Item 1.
Business
Overview
We are a real estate investment company focused on investing in office, industrial and retail properties located in the Midwest and South Central regions of the United States. We target properties located in the area bounded by Minnesota and Texas to the north and south, and by Illinois and Colorado to the east and west, although we will consider properties outside this target area if we identify attractive opportunities. We believe these markets are currently underserved in financing and market transaction options for which we can provide advantageous solutions. We believe the size and location of opportunities in this region will be a desirable fit for our real estate portfolio and can be pursued at attractive yields.
Corporate Information and History
We were incorporated in the State of Utah on November 1, 2007, for the sole purpose of becoming the holding company of Guidebook, which converted from a Utah limited liability company to a Utah corporation on November 1, 2007. Guidebook was organized in the State of Utah as a limited liability company on June 16, 2003 and was focused on providing “do-it-yourself” instructional manuals for residential electrical, plumbing, and remodeling applications. On June 7, 2013, we entered into contribution agreements with members of 5130 Industrial Street, LLC (“5130 LLC”), and TalonRE, and with Talon OP, L.P. (“Talon OP”), collectively referred to as the “Formation Transactions” and changed our name to Talon Real Estate Holding Corp. On June 7, 2013, we sold all of the outstanding shares of Guidebook to Kim McReynolds, divesting ourselves of our historic “do-it-yourself” instructional manual business. The purchase price for the divestiture primarily consisted of the buyer’s agreement for Guidebook to indemnify and hold our company harmless from certain liabilities arising from the sale.
Substantially all of our assets are held by, and our operations are conducted through, Talon OP, which we refer to as our Operating Partnership. We are the sole general partner of the Operating Partnership, and, as such, we generally have the exclusive power to manage and conduct the business and affairs of the Operating Partnership, subject to certain limited approval and voting rights of the limited partners, which are described more fully herein. As of December 31, 2014, we owned 64.5% of the common units of the Operating Partnership which holds our portfolio of commercial properties.
Organizational Structure
We intend to elect to be taxed as a REIT no sooner than the calendar year in which we qualify to be taxed as such under the Revenue Code, and it is advantageous to our shareholders for the Company to do so. Because we plan to conduct substantially all of our operations through our Operating Partnership, we intend to utilize an Umbrella Partnership Real Estate Investment Trust structure, or UPREIT, although we are currently not a REIT. This structure is designed to provide tax deferral benefits to property owners who contribute their property to our company. We believe using an UPREIT structure will give us an advantage in acquiring properties from persons who may not otherwise sell their properties because of unfavorable tax consequences or it may make our offer more competitive than the pure cash buyer. The UPREIT structure allows deferral of gain recognition by an owner of appreciated real estate if that owner contributes the real estate to the Operating Partnership in exchange for partnership interest. The contributor’s gain is deferred until the partnership interest is exchanged for our holding company’s common stock.
Our principal executive offices are located at 5500 Wayzata Boulevard Suite 1070, Minneapolis, Minnesota and our telephone number is 612-604-4600. Our web address is www.talonreit.com. The information on, or otherwise accessible through, our website does not constitute a part of this report or any other report or document we file with or furnish to the Securities and Exchange Commission.
Distribution Policy
We intend to make quarterly distributions to our common shareholders when available. Upon electing REIT status, U.S. federal income tax law requires that a REIT distribute annually at least 90% of its net taxable income, excluding net capital gains, and that it pay tax at regular corporate rates to the extent that it annually distributes less than 100% of its REIT taxable income, including capital gains.
To the extent that in respect of any calendar year after we have elected to become a REIT, cash available for distribution is less than our taxable income, we could be required to sell assets to make cash distributions or make a portion of the required distribution in the form of a taxable stock distribution or distribution of debt securities. We generally will not be required to make distributions with respect to activities conducted through any TRS.
Dividends and other distributions will be authorized by our board of directors in its sole discretion out of funds legally available therefor and will be dependent upon a number of factors, including actual results of operations, restrictions under the law of our state of organization, our financial condition, our need to meet the distribution requirements of a REIT when elected, and other factors described below. We cannot assure you that our distributions will be made or sustained or that our board of directors will not change our distribution policy in the future. Any dividends or other distributions we pay in the future will depend upon our actual results of operations, economic conditions, debt service requirements and other factors that could differ materially from our current expectations. Our actual results of operations will be affected by a number of factors, including the revenue we receive from our assets, our operating expenses, interest expense and unanticipated expenditures. For more information regarding risk factors that could materially adversely affect our actual results of operations, please see “Risk Factors.”
We anticipate that our distributions generally will be taxable as ordinary income to our shareholders, although a portion of the distributions may be designated by us as qualified dividend income or capital gain, or may constitute a return of capital. We will furnish annually to each of our shareholders a statement setting forth distributions paid during the preceding year and their characterization as ordinary income, return of capital, qualified dividend income or capital gain.
Our Strategy
Commercial real estate trends have been negative for an extended period of time but we believe that there is evidence that the real estate market is in recovery. We believe there may be many potential sellers that are seeking an exit strategy now or in the near future and we may be able to offer these sellers some advantages that make us a more competitive buyer. Our objective is to accumulate quality properties at attractive yields as the economy continues its recovery.
We believe there is significant opportunity to acquire quality property by providing liquidity to the market. We believe that our structure will provide investors more liquid equity with diversified real estate exposure. In turn, we anticipate that we will encourage real property owners to sell their properties to us increasing the size of our company and providing us with more diversified real estate exposure. We provide tax-advantageous solutions for property owners due to our UPREIT operating structure. This structure is advantageous for real estate owners seeking to mitigate and defer their immediate tax obligations, stay invested in real estate, diversify their holdings, and seek potential future growth and liquidity by accepting Talon OP common units which can later be converted on a one for one basis for Talon Real Estate Holding Corp. common stock under the ticker “TALR” and/or Talon OP preferred units which provide rights to certain distributions and can later be redeemed for the liquidation preference and any accrued and unpaid distributions.
Our strategy is to offer these tax-deferred solutions to real estate owners as part of diversifying our shareholder base, creating liquidity and shareholder value. We continue to believe office and industrial properties offer the most attractive return on equity metrics currently. Retail will also be part our overall portfolio but we anticipate it will contribute less to the overall target portfolio over the long-term than office and industrial properties.
The middle corridor of the United States continues to offer higher cap rates compared to the west and east coasts and we will continue to explore additional investment options within this region to continue our mission to provide competitive returns in our sector.
We seek to provide investors the opportunity to have liquidity with real estate exposure in a geographically diversified portfolio with tactical asset allocation. Our strategy is to expand our property holdings to seek diversification by focusing on the following key elements:
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We will target office, industrial and retail properties between Minnesota and Texas to the north and south, and Illinois and Colorado to the east and west, ranging in size from 10,000 to 500,000 square feet although we may acquire properties outside of these parameters.
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The target market value for our properties is expected to be in the range of $1.0 million to $50 million, although we might acquire larger or smaller properties depending on the opportunities available to us and our access to capital or ability to issue equity interests as consideration.
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Our target properties ideally will be strategically situated in metropolitan areas not traditionally explored by institutional investors. These may include secondary and tertiary markets in our geographic territory.
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We plan to invest in both core income-producing properties requiring relatively small improvements or enhancements and value-added properties that will require more significant investments of capital or management attention (including, but not limited to, leasing vacant space or extending expiring leases) that we expect to provide current income as well as the increased potential for higher long-term value to our company. Our long-term plan is to invest in value-added properties while maintaining a significant part of our portfolio in core properties. Our investment allocation between these two types of properties may significantly fluctuate in the short term as we seek the best opportunities.
Our Competitive Strengths
We believe the following competitive strengths distinguish us from other property owners and will enable us to capitalize on the economic conditions in our target real estate markets as we seek to expand our portfolio:
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Experienced Management Team with Extensive Experience and Network. Our management team, led by MG Kaminski, our Chief Executive Officer, and Eun Stowell, our Chief Financial Officer, has extensive experience in the real estate industry and has cultivated an extensive network of contacts that we expect to tap to identify acquisition opportunities. Mr. Kaminski has over 25 years of experience in purchasing, selling, managing, leasing, and constructing commercial real estate where he owned over 2.6 million square feet. This square footage represented 32 buildings in office, industrial and retail space. His further experience includes financing and structuring real estate deals through traditional banking institutions and brokerage firms. This diverse and extensive experience in all aspects of commercial real estate creates unique insight in the day-to-day operations as well as strategic portfolio level management of commercial properties. He is well prepared to respond to all manners of tenant, property, financing and market issues, and he has significant knowledge and an extensive network of contacts in the Minneapolis/St. Paul metropolitan area and other similar markets in the Midwest to drive the acquisition and financing pipeline. He also has significant asset management experience, serving as President of Wayzata Capital Management, LLC from August 1996 to December 2012. Ms. Stowell has worked in the investment industry her entire professional career and the last decade in the real estate industry. She most recently served as Chief Compliance Officer, Director of Finance and Accounting, and Collateralized Debt Obligation (CDO) Portfolio Manager at Castle Peak Capital Advisors, LLC, an asset management company investing and managing primarily residential mortgage loans and mortgage-backed securities, from December 2008 until joining us in June 2013. Prior to Castle Peak, she worked at both private and public investment firms as well as a large CPA firm and holds an inactive CPA license from the state of Minnesota. We believe our management team’s significant experience will help us successfully identify and execute on opportunities for expansion.
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Committed and Incentivized Management Team. Our management team is committed to our operations and growth. As of December 31, 2014, our management team owned approximately 46% of our common stock thereby aligning management’s interests with those of our shareholders. We expect management will continue to hold a significant ownership interest in our company in the foreseeable future including if we become subject to the ownership requirements under the Code for qualification as a REIT. To comply with these requirements, not more than 50% of the value of the outstanding shares of our stock (after taking into account options to acquire shares of stock) may be owned, directly, indirectly or through attribution, by five or fewer individuals at any time during the last half of a taxable year (other than the first year for which an election to be a REIT has been made). Our board of directors has significant experience in leadership roles for both private and public companies and we expect that they will be an invaluable source of leadership for our company.
