Reports of Independent Registered Public Accounting Firm - Grant Thornton LLP
Consolidated Balance Sheets - December 31, 2004 and 2003
Consolidated Statements of Operations -
Years Ended December 31, 2004, 2003, and 2002
Consolidated Statements of Stockholders’ Equity -
Years Ended December 31, 2004, 2003, and 2002
Consolidated Statements of Cash Flows -
Years Ended December 31, 2004, 2003, and 2002
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
Schedule II - Valuation and Qualifying Accounts
Schedule III - Real Estate and Accumulated Depreciation
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. Exhibits
The following documents are filed as Exhibits to this report:
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES (Continued)
* Filed herewith
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.
TARRAGON CORPORATION
Dated: March 16, 2005
By:
/s/ William S. Friedman
William S. Friedman
Chief Executive Officer, Director,
and Chairman of the Board
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.
TARRAGON CORPORATION
INDEX TO EXHIBITS
* Filed herewith