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Disciplined Approach to Underwriting and Due Diligence. Before acquiring a property, our team of real estate investment professionals, led by Mr. Kaminski and Ms. Stowell, will apply a disciplined underwriting and due diligence process. The due diligence process will focus on identifying properties in our target market that are located in metropolitan areas with historically strong, stable economies and stable or growing populations, with an emphasis on areas of growth within these metropolitan areas. We also will focus on identifying properties that can be acquired at prices we believe represent a strong value for any reason.
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UPREIT Structure. Because we intend to conduct our operations through the Operating Partnership, our organizational structure will be considered an Umbrella Partnership Real Estate Investment Trust, referred to in our industry as an UPREIT. This structure is designed to provide tax deferral benefits to property owners who contribute their property to our company. We believe using an UPREIT structure will give us an advantage in acquiring properties from persons who may not otherwise sell their properties because of unfavorable tax results. Generally, a sale or contribution of property directly to a REIT is a taxable transaction to the selling property owner. In an UPREIT structure, a seller of a property who desires to defer taxable gain on the sale of property may contribute the property to the Operating Partnership in exchange for (i) common units in the partnership and defer taxation of gain until the seller later elects to require the Operating Partnership to redeem all (but not less than all) of their common units for cash equal to the then-current value of an equal number of shares of our common stock (determined in accordance with and subject to adjustment under the partnership agreement of our Operating Partnership), or, at our election, as the sole general partner, on behalf of the Operating Partnership, to exchange their common units for shares of our common stock on a one-for-one basis, subject to certain adjustments and the restrictions on ownership and transfer of our stock or the Operating Partnership sells the property and/or (ii) Talon OP preferred units which provide rights to certain distributions and can later be redeemed for the liquidation preference and any accrued and unpaid distributions. This ability to offer tax-deferred purchase terms could make us a more attractive buyer to some property sellers.
Competition
We believe that the competition for leasing the properties we own and for completing acquisition opportunities we may target is highly fragmented. We compete with REITs, institutional investors, public and private real estate companies, as well as other commercial real estate operators and developers who have properties in our vicinity and the areas where we target acquisitions. We believe that the following competitive factors influence our ability to attract tenants to our current properties: location, price and terms, the appearance of properties and the speed at which we can execute leases.
As leases at the properties we own and any future properties we may acquire expire, we may encounter significant competition to renew or re-lease space. As a result, we may be required to provide rent concessions or abatements, incur charges for tenant improvements and other inducements, including early termination rights or below-market renewal options, or we may not be able to timely lease vacant space. In that case, our financial condition, results of operations, cash flow, per share trading price of our common stock and ability to satisfy our debt service obligations and to pay dividends may be adversely affected.
We believe that the following competitive factors will influence our ability to acquire additional properties and grow our business: offer price, access to capital and ability to quickly identify and consummate transactions. Competition may have the effect of reducing the number of suitable acquisition opportunities available to us and increase the price required to consummate an acquisition opportunity. Likewise, competition with sellers of similar properties to locate suitable purchasers may result in us receiving lower proceeds from any sale we might seek to make or in us not being able to dispose of a property at a time of our choosing due to the lack of an acceptable return.
Acquisition Pipeline
We are actively pursuing multiple property acquisition opportunities in different states throughout our primary geographic region. We are continually engaging in internal research as well as informal discussions with various parties regarding our potential interest in these types of potential acquisitions. On January 23, 2015, Talon OP had entered into a purchase agreement with Hoopeston I, L.L.C. and Broadmoor Place Associates, LLC to acquire an office building with approximately 115,811 rentable square feet located in Mission, Kansas. The building is currently 90% occupied and fits well in our target acquisition strategy. We expect to finance the acquisition of this property with some debt and are currently completing due diligence and financing activity customary for this type of transaction.
There is no assurance that any currently available properties will remain available, or that we will pursue or complete any of these potential acquisitions, at prices acceptable to us or at all.
Talon RE, a wholly owned subsidiary of our Operating Partnership, has entered into a contribution agreement to acquire a 51% interest in 5130 LLC, subject to receiving consent to the transfer from the entity’s lender. 5130 LLC owns an industrial complex consisting of two properties with approximately 171,639 rentable square feet located in Maple Plain, Minnesota.
Our Current Property Interests
We currently own four properties located in and around the Minneapolis-St. Paul metropolitan area of Minnesota.
On June 7, 2013, we acquired a 49% interest in an entity that owns an industrial complex consisting of two buildings with approximately 171,639 square feet located in the Minneapolis-St. Paul metropolitan area. The buildings currently have a combined occupancy of 81%. We have entered into a contribution agreement to acquire the remaining interest in this entity, subject to receiving consent to the transfer from the entity’s lender.
During 2014, we completed two acquisitions with a purchase price totaling approximately $58 Million and over 1 million in gross building square feet. On May 29, 2014, we completed the acquisition of a 227,000 square foot building situated on 20 acres of land in Minnetonka, MN that is currently about 90% occupied primarily by over 100 tenants who are wholesale distributors. On July 2, 2014, we completed the acquisition of a thirteen story office tower located in downtown St. Paul, MN totaling 856,223 total building square feet that was 62% occupied at time of acquisition and is currently about 66% occupied by corporate and government tenants.
The following table sets forth information regarding our top 5 largest tenants as of December 31, 2014.
(1)
The two properties located in Maple Plain, MN lease approximately 14% of the Company’s rentable space and account for approximately 10% of the Company’s total base rent revenues for the year ended December 31, 2014. The property located in Minnetonka, MN leases approximately 15% of the Company’s rentable space and accounts for approximately 19% of the Company’s total base rent revenues for the year ended December 31, 2014. No major tenants are located at the property in Minnetonka, MN. The property located in St. Paul, MN leases approximately 44% of the Company’s rentable space and accounts for approximately 71% of the Company’s total base rent revenues for the year ended December 31, 2014.
(2)
The two properties located in Maple Plain, MN were acquired June 7, 2013. The property located in Minnetonka, MN was acquired on May 29, 2014. The property located in St. Paul, MN was acquired on July 2, 2014. Rent included in this table represents only base rent earned by the Company since acquisition date for the year ended December 31, 2014.
The future square feet expiring for the current leases in place as of December 31, 2014 are as follows:
Years ending December 31,
Financings and Leverage Policy
We anticipate using a number of different sources to finance our acquisitions and operations, including cash flows from operations, issuance of debt securities or equity securities (which might be shares of our common or preferred stock or limited partnership units in the Operating Partnership that are redeemable for our common stock or provide rights to certain distributions), private financings (such as additional bank credit facilities, which may or may not be secured by our assets), asset sales, seller financing, property-level mortgage debt, or any combination of these sources, to the extent available to us, or other sources that may become available from time to time. Any debt that we incur may be recourse or non-recourse and may be secured or unsecured. We also might consider joint venture or other partnering opportunities as they arise in order to acquire properties that would otherwise be unavailable to us. We may use the proceeds of our borrowings to acquire assets, to refinance existing debt or for general corporate purposes.
Although we are not required to maintain any particular leverage ratio, we intend, when appropriate, to employ prudent amounts of leverage and to use debt as a means of providing additional funds for the acquisition of assets, to refinance existing debt or for general corporate purposes. We expect to use leverage conservatively, assessing the appropriateness of new equity or debt capital based on market conditions, including prudent assumptions regarding future cash flow, the creditworthiness of tenants and future rental rates. Our articles of incorporation and bylaws do not limit the amount of debt that we may incur. As of December 31, 2014, our ratio of debt to total assets (net of accumulated depreciation) was approximately 80% based on the net depreciated cost of our properties.
Our board of directors will consider a number of factors in evaluating the amount of debt that we may incur. Our board of directors may from time to time modify its views regarding the appropriate amount of debt financing in light of then-current economic conditions, relative costs of debt and equity capital, market value of our portfolio, general conditions in the market for debt and equity securities, fluctuations in the market price of our common stock, growth and acquisition opportunities and other factors. Our decision to use leverage in the future to finance our assets will be at our discretion and will not be subject to the approval of our shareholders.
Regulation
Properties in which we plan to invest are subject to various covenants, laws, ordinances and regulations, including environmental regulations and regulations relating to common areas and fire and safety requirements.
Americans with Disabilities Act
Properties in which we plan to invest are subject to Title III of Americans with Disabilities Act, or the ADA, to the extent that such properties are “public accommodations” as defined by the ADA. The ADA may require removal of structural barriers to access by persons with disabilities in certain public areas of our properties where such removal is readily achievable.
Environmental Matters
Under various federal, state and local laws and regulations relating to the environment, as a current or former owner or operator of real property, we may be liable for costs and damages resulting from the presence or discharge of hazardous or toxic substances, waste or petroleum products at, on, in, under, or migrating from such property or properties, including costs to investigate, clean up such contamination and liability for natural resources. Such laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the presence of such contamination, and the liability may be joint and several. These liabilities could be substantial and the cost of any required remediation, removal, fines, or other costs could exceed the value of the property and/or our aggregate assets. In addition, the presence of contamination or the failure to remediate contamination at any properties we own or acquire may expose us to third-party liability for costs of remediation and/or personal or property damage or may materially adversely affect our ability to sell, lease or develop the properties or to borrow using such property or properties as collateral. In addition, environmental laws may create liens on contaminated sites in favor of the government for damages and costs it incurs to address such contamination. Moreover, if contamination is discovered on any properties we own or acquire, environmental laws may impose restrictions on the manner in which the property may be used or businesses may be operated, and these restrictions may require substantial expenditures.
The properties we own, and any properties we acquire in the future, may contain, have contained, or be adjacent to or near other properties that have contained or currently contain storage tanks for the storage of petroleum products or other hazardous or toxic substances. Similarly, any properties we own or acquire might have been used in the past for commercial or industrial purposes that involve or involved the use of petroleum products or other hazardous or toxic substances, or are adjacent to or near properties that have been or are used for similar commercial or industrial purposes. As a result, such property or properties may have been or may be impacted by contamination arising from the releases of such hazardous substances or petroleum products. If we deem it appropriate in the future, we may take steps to address identified contamination or mitigate risks associated with such contamination; however, we are unable to ensure that further actions will not be necessary. As a result of the foregoing, we could potentially incur material liabilities.
Environmental laws also govern the presence, maintenance and removal of asbestos-containing building materials, or ACBM, and may impose fines and penalties for failure to comply with these requirements or expose us to third-party liability (e.g., liability for personal injury associated with exposure to asbestos). Such laws require that owners or operators of buildings containing ACBM (and employers in such buildings) properly manage and maintain the asbestos, adequately notify or train those who may come into contact with asbestos, and undertake special precautions, including removal or other abatement, if asbestos would be disturbed during renovation or demolition of a building. Any properties we own or acquire may contain ACBM and we could be liable for such damages, fines or penalties.
In addition, the properties we own or acquire will be, subject to various federal, state, and local environmental and health and safety requirements, such as state and local fire requirements. Such environmental and health and safety laws and regulations could subject us or our tenants to liability resulting from activities on the properties or the failure to comply with such requirements. Environmental liabilities could affect a tenant’s ability to make rental payments to us. In addition, changes in laws could increase the potential liability for noncompliance. The costs associated with such liability could be substantial and could have a material adverse effect on us.
When excessive moisture accumulates in buildings or on building materials, mold growth may occur, particularly if the moisture problem remains undiscovered or is not addressed over a period of time. Some molds may produce airborne toxins or irritants. Indoor air quality issues can also stem from inadequate ventilation, chemical contamination from indoor or outdoor sources, and other biological contaminants such as pollen, viruses and bacteria. Indoor exposure to airborne toxins or irritants above certain levels have been alleged to cause a variety of adverse health effects and symptoms, including allergic or other reactions. As a result, the presence of significant mold or other airborne contaminants at the properties we own or acquire could require us to undertake a costly remediation program to contain or remove the mold or other airborne contaminants from the affected property or increase indoor ventilation. In addition, the presence of significant mold or other airborne contaminants could expose us to liability from our tenants, employees of our tenants or others if property damage or personal injury occurs. We are not presently aware of any material adverse indoor air quality issues at our current properties.
REIT Qualification
We intend to elect to be taxed as a REIT for the calendar year in which we qualify to be taxed as such under the Revenue Code and it is advantageous to the shareholders to do so. The earliest we could qualify would be our taxable year ending on December 31, 2015. Our qualification as a REIT will depend upon our ability to meet on a continuing basis, through actual investment and operating results, various complex requirements under the Code relating to, among other things, the sources of our gross income, the composition and values of our assets, our distribution levels and the diversity of ownership of our shares. We believe that we have been organized in conformity with the requirements for qualification and taxation as a REIT under the Code, and that our intended manner of operation will enable us to meet the requirements for qualification and taxation as a REIT. We intend to amend our articles to include certain restrictions to enable us to meet the requirements for qualification and taxation as a REIT.
So long as we qualify as a REIT, we generally will not be subject to U.S. federal income tax on our REIT taxable income we distribute currently to our shareholders. If we fail to qualify as a REIT in any taxable year and do not qualify for certain statutory relief provisions, we will be subject to U.S. federal income tax at regular corporate rates and may be precluded from qualifying as a REIT for the subsequent four taxable years following the year during which we lose our REIT qualification. Even if we qualify for taxation as a REIT, we may be subject to certain U.S. federal, state and local taxes on our income or property. In addition, any TRS we own will be subject to U.S. federal, state and local taxes on its income or property.
Investment Company Act of 1940
We intend to conduct our operations so that neither we nor any of our subsidiaries are required to register as an investment company under the Investment Company Act of 1940.
Risk Management
Our risk management activities are overseen by our board of directors. We will face various forms of risk in our business ranging from broad economic, commercial and industrial market and interest rate trends to more specific factors such as credit risk related to our tenants, leasing of properties and competition for properties. See also “Risk Factors.” We believe that the real estate market and credit risk expertise developed by our Chief Executive Officer and Chief Financial Officer will allow us to navigate these risks.
Insurance
We currently maintain property, liability, and umbrella coverage under a blanket policy for the each property. We believe the policy specifications and insured limits covering our properties are appropriate and adequate given the relative risk of loss, the cost of the coverage and industry practice; however, our insurance coverage may not be sufficient to fully cover our losses.
Employees
We have structured our operations in a manner that minimizes overhead and relies on third parties to supply experience and expertise necessary to identify and exploit potential acquisition opportunities. We will attempt to minimize general and administrative expenses by maintaining adequate levels of overhead and staff while outsourcing operational duties to consultants and independent contractors where appropriate. We currently have five full-time employees, but expect to eventually hire more employees appropriate for the development of our business.
Executive Officers
Set forth below are the names, ages and titles of the persons serving as our executive officers.
Name
Age
Position
MG Kaminski
Chief Executive Officer
Eun Stowell
Chief Financial Officer
MG Kaminski has served as our Chief Executive Officer and a Director since June 7, 2013. Mr. Kaminski has over 25 years of experience in managed, leased, and constructed real estate. Prior to joining us, he served as President of a variety of real estate companies, including Kasa Real Estate, LLC, a real estate property management company, from December 2010 to June 7, 2013, WP Construction, LLC, a real estate construction company, from May 2006 to December 2012, Wayzata Properties, LLC, a real estate management company, from December 2003 to December 2011 and WP Brokerage, LLC, a leasing real estate company, from October 2005 to December 2010. Mr. Kaminski also has significant asset management experience, serving as President of Wayzata Capital Management, LLC from August 1996 to December 2012. Mr. Kaminski’s qualifications to serve on our board of directors include, among other skills and qualifications, his extensive experience as a manager and in the real estate industry.
On May 18, 2012, the Hennepin County District Court appointed Colliers International as a receiver for the 555,945 sq. ft. Parkdale office park in St. Louis Park, MN. The property is owned by Parkdale Properties, LLC., for which Mr. Kaminski served as chief manager.
On June 28, 2011, a court appointed Cassidy Turley as a receiver for the 67,000 sq. ft. Boatworks building in Wayzata, MN. The property is owned by Bay Holdings, LLC, for which Mr. Kaminski served as chief manager.
Eun Stowell has served as our Chief Financial Officer since June 7, 2013. Prior to joining us, Ms. Stowell served as Chief Financial Officer at Talon Real Estate, LLC from April 1, 2013 to June 7, 2013 and as Chief Compliance Officer, Director of Finance and Accounting, and CDO Portfolio Manager at Castle Peak Capital Advisers, LLC, a private equity investment company and registered investment adviser, from December 2008 to April 2013. Prior to her work at Castle Peak Capital Advisers, Ms. Stowell was a portfolio manager among other various roles at GMAC-Rescap, LLC, a financial services company that focused on residential real estate loans and securities. Prior to that, she worked at a multi-strategy private investment firm and KPMG LLP. Ms. Stowell holds an inactive CPA license from the state of Minnesota.
Item 1A.
Item 1A.
Risk Factors
Set forth below and elsewhere in this Annual Report on Form 10-K, and in other documents we file with the Securities and Exchange Commission, are risks and uncertainties that could cause our actual results to differ materially from the results contemplated by the forward-looking statements contained in this Annual Report on Form 10-K and in other written and oral communications from time to time. Our business could be harmed by any of these risks. The trading price of our common stock could decline due to any of these risks. In assessing these risks, you should also refer to the other information contained in this Annual Report on Form 10-K, including our financial statements and related notes.
RISKS RELATED TO OUR BUSINESS AND FINANCIAL CONDITION
We are a company with limited operating history for you to evaluate our business.
Our predecessor was incorporated in the State of Utah on November 1, 2007, for the sole purpose of becoming the holding company of Guidebook, which focuses on providing “do-it-yourself” instructional manuals for residential electrical, plumbing, and remodeling applications. We divested Guidebook in connection with the transactions forming our current business. We formed our Operating Partnership in June 2013 and currently are engaged in the business of investing in office, industrial and retail properties located in our target markets. We have a limited operating history for you to consider in evaluating our business and prospects. In addition, our business plan involves significant expansion of our real estate holdings that have not been agreed upon as of the date of this filing. As a result, it is difficult for potential investors to evaluate our business and prospects.
Our operations are subject to all of the risks, difficulties, complications and delays frequently encountered in connection with the formation of any new business, as well as those risks that are specific to the real estate industry.
Our business plan requires additional liquidity and capital resources that might not be available on terms that are favorable to us, or at all, which raises substantial doubt about our ability to continue as a going concern or restricts our ability to grow and adversely affect our results of operations.
We currently do not have available cash and cash flows from current operations to provide us with adequate liquidity for the foreseeable future. Our current liabilities exceed our unrestricted cash and we have very limited cash flow from current operations. As of December 31, 2014, we had unrestricted cash of $147,157 and current liabilities including accounts payable and accrued expenses substantially in excess of the available cash. We therefore will require additional capital and/or increased cash flow from future operations to fund our ongoing business. There is no guarantee that we will be able to raise any required additional capital or generate sufficient cash flow from our current and future operations to fund our ongoing business. If the amount of capital we are able to raise together with our income from operations is not sufficient to satisfy our capital needs, we may be required to cease our operations or alter our growth plans. If we are unable to continue as a going concern, we may have to liquidate our assets and may receive less than the value at which those assets are carried on our consolidated financial statements, and it is likely that investors will lose all or a part of their investment.
Any additional capital raised through the sale of equity or the issuance of equity in connection with property acquisitions may dilute the ownership percentage of our shareholders. This could also result in a decrease in the fair market value of our equity securities because our assets would be owned by a larger pool of outstanding equity. The terms of securities we issue in future capital transactions may be more favorable to our new investors, and may include preferences, superior voting rights and the issuance of warrants or other derivative securities, and issuances of incentive awards under equity employee incentive plans, which may have a further dilutive effect. Debt financing, if available, may involve restrictive covenants or additional security interests in our assets and would increase our expenses due to interest payment requirements.
Our ability to obtain needed financing may be impaired by such factors as the capital markets (both generally and in the real estate industry in particular), our status as a new enterprise without a significant demonstrated operating history, the substantial doubt about our ability to continue as a going concern, and/or the loss of key management.
We may incur substantial costs in pursuing future capital financing, including investment banking fees, legal fees, accounting fees, securities law compliance fees, printing and distribution expenses and other costs. We may also be required to recognize non-cash expenses in connection with certain securities we may issue, such as convertible notes and warrants, which may adversely impact our financial condition and results of operations.
We own a 49% interest in one of our real estate investments and therefore do not exercise voting control over the property.
Our Operating Partnership currently owns a 49% interest in an entity that owns an industrial complex located in the Minneapolis-St. Paul metropolitan area. An affiliate of MG Kaminski, our Chief Executive Officer, owns the other 51% interest in the entity. Talon RE, a wholly owned subsidiary of our Operating Partnership, entered into a contribution agreement with Mr. Kaminski to acquire his remaining interest in the entity, subject to receiving consent to the transfer from the entity’s lender, but there can be no assurance that the lender will consent to the transfer or that we will ever acquire a controlling interest in the entity that owns the complex.
Our current non-controlling interest in the industrial complex and any future co-investments we might make with third parties through partnerships, joint ventures or other entities are subject to a variety of risks. For example, we might not be in a position to exercise sole decision-making authority regarding the property subject to a co-investment. Partners or co-venturers in a co-investment also might become bankrupt or fail to satisfy their obligations with respect to a property. Partners or co-venturers may have economic or other business interests or goals which are inconsistent with our business interests or goals, and may be in a position to take actions contrary to our policies or objectives, and they may have competing interests in our markets that could create conflict of interest issues. Such investments may also have the potential risk of impasses on decisions, such as a sale, because neither we nor the partner or co-venturer would have full control over the partnership or joint venture. In addition, prior consent of any joint venture partners may be required for a sale or transfer to a third party of our interests in the joint venture, which would restrict our ability to dispose of our interest in the joint venture. If we become a limited partner or non-managing member in any partnership or limited liability company and such entity takes or expects to take actions that could jeopardize our status as a REIT or require us to pay tax, we may be forced to dispose of our interest in such entity. Disputes between us and partners or co-venturers may result in litigation or arbitration that would increase our expenses and prevent our officers or directors from focusing their time and effort on our business. Consequently, actions by or disputes with partners or co-venturers might result in subjecting any properties owned by the partnership or joint venture to additional risk. In addition, we may in certain circumstances be liable for the actions of our third-party partners or co-venturers. Any such joint ventures may be subject to debt and the refinancing of such debt may require equity capital calls.
Our lack of diversification increases the risk of an investment in our company, and our financial condition and results of operations may deteriorate if we fail to diversify.
We currently own an interest in four commercial properties located in the Minneapolis-St. Paul area. Although we intend to continue to acquire additional properties for our portfolio, our ability to diversify our portfolio will depend on our access to additional capital and financing sources and the availability of suitable acquisition targets. We also intend to finance some acquisitions with shares of our company’s common stock or the Operating Partnership’s limited partnership units so our ability to diversify may also depend on the willingness of real estate owners to exchange their real estate holdings for such securities, which we anticipate will have limited liquidity. Until such time as we are able to diversify our property holdings, if at all, our results of operations will depend on economic conditions in the Minneapolis-St. Paul area and could fluctuate significantly depending on local economic factors that are outside of our control. In addition, natural disasters in this area, such as tornados, could significantly damage our only current property and materially and adversely affect our financial condition, results of operations and prospects.
As of December 31, 2014, there was approximately $48.7 million of indebtedness outstanding securing the buildings in which we have an interest, which could expose us to default, prevent the disposition of any of the properties or result in a significant loss upon disposition of any of the properties.
The appraised value or purchase price of acquired properties are not necessarily equal to the fair market value or the consideration we would receive if we disposed of the properties in arm’s length transactions. If the fair market value of the any property is less than the amount of outstanding debt secured by the property, the entity that owns the property might not be able to dispose of it or, if it does dispose of the property, it could be at a substantial loss that would adversely affect our results of operations and financial condition. In addition, payments of principal and interest on the indebtedness related to the property may require us to contribute cash resources to operate the property, and indebtedness on any future properties we may acquire or seek to acquire in the future could leave us with insufficient cash resources to operate our business or to pay dividends to our shareholders.
We are not in compliance with the financial covenants under our loan agreement with Bell State Bank & Trust, and Bell State Bank & Trust may accelerate the loan, which would have a material adverse effect on our cash flows and results of operations for the period and the year in which the payment would be made.
Pursuant to the loan agreement with Bell State Bank & Trust, Talon Bren Road LLC must comply with the debt service coverage ratio ("DSCR") test which requires maintenance of a debt service coverage ratio of 1.35 to 1.00 as of the last day of each fiscal year for the period of 12 months ending on such date, commencing December 31, 2014. As of December 31, 2014, Talon Bren Road LLC was out of compliance with the DSCR test. The Company made an additional principal payment of $258,857 on September 25, 2014 which caused the DSCR to be reduced to 1.18 for the year ended December 31, 2014 which is below the required ratio. Failure to meet the debt service coverage ratio covenant allows the lender to declare an event of default under the terms of the loan agreement and cause all outstanding unpaid principal balance of the loan and all accrued and unpaid interest thereon to be immediately due. The lender is aware of such noncompliance, and we are seeking modification of the loan agreement and/or waiver of this covenant. However, there is no assurance the lender will agree to such modification and/or waiver, and a declaration of default and acceleration of the loan by the lender could have a material adverse effect on cash flows and results of operations for the period and the year in which the payment would be made. In addition, we may be unable to borrow or obtain sufficient funds for repayment on terms acceptable to us or at all, and our ability to obtain future financing may also be impacted negatively.
We are dependent on key personnel and need to hire additional qualified personnel for our business to succeed.
Our performance is substantially dependent on the performance of our senior management, including MG Kaminski, our Chief Executive Officer, and Eun Stowell, our Chief Financial Officer. The loss of the services of any of our executive officers could have a material adverse effect on our business, results of operations and our financial condition. Our future success also depends on our continuing ability to attract and retain highly qualified managerial and other personnel. Competition for such personnel is intense and we may not be able to retain our key managerial and other employees or may not be able to attract and retain additional highly qualified managerial and other personnel in the future. The inability to attract and retain the necessary managerial and other personnel could have a material adverse effect upon our business, results of operations and financial condition.
Properties formerly managed by our Chief Executive Officer have been placed into receivership.
MG Kaminski, our Chief Executive Officer, has over 25 years of experience in the real estate business. In those years, he has acquired, financed, managed, leased and constructed properties. With the downturn in the U.S. economy and specifically the real estate markets beginning in 2008, he experienced significant setbacks. In 2009, properties owned by Mr. Kaminski and his affiliates experienced rapid vacancies and in order to compete for remaining leases, rents were dropped dramatically, almost 50% in some cases, to retain and attract tenants. During that depressed real estate market of high vacancies and greatly reduced rents, some of these properties could not cover their debt payments and could not be refinanced. Those properties were placed into receivership in 2011 and 2012. There is no assurance that properties we acquire or manage will produce adequate cash flow and will not be placed in receivership.
We may not be able to operate as a REIT and our management team has no REIT experience.
Our board of directors and executive officers have no prior experience operating a REIT. There is a risk that the past experience of our management team will not be sufficient to operate our company as a REIT. We may not qualify to elect REIT status for the taxable year ending December 31, 2015, or at all. Our failure to qualify as a REIT may have an adverse effect on our tax position, financial condition, results of operations, cash flow and trading price of our common stock.
Our management team has never run a public company.
Our executive officers have no prior experience operating a publicly-traded company. There is a risk that the past experience of our management team will not be sufficient to timely meet disclosure requirements of the Securities and Exchange Commission (the “SEC”) or otherwise comply with securities laws applicable to publicly-traded companies. Our failure to operate as a public company would have an adverse effect on our financial condition, results of operations, cash flow and trading price of our common stock.
If we fail to maintain proper and effective internal controls, our ability to produce accurate and timely financial statements could be impaired, and investors’ views of us could be harmed.
Our company relies on limited accounting personnel to execute our accounting processes and limited other supervisory resources with which to address our internal control over financial reporting. Our ability to prepare financial statements in accordance with generally accepted accounting principles may be adversely impacted if we do not establish and maintain effective internal controls. Failure to implement required, or new or improved controls, or the difficulties encountered in the implementation of such controls, could harm our results of operations, cause us to fail to meet our reporting obligations or lead to a loss of investor confidence.
Our insurance may be inadequate to cover liabilities we may incur.
Our ownership of real property may result in us becoming subject to liability for pollution, property damage, personal injury, death or other hazards. Although we expect to obtain insurance in accordance with industry standards to address such risks, such insurance has limitations on liability that may not be sufficient to cover the full extent of such liabilities. In addition, such risks may not, in all circumstances, be insurable or, in certain circumstances, we may choose not to obtain insurance to protect against specific risks due to the high premiums associated with such insurance or for other reasons. The payment of such uninsured liabilities would reduce the funds available to us. If we suffer a significant event or occurrence that is not fully insured, or if the insurer of such event is not solvent, we could be required to divert funds from capital investment or other uses towards covering our liability for such events, and we may not be able to continue to obtain insurance on commercially reasonable terms.
We rely on revenues derived from key tenants.
We derive significant revenues from certain key tenants. We could be adversely affected in the event of the bankruptcy or insolvency of, or a downturn in the business of, any of our key tenants, or in the event that any such tenant does not renew its leases as they expire or renews such leases at lower rental rates. See "Item 1 - Our Current Property Interests" for quantified information with respect to the percentage of our minimum rents received from major tenants.
RISKS RELATED TO OUR INDUSTRY
Our ownership of commercial real estate involves a number of risks, the effects of which could adversely affect our business.
General economic and market risks. In periods during, or following, a general economic decline or recessionary climate, our assets may not generate sufficient cash to pay expenses, service debt or cover maintenance, and, as a result, our results of operations, cash flows and ability to pay dividends (if any) may be adversely affected. Several factors may adversely affect the economic performance and value of our properties. These factors include, among other things:
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changes in the national, regional and local economic climate;
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local real estate conditions such as an oversupply of properties or a reduction in demand for properties;
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the attractiveness of our properties to tenants or buyers;
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competition from other available properties;
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changes in market rental rates and related concessions granted to tenants such as free rent, tenant allowances and tenant improvement allowances; and
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the need to periodically repair, renovate and re-lease space.
Uncertain economic conditions may adversely impact current or future tenants and, accordingly, could affect their ability to pay rents owed to us pursuant to their leases. In periods of economic uncertainty, tenants are more likely to close less profitable locations or to declare bankruptcy, and, pursuant to various bankruptcy laws, leases may be rejected and thereby terminated. Furthermore, our ability to sell or lease our properties at favorable rates, or at all, may be negatively impacted by general or local economic conditions.
Our ability to collect rent from tenants may affect our ability to pay for adequate maintenance, insurance and other operating costs. Also, the expense of owning and operating a property is not necessarily reduced when circumstances such as market factors cause a reduction in income from the property. If a property is mortgaged and we are unable to meet the mortgage payments, the lender could foreclose on the mortgage and take title to the property. In addition, interest rate levels, the availability of financing, changes in laws and governmental regulations (including those governing usage, zoning and taxes) may adversely affect our financial condition.
Leasing risk. Our operating revenues are dependent upon entering into leases with and collecting rents from tenants. In uncertain economic times, tenants whose leases are expiring may desire to decrease the space they lease or may be unwilling to continue their lease. When leases expire or are terminated, replacement tenants may not be available upon acceptable terms and market rental rates may be lower than the previous contractual rental rates. Also, during uncertain economic conditions, tenants may approach us for additional concessions in order to remain open and operating. The granting of these concessions may adversely affect our results of operations and cash flows to the extent that they result in reduced rental rates, additional capital improvements, or allowances paid to or on behalf of the tenants.
Uninsured losses and condemnation costs. Accidents, terrorism incidents, tornados or other acts of God and other losses at our properties for any reason could adversely affect our operating results. Casualties may occur that significantly damage an operating property, and insurance proceeds may be less than the total loss incurred by us. We maintain casualty insurance under policies we believe to be appropriate, but some types of losses, such as those related to the termination of longer-term leases and other contracts, generally are not insured. Certain types of insurance may not be available or may be available on terms that could result in large uninsured losses. Property ownership also involves potential liability to third parties for such matters as personal injuries occurring on the property. Such losses may not be fully insured. In addition to uninsured losses, various government authorities may condemn all or parts of operating properties. Such condemnations could adversely affect the viability of such projects.
Environmental issues. Environmental issues that arise at our properties could have an adverse effect on our financial condition and results of operations. Federal, state and local laws and regulations relating to the protection of the environment may require a current or previous owner or operator of real estate to investigate and clean up hazardous or toxic substances or petroleum product releases at a property. If determined to be liable, the owner or operator may have to pay a governmental entity or third parties for property damage and for investigation and clean-up costs incurred by such parties in connection with the contamination, or perform such investigation and clean-up itself. Although certain legal protections may be available to prospective purchasers of property, these laws typically impose clean-up responsibility and liability without regard to whether the owner or operator knew of or caused the presence of the regulated substances. Even if more than one person may have been responsible for the release of regulated substances at the property, each person covered by the environmental laws may be held responsible for all of the clean-up costs incurred. In addition, third parties may sue the owner or operator of a site for damages and costs resulting from regulated substances emanating from that site. Unidentified environmental liabilities could have an adverse effect on our financial condition and results of operations.
Liquidity risk. Real estate investments are relatively illiquid and can be difficult to sell and convert to cash quickly, especially if market conditions are not favorable. As a result, our ability to sell one or more of our properties, whether in response to any changes in economic or other conditions or in response to a change in strategy, may be limited. In the event we want to sell a property, we may not be able to do so in the desired time period, the sales price of the property may not meet our expectations or requirements, and we may be required to record an impairment loss on the property as a result.
We face possible risks associated with the physical effects of climate change.
We cannot assert with certainty whether climate change is occurring and, if so, at what rate. However, the physical effects of climate change could have a material adverse effect on our properties, operations and business. To the extent climate change causes changes in weather patterns, our markets could experience increases in storm intensity and rising sea-levels. Over time, these conditions could result in declining demand for office space in our buildings or our inability to operate the buildings at all. Climate change may also have indirect effects on our business by increasing the cost of (or making unavailable) property insurance on terms we find acceptable, increasing the cost of energy and increasing the cost of snow removal at our properties. There can be no assurance that climate change will not have a material adverse effect on our properties, operations or business.
Data security breaches may cause damage to our business and reputation.
In the ordinary course of our business we maintain sensitive data, including our proprietary business information and the information of our tenants and business partners, in our networks. Notwithstanding the security measures undertaken, our information technology may be vulnerable to attacks or breaches resulting in proprietary information being publicly disclosed, lost or stolen. There can be no assurance that our security efforts and measures will be effective or that attempted security breaches or disruptions would not be successful or damaging. Protected information, networks, systems and facilities remain vulnerable because the techniques used in such attempted security breaches evolve and may not be recognized or detected until launched against a target. Accordingly, we may be unable to anticipate these techniques or to implement adequate security barriers or other preventative measures.
Data and security breaches could:

disrupt the proper functioning of our networks and systems and therefore our operations and/or those of our client tenants;

result in misstated financial reports, violations of loan covenants, missed reporting deadlines, and/or missed permitting deadlines;

result in our inability to properly monitor our compliance with the rules and regulations regarding our qualification as a REIT;

result in the unauthorized access to, and destruction, loss, theft, misappropriation, or release of proprietary, confidential, sensitive, or otherwise valuable information of ours or others, which others could use to compete against us or for disruptive, destructive, or otherwise harmful purposes and outcomes;

result in our inability to maintain the building systems relied upon by our client tenants for the efficient use of their leased space;

require significant management attention and resources to remedy any damages that result;

subject us to claims for breach of contract, damages, credits, penalties, or termination of leases or other agreements; and/or

damage our reputation among our client tenants and investors generally.
Competition may impede our ability to attract or retain tenants or re-let space, which could materially and adversely affect us.
We face significant competition for tenants from other owners and operators of office, industrial and retail properties in the Minneapolis-St. Paul area and expect to experience similarly significant competition in areas where we acquire additional properties. These competitors may possess more substantial resources and access to capital than we have, as well as greater expertise or flexibility in designing space to meet prospective tenants’ needs, or may be more willing, especially in difficult economic times, to make space available to prospective tenants at lower prices than comparable spaces in our properties. Thus, competition could negatively affect our ability to attract and retain tenants and may reduce the rents we are able to charge, which could materially and adversely affect us.
Compliance or failure to comply with federal, state and local regulatory requirements could result in substantial costs.
Our properties are subject to various federal, state and local regulatory requirements, such as the Americans with Disabilities Act and state and local fire, health and life safety requirements. Compliance with these regulations may involve upfront expenditures and ongoing costs. If we fail to comply with these requirements, we could incur fines or other monetary damages. We do not know whether existing requirements will change or whether compliance with existing or future requirements will require significant unanticipated expenditures that will affect our cash flows and results of operations.
We may face risks associated with property acquisitions.
We intend to invest in property acquisitions, which carry certain risks including:
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we may have difficulty finding properties that are consistent with our strategy and that meet our standards;
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we may have difficulty negotiating with new or existing tenants;
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the extent of competition for a particular market for attractive acquisitions may hinder our desired level of property acquisitions;
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the actual costs and timing of repositioning or redeveloping acquired properties may be greater than our estimates;
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we may acquire properties subject to liabilities and without any recourse, or with only limited recourse, with respect to unknown liabilities such as liabilities for clean-up of undisclosed environmental contamination, claims by tenants, vendors or other persons dealing with the former owners of the properties, liabilities incurred in the ordinary course of business and claims for indemnification by general partners, directors, officers and others indemnified by the former owners of the properties;
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the occupancy levels, lease-up timing and rental rates may not meet our expectations;
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the acquired property may be in a market that is unfamiliar to us and could present additional unforeseen business challenges;
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acquired properties may fail to perform as expected;
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the timing of property acquisitions may lag the timing of property dispositions, leading to periods of time where projects proceeds are not invested as profitably as we desire;
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we may be unable to obtain financing for acquisitions on favorable terms or at all; and
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we may be unable to quickly and efficiently integrate new acquisitions into our existing operations, and significant levels of management’s time and attention could be involved in these projects, diverting their time from our day-to-day operations.
Any of these risks could have an adverse effect on our results of operations and financial condition. In addition, we may acquire properties subject to liabilities, and with no or limited recourse against the prior owners or other third parties. As a result, if a liability were asserted against us based upon ownership of those properties, we might have to pay substantial sums to settle or contest it, which could adversely affect our business, results of operations and cash flow.
Pursuant to the Formation Transactions, our Operating Partnership acquired a 49% interest in an entity that owns an industrial complex located in the Minneapolis-St. Paul metropolitan area. However, affiliates of MG Kaminski, our Chief Executive Officer, own the other 51% interest in the entity. Talon RE, a wholly owned subsidiary of our Operating Partnership, entered into a contribution agreement with Mr. Kaminski to acquire his remaining interest in the entity, subject to receiving consent to the transfer from the entity’s lender, but there can be no assurance that the lender will consent to the transfer or that we will ever acquire a controlling interest in the entity that owns the complex.
We may acquire properties or portfolios of properties through tax deferred contribution transactions, which could result in dilution and limit our ability to sell such assets.
In the future we may acquire properties or portfolios of properties through tax deferred contribution transactions in exchange for partnership interests in the Operating Partnership, which may dilute our interest in our properties. This acquisition structure may have the effect of, among other things, reducing the amount of tax depreciation we could deduct over the tax life of the acquired properties, and may require that we agree to protect the respective contributor’s ability to defer recognition of taxable gain through restrictions on our ability to dispose of the acquired properties or the allocation of partnership debt to the contributor to maintain their tax bases. These restrictions could limit our ability to sell an asset at a time, or on terms, that would be favorable absent such restrictions.
Security breaches and other disruptions could compromise our information and expose us to liability, which would cause our business and reputation to suffer.
In the ordinary course of our business we acquire and store sensitive data, including intellectual property, our proprietary business information and personally identifiable information of our prospective and current tenants, our employees and third-party service providers in our branch offices and on our networks and website. The secure processing and maintenance of this information is critical to our operations and business strategy. Despite our security measures, our information technology and infrastructure may be vulnerable to attacks by hackers or breached due to employee error, malfeasance or other disruptions. Any such breach could compromise our networks and the information stored there could be accessed, publicly disclosed, lost or stolen. Any such access, disclosure or other loss of information could result in legal claims or proceedings, liability under laws that protect the privacy of personal information, regulatory penalties, disruption to our operations and the services we provide to customers or damage our reputation, which could adversely affect our results of operations and competitive position.
RISKS RELATED TO FEDERAL INCOME TAX
If we elect to be taxed as a REIT, any failure to qualify as a REIT for federal income tax purposes could have a material adverse impact on us and our shareholders.
We intend to elect to be treated as a REIT for federal income tax purposes and operate in a manner to continue to qualify as a REIT. Qualification as a REIT involves the application of highly technical and complex provisions of the Internal Revenue Code (the “Code”), for which there are only limited judicial or administrative interpretations. Certain facts and circumstances not entirely within our control may affect our ability to qualify as a REIT. In addition, we can provide no assurance that legislation, new regulations, administrative interpretations or court decisions will not adversely affect our qualification as a REIT or the federal income tax consequences of our REIT status.
If we were to fail to qualify as a REIT or maintain our REIT status, we would not be allowed a deduction for distributions to shareholders in computing our taxable income. In this case, we would be subject to federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate rates. Unless entitled to relief under certain Code provisions, we also would be disqualified from operating as a REIT for the four taxable years following the year during which qualification was lost. As a result, we would be subject to federal and state income taxes which could adversely affect our results of operations and distributions to shareholders. Although we currently intend to operate in a manner designed to qualify as a REIT, it is possible that future economic, market, legal, tax or other considerations may cause us to revoke the REIT election.
In order to qualify as a REIT, under current law, we generally are required each taxable year to distribute to our shareholders at least 90% of our net taxable income (excluding any net capital gain). To the extent that we do not distribute all of our net capital gain or distribute at least 90%, but less than 100%, of our other taxable income, we are subject to tax on the undistributed amounts at regular corporate rates. In addition, we are subject to a 4% nondeductible excise tax to the extent that distributions paid by us during the calendar year are less than the sum of the following:
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85% of our ordinary income;
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95% of our net capital gain income for that year; and
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100% of our undistributed taxable income (including any net capital gains) from prior years.
We generally intend to make distributions to our shareholders to comply with the 90% distribution requirement to avoid corporate-level tax on undistributed taxable income and to avoid the nondeductible excise tax. Distributions could be made in cash, stock or in a combination of cash and stock. Differences in timing between taxable income and cash available for distribution could require us to borrow funds to meet the 90% distribution requirement, to avoid corporate-level tax on undistributed taxable income and to avoid the nondeductible excise tax. Satisfying the distribution requirements may also make it more difficult to fund new investment or development projects.
If we elect to be taxed as a REIT, certain property transfers may be characterized as prohibited transactions, resulting in a tax on any gain attributable to the transaction.
From time to time, we may transfer or otherwise dispose of some of our properties. Under the Code, if we elect to be taxed as a REIT, any gains resulting from transfers or dispositions, from other than our taxable REIT subsidiary, that are deemed to be prohibited transactions would be subject to a 100% tax on any gain associated with the transaction. Prohibited transactions generally include sales of assets that constitute inventory or other property held for sale to customers in the ordinary course of business. Since we intend to acquire properties primarily for investment purposes, we do not believe that our occasional transfers or disposals of property will be deemed to be prohibited transactions. However, whether or not a transfer or sale of property qualifies as a prohibited transaction depends on all the facts and circumstances surrounding the particular transaction. The Internal Revenue Service (the “IRS”) may contend that certain transfers or disposals of properties by us are prohibited transactions. If the IRS were to argue successfully that a transfer or disposition of property constituted a prohibited transaction, we would be required to pay a tax equal to 100% of any gain allocable to us from the prohibited transaction. In addition, income from a prohibited transaction might adversely affect our ability to satisfy the income tests for qualification as a REIT for federal income tax purposes.
The stock ownership limit imposed by the Code for REITs and our articles as we intend to amend it may restrict business combination opportunities.
To qualify as a REIT under the Code, not more than 50% in value of our outstanding stock may be owned, directly or indirectly, by five or fewer individuals (as defined in the Code to include certain entities) at any time during the last half of each taxable year after our first year in which we qualify as a REIT. We anticipate amending our articles such that, with certain exceptions, it would authorize our board of directors to take the actions that are necessary or appropriate to preserve our qualification as a REIT once we elect REIT status. Unless an exemption is granted by our board of directors, our articles are expected to prohibit the actual, beneficial or constructive ownership by any person of more than 10% in value or number of shares, whichever is more restrictive, of the outstanding shares of our common stock or more than 10% in value of the aggregate outstanding shares of all classes and series of our stock. In addition, our articles would generally prohibit beneficial or constructive ownership of shares of our capital stock by any person that owns, actually or constructively, an interest in any of our tenants that would cause us to own, actually or constructively, 10% or more of any of our tenants. Our board of directors may grant an exemption in its sole discretion, subject to such conditions, representations and undertakings as it may determine.
These ownership limitations in our articles are common in REIT charters and are intended, among other purposes, to assist us in complying with the tax law requirements and to minimize administrative burdens. However, these ownership limits might also delay or prevent a transaction or a change in our control that might involve a premium price for our common stock or otherwise be in the best interests of our shareholders. Our board of directors may grant MG Kaminski, our Chief Executive Officer, and his affiliates an exemption from the ownership limits.
If we elect to be taxed as a REIT, complying with REIT requirements may affect our profitability and may force us to liquidate or forgo otherwise attractive investments.
To qualify as a REIT, we must continually satisfy tests concerning, among other things, the nature and diversification of our assets, the sources of our income and the amounts we distribute to our shareholders. We may be required to liquidate or forgo otherwise attractive investments in order to satisfy the asset and income tests or to qualify under certain statutory relief provisions. We also may be required to make distributions to shareholders at disadvantageous times or when we do not have funds readily available for distribution. As a result, having to comply with the distribution requirement could cause us to: (1) sell assets in adverse market conditions; (2) borrow on unfavorable terms; or (3) distribute amounts that would otherwise be invested in future acquisitions, capital expenditures or repayment of debt. Accordingly, satisfying the REIT requirements could have an adverse effect on our business results, profitability and ability to execute our business plan. Moreover, if we are compelled to liquidate our investments to meet any of these asset, income or distribution tests, or to repay obligations to our lenders, we may be unable to comply with one or more of the requirements applicable to REITs or may be subject to a 100% tax on any resulting gain if such sales constitute prohibited transactions.
New legislation or administrative or judicial action, in each instance potentially with retroactive effect, could make it more difficult or impossible for us to qualify as a REIT.
The present federal income tax treatment of REITs may be modified, possibly with retroactive effect, by legislative, judicial or administrative action at any time, which could affect the federal income tax treatment of an investment in us. The federal income tax rules relating to REITs constantly are under review by persons involved in the legislative process, the IRS and the U.S. Treasury Department, which results in frequent statutory changes and revisions to regulations and interpretations. Revisions in federal tax laws and interpretations thereof could adversely affect us or cause us to change our investments and commitments and affect the tax considerations of an investment in us.
RISKS RELATED TO OUR SECURITIES
Our common stock is considered a “penny stock.” The application of the “penny stock” rules to our common stock could limit the trading and liquidity of our common stock, adversely affect the market price of our common stock and increase the transaction costs to sell those shares.
Our common stock is a “low-priced” security or “penny stock” under rules promulgated under the Securities Exchange Act of 1934, as amended. In accordance with these rules, broker-dealers participating in transactions in low-priced securities must first deliver a risk disclosure document which describes the risks associated with such stocks, the broker-dealers’ duties in selling the stock, the customer’s rights and remedies and certain market and other information. Furthermore, broker-dealers must make a suitability determination approving the customer for low-priced stock transactions based on the customer’s financial situation, investment experience and objectives. Broker-dealers must also disclose these restrictions in writing to the customer, obtain specific written consent from the customer, and provide monthly account statements to the customer. The effect of these restrictions will likely decrease the willingness of broker-dealers to make a market in our common stock, will decrease liquidity of our common stock and will increase transaction costs for sales and purchases of our common stock as compared to other securities.
Shareholders may be diluted significantly through our efforts to obtain financing or complete acquisitions through the issuance of additional shares of our common stock or limited partnership units of the Operating Partnership, which are redeemable for shares of our common stock.
We are authorized to issue up to (1) 90,000,000 shares of common stock and (2) 10,000,000 shares of preferred stock. Our board of directors has the authority, without action or vote of the shareholders, to issue all or part of the authorized but unissued shares of common stock and preferred stock with various preferences and other rights. Additionally, the limited partnership units of the Operating Partnership are redeemable for shares of our common stock, and we, as the sole general partner, are authorized to issue additional interests in the Operating Partnership in the form of such units. Moving forward, we may attempt to conduct acquisitions and/or mergers of other entities or assets using our common stock or limited partnership units of the Operating Partnership as payment for such transactions. If such transactions occur, this may result in substantial dilution of the ownership interests of existing shareholders, and dilute the book value of our common stock.
The Over-the-Counter Bulletin Board is a quotation system, not an issuer listing service, market or exchange. Therefore, buying and selling stock on the OTC Bulletin Board is not as efficient as buying and selling stock through an exchange. As a result, it may be difficult for you to sell your common stock or you may not be able to sell your common stock for an optimum trading price.
Our common stock is quoted on the Over the Counter Bulletin Board (the “OTCBB”). The OTCBB is a regulated quotation service that displays real-time quotes, last sale prices and volume limitations in over-the-counter securities. Because trades and quotations on the OTCBB involve a manual process, the market information for such securities cannot be guaranteed. In addition, quote information, or even firm quotes, may not be available. The manual execution process may delay order processing and intervening price fluctuations may result in the failure of a limit order to execute or the execution of a market order at a significantly different price. Execution of trades, execution reporting and the delivery of legal trade confirmations may be delayed significantly. Consequently, one may not be able to sell shares of our common stock at the optimum trading prices.
When fewer shares of a security are being traded on the OTCBB, volatility of prices may increase and price movement may outpace the ability to deliver accurate quote information. Lower trading volumes in a security may result in a lower likelihood of an individual’s orders being executed, and current prices may differ significantly from the price one was quoted by the OTCBB at the time of the order entry. Orders for OTCBB securities may be canceled or edited like orders for other securities. All requests to change or cancel an order must be submitted to, received and processed by the OTCBB. Due to the manual order processing involved in handling OTCBB trades, order processing and reporting may be delayed, and an individual may not be able to cancel or edit an order. Consequently, one may not be able to sell shares of common stock at the optimum trading prices.
The dealer’s spread (the difference between the bid and ask prices) may be large and may result in substantial losses to the seller of securities on the OTCBB if the common stock or other security must be sold immediately. Further, purchasers of securities may incur an immediate “paper” loss due to the price spread. Moreover, dealers trading on the OTCBB may not have a bid price for securities bought and sold through the OTCBB. Due to the foregoing, demand for securities that are traded through the OTCBB may be decreased or eliminated.
We expect volatility in the price of our common stock, which may subject us to securities litigation resulting in substantial costs and liabilities and diverting management’s attention and resources.
The market for our common stock may be characterized by significant price volatility when compared to seasoned issuers, and we expect that our share price will be more volatile than a seasoned issuer for the indefinite future. In the past, plaintiffs have often initiated securities class action litigation against a company following periods of volatility in the market price of its securities. We may in the future be a target of similar litigation. Securities litigation could result in substantial costs and liabilities and could divert management’s attention from our day-to-day operations and consume resources, such as cash.
We are an “emerging growth company,” under federal securities laws and we cannot be certain if the reduced reporting requirements applicable to emerging growth companies will make our common stock less attractive to investors.
We are an “emerging growth company,” as defined in the JOBS Act. For as long as we continue to be an emerging growth company, we may take advantage of exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies, including not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. The JOBS Act also permits emerging growth companies to take advantage of an extended transition period to comply with new or revised accounting standards applicable to U.S. public companies. We are electing to use the extended transition period for complying with these new or revised accounting standards. As a result, our financial statements may not be comparable to those of companies that comply with public company effective dates. We could be an emerging growth company for up to five years after our first sale of equity securities pursuant to an effective registration statement under the Securities Act, although we could lose that status sooner if our revenues exceed $1 billion, if we issue more than $1 billion in non-convertible debt in a three-year period, or if the market value of our common stock held by non-affiliates exceeds $700 million as of any June 30 before that time, in which case we would no longer be an emerging growth company as of the following December 31. We cannot predict if investors will find our common stock less attractive because we may rely on these exemptions.
We have not established a minimum distribution payment level and we cannot assure you of our ability to pay distributions in the future.
We will be generally required to distribute to our shareholders at least 90% of our taxable income each year for us to qualify as a REIT under the Internal Revenue Code, or the Code, for which we currently do not qualify. We have not established a minimum distribution payment level and our ability to pay distributions may be adversely affected by a number of factors, including the risk factors described herein. All distributions will be made at the discretion of our board of directors and will depend on our earnings, financial condition, maintenance of our REIT qualification and other factors that our board of directors may deem relevant from time to time. As a result, no assurance can be given that we will be able to make distributions to our shareholders at any time or that the level of any distributions will achieve any specific market yield or will increase or be maintained over time. Any failure to achieve expected distributions could materially and adversely affect the price of our common stock.
We may employ leverage in the future which could expose us to additional risks, may impair our ability to pay dividends and may adversely affect the market price of our common stock.
If we incur indebtedness in the future to fund our growth or operations, it is likely that the instruments governing such indebtedness will contain covenants restricting our operating flexibility. We may incur debt that is secured by all or a portion of the properties in our portfolio. We will bear the costs and fees associated with any such incurrence and ongoing interest expense that will reduce the amount of funds available to common shareholders. Because our decision to issue debt will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future incurrence and any such incurrence could reduce the market price of our common stock.
Certain provisions of our articles may make a takeover difficult even if such takeover could be beneficial to some of our shareholders.
Our articles of incorporation authorize the issuance of “blank check” preferred stock with such designations, rights and preferences as may be determined from time to time by our board of directors. Accordingly, our board is empowered, without further shareholder action, to issue shares or series of preferred stock with dividend, liquidation, conversion, voting or other rights that could adversely affect the voting power or other rights, including the ability to receive dividends, of our common shareholders. The issuance of such preferred stock could be utilized, under certain circumstances, as a method of discouraging, delaying or preventing a change in control. Although we have no present intention of issuing any shares or series of preferred stock, we cannot guarantee that we will not make such an issuance in the future.
A significant portion of our shares are subject to resale restrictions. This could cause low trading volume and liquidity of our common stock for the near future.
All 16,743,522 of the shares of our common stock outstanding as of December 31, 2014 including 1,281,300 of such shares issued in restricted stock grants to our executive officers and directors were subject to resale restrictions as a result of securities laws (including Rule 144 of the Securities Act) or lock-up agreement at issuance. As of December 31, 2014, 10.7 million shares of our common stock are subject to such resale restrictions. Because many of our shares are still subject to resale restrictions, there may be limited liquidity and trading volume of our common stock, which may lead to increased transaction costs for sales and purchases of our common stock as compared to other securities and the possible inability to identify a buyer for your shares.
Certain of our officers and directors have sufficient voting power to make corporate governance decisions that could have a significant effect on us and the other shareholders.
MG Kaminski, our Chief Executive Officer, beneficially owns approximately 51% of our outstanding common stock on a fully diluted basis. As a result, Mr. Kaminski, alone will be able to exert a significant degree of influence over our management and affairs and over matters requiring shareholder approval, including the election of directors and approval of significant corporate transactions. In addition, this concentration of ownership may delay or prevent a change in our control and might affect the market price of our common stock, even when a change in control may be in the best interest of all stockholders. Furthermore, the interests of this concentration of ownership may not always coincide with our interests or the interests of other shareholders.
RISKS RELATED TO OUR ORGANIZATIONAL STRUCTURE
Conflicts exist or could arise in the future between the interests of our shareholders and the interests of the holders of limited partnership units in our Operating Partnership, which may impede business decisions that could benefit our shareholders.
Conflicts of interest exist or could arise in the future as a result of the relationships between us and our affiliates, on the one hand, and our Operating Partnership or any partner thereof, the other. Our directors and officers have duties to our company under applicable Minnesota law in connection with their management of our company. At the same time, we, as the general partner of our Operating Partnership, have fiduciary duties and obligations to our Operating Partnership in connection with the management of our Operating Partnership and its limited partners under Minnesota law and the partnership agreement of our Operating Partnership. Our fiduciary duties and obligations as general partner to our Operating Partnership and its partners may come into conflict with the duties of our directors and officers to our company. If we become subject to and are unable to resolve any conflicts of interests, our business and results of operations could be materially and adversely impacted.
The partnership agreement of our Operating Partnership provides that neither we nor our directors and officers are liable to our Operating Partnership for losses sustained, liabilities incurred or benefits not derived as a result of any act or omission, so long as such person acted in good faith and in the belief that such conduct or omission was in the best interests of our Operating Partnership. The partnership agreement provides for indemnification of us, our affiliates and each of our respective officers and directors to the extent those persons would be indemnified by us pursuant to our articles of incorporation if such persons were directors, officers, agents or employees of our company. The provisions of Minnesota law that allow the common law fiduciary duties of a general partner to be modified by a partnership agreement have not been resolved in a court of law, and we have not obtained an opinion of counsel covering the provisions set forth in the partnership agreement that purport to waive or restrict our fiduciary duties that would be in effect under common law were it not for the partnership agreement. As a result, our shareholders may have limited rights against us in connection with addressing conflicts of interest, which could limit their recourse against us in the event of actions we take with which our shareholders do not agree.
Our organizational documents may inhibit a takeover that shareholders consider favorable.
Provisions of our articles of incorporation and bylaws may delay or discourage transactions involving an actual or potential change in our control or change in our management, including transactions in which shareholders might otherwise receive a premium for their shares, or transactions that our shareholders might otherwise deem to be in their best interests. These provisions:
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permit our board of directors to issue up to 10,000,000 shares of preferred stock, with any rights, privileges and preferences as our board may designate, including the right to approve an acquisition or other change in our control;
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provide that the authorized number of directors may be changed by an amendment to our bylaws by our board of directors;
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permit the division of our board of directors into up to three classes;
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provide that all vacancies, including newly created directorships, may, except as otherwise required by law, be filled by the affirmative vote of a majority of directors then in office, even if less than a quorum; and
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do not provide for cumulative voting rights.
Also, to assist us in complying with the limitations on the concentration of ownership of a REIT imposed by the Code, we intend to amend our articles to prohibit any stockholder from beneficially or constructively owning more than 10% by value or number of shares, whichever is more restrictive, of our outstanding shares of common stock, or 10% by value or number of shares, whichever is more restrictive, of our outstanding capital stock. Only our board of directors, in its sole discretion, may waive the 10% ownership limit with respect to a particular stockholder.
Our board of directors and management team may change our investment and financing policies without shareholder approval and we may become more highly leveraged, which may increase our risk of default under our debt obligations.
Our investment and financing policies are exclusively determined by our board of directors and management team. Accordingly, our shareholders do not control these policies. Further, our organizational documents do not limit the amount or percentage of indebtedness, funded or otherwise, that we may incur. Our board of directors may alter our policy on borrowing at any time without shareholder approval and we could become more highly leveraged, which could result in an increase in our debt service. Higher leverage also increases the risk of default on our obligations. In addition, a change in our investment policies, including the manner in which we allocate our resources across our portfolio or the types of assets in which we seek to invest, may increase our exposure to interest rate risk, real estate market fluctuations and liquidity risk. Changes to our policies with regards to the foregoing could adversely affect our financial condition, results of operations, cash flow and the trading price of our common stock.
We are a holding company with no direct operations and, as such, we will rely on funds received from our Operating Partnership to pay liabilities, and the interests of our shareholders will be structurally subordinated to all liabilities and obligations of our Operating Partnership and its subsidiaries.
We are a holding company and will conduct substantially all of our operations through our Operating Partnership. We do not have, apart from an interest in our Operating Partnership, any independent operations. As a result, we will rely on distributions from our Operating Partnership to pay any dividends we might declare on shares of our common stock. We will also rely on distributions from our Operating Partnership to meet any of our obligations, including any tax liability on taxable income allocated to us from our Operating Partnership. In addition, because we are a holding company, your claims as shareholders will be structurally subordinated to all existing and future liabilities and obligations (whether or not for borrowed money) of our Operating Partnership and its subsidiaries. Therefore, in the event of our bankruptcy, liquidation or reorganization, our assets and those of our Operating Partnership and its subsidiaries will be available to satisfy the claims of our shareholders only after all of our and our Operating Partnership’s and its subsidiaries’ liabilities and obligations have been paid in full.
If we elect to be taxed as a REIT, dividends payable by REITs do not qualify for the reduced tax rates available for some dividends.
The maximum tax rate applicable to income from “qualified dividends” payable to U.S. shareholders that are individuals, trusts and estates is 15% (20% in the case of taxpayers whose income exceeds certain thresholds). Dividends payable by REITs, however, are not eligible for the reduced rates. Although these rules do not adversely affect the taxation of REITs or dividends payable by REITs, investors who are individuals, trusts and estates may perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the shares of REITs, including the per share trading price of our common stock.
Our Operating Partnership may issue additional partnership interests to third parties without the consent of our shareholders, which would reduce our ownership percentage in our Operating Partnership and may have a dilutive effect on the amount of distributions made to us by our Operating Partnership and, therefore, the amount of distributions we can make to our shareholders.
In connection with future acquisitions of properties or otherwise, we expect to issue additional partnership interests to third parties. Such issuances will reduce our ownership percentage in our Operating Partnership and may affect the amount of distributions made to us by our Operating Partnership and, therefore, the amount of distributions we can make to our shareholders. Because you will not directly own partnership interests, you will not have any voting rights with respect to any such issuances or other partnership level activities of our Operating Partnership.
Item 1B.
Item 1B.
Unresolved Staff Comments
None.
Item 2.
Item 2.
Properties
The information set forth under Item 1 “Business - Our Current Property Interests” is incorporated herein by reference.
Item 3.
Item 3.
Legal Proceedings
None.
Item 4.
Item 4.
Mine Safety Disclosures
Not applicable.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
The common stock of our predecessor, Guide Holdings, Inc., was listed for quotations on the OTCBB on December 28, 2010, under the symbol “GHGD.” Our shares of common stock continued to be quoted on the OTCBB subsequent to June 7, 2013 under the symbol “TALR.” There currently is no established trading market for shares of our common stock. We cannot give any assurance that any market for our common stock will develop or be maintained. If an established trading market ever develops in the future, the sale of shares of our common stock that are deemed to be “restricted securities” pursuant to Rule 144 under the Securities Act of 1933, as amended, by members of management or others may have a substantial adverse impact on any such market. In general, pursuant to Rule 144, non-affiliate stockholders may sell freely after six months subject only to the current public information requirement. Affiliates may sell after six months subject to the Rule 144 volume, manner of sale (for equity securities), current public information, and notice requirements. All current holders of shares of our common stock have satisfied the six-month holding period requirement of Rule 144.
The following table sets forth, for the periods indicated over the last two years, the high and low prices of actual transactions on the OTCBB instead of bid and ask quotations due to limited trading volume. In the event there were no shares traded during the period, the last actual transaction price from a previous period was used.
These prices were obtained from Bloomberg Finance, L.P. and do not necessarily reflect actual transactions, retail markups, mark downs or commissions.
Stockholders of Record. As of December 31, 2014, we had over 100 stockholders of record of our common stock, excluding holders whose stock is held either in nominee name and/or street name brokerage accounts.
Dividends. Our predecessor did not declare any cash dividends and we have not declared any cash dividend subsequent to June 7, 2013. We intend to elect to be taxed as a REIT for federal income tax purposes no earlier than with our taxable year ending December 31, 2015. In connection with electing to be taxed to qualify as a REIT, each year we must distribute dividends, other than capital gain dividends and deemed distributions of retained capital gain, to our shareholders in an aggregate amount at least equal to the sum of:
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90% of our “REIT taxable income,” computed without regard to the dividends paid deduction and our net capital gain or loss, and
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90% of our after-tax net income, if any, from foreclosure property, minus
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the sum of certain items of non-cash income.
If we elect to be taxed as a REIT, we must pay such distributions in the taxable year to which they relate, or in the following taxable year if either (i) we declare the distribution before we timely file our federal income tax return for the year and pay the distribution on or before the first regular dividend payment date after such declaration or (ii) we declare the distribution in October, November or December of the taxable year, payable to shareholders of record on a specified day in any such month, and we actually pay the dividend before the end of January of the following year. The distributions under clause (i) are taxable to the shareholders in the year in which paid, and the distributions in clause (ii) are treated as paid on December 31st of the prior taxable year. In both instances, these distributions relate to our prior taxable year for purposes of the 90% distribution requirement.
If we elect to be taxed as a REIT, we will pay federal income tax on taxable income, including net capital gain, that we do not distribute to shareholders. Furthermore, if we fail to distribute during a calendar year, or by the end of January following the calendar year in the case of distributions with declaration and record dates falling in the last three months of the calendar year we will be taxed on, at least the sum of:
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85% of our REIT ordinary income for such year,
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95% of our REIT capital gain income for such year, and
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any undistributed taxable income from prior periods.
It is possible that we may not have sufficient cash to meet the distribution requirements discussed above. This could result because of competing demands for funds, or because of timing differences between the actual receipt of income and actual payment of deductible expenses and the inclusion of that income and deduction of such expenses in arriving at our REIT taxable income. For example, we may not deduct recognized capital losses from our “REIT taxable income.” Further, it is possible that, from time to time, we may be allocated a share of net capital gain attributable to the sale of depreciated property that exceeds our allocable share of cash attributable to that sale. As a result of the foregoing, we may have less cash than is necessary to distribute taxable income sufficient to avoid corporate income tax and the excise tax imposed on certain undistributed income or even to meet the 90% distribution requirement. In such a situation, we may need to borrow funds, raise funds through the issuance of additional shares of common stock or, if possible, pay taxable dividends of our common stock or debt securities.
Unregistered Sales of Equity Securities
No private placement of the Company’s shares of common stock was completed in 2014.
Stock Repurchases
None.
Item 6.
Item 6.
Selected Financial Data
Not required for a Smaller Reporting Company.
Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read together with the section titled “Selected Financial Data” and our audited financial statements and related notes which are included elsewhere in this Annual Report on Form 10-K. Our actual results could differ materially from those anticipated in the forward-looking statements included in this discussion as a result of certain factors, including, but not limited to, those discussed in “Risk Factors” included elsewhere in this Annual Report on Form 10-K.
Overview
Talon Real Estate Holding Corp is a publicly traded real estate corporation that invests primarily in single and multi-tenant office, industrial and retail properties within the Midwest and South Central regions of the United States. It currently owns four properties located in and around Minneapolis-St. Paul metropolitan area of Minnesota. Headquartered in Minneapolis, MN and founded in June 2013, Talon’s primary objective is to provide shareholders with attractive returns from investments in real estate through dividend distribution and growth.
On June 7, 2013 we acquired a 49% interest in an entity that owns an industrial complex consisting of two buildings with approximately 171,639 square feet located in the Minneapolis-St. Paul metropolitan area. We have entered into a contribution agreement to acquire the remaining interest in this entity, subject to receiving consent to the transfer from the entity’s lender. The two buildings currently have a combined occupancy of 81%.
In 2014, we completed two acquisitions totaling approximately $58 Million and over 1 million in gross building square feet. On May 29, 2014, we completed the acquisition of a 227,000 square foot building situated on 20 acres of land in Minnetonka, MN that was 90% occupied primarily by over 100 tenants who are wholesale distributors. This property contributes to our core stable income investment strategy. On July 2, 2014, we completed the acquisition of a thirteen-story office tower located in downtown St. Paul, MN totaling 856,223 total building square feet that was 62% occupied by corporate and government tenants at time of acquisition and is currently 66% occupied. Management acquired the St. Paul property for its attractive value-add and growth potential.
We plan to invest in both core income-producing properties requiring relatively small improvements or enhancements and value-added properties that will require more significant investments of capital or management attention (including, but not limited to, leasing vacant space or extending expiring leases) that we expect to provide current income as well as the increased potential for higher long-term value to our company. Our long-term plan is to invest in value-added properties while maintaining a significant part of our portfolio in core properties. Our investment allocation between these two types of properties may significantly fluctuate in the short term as we seek the best opportunities.
Factors That May Influence Our Operating Results
Acquisition Strategy. We plan to grow our business through the acquisition of new properties, initially targeting properties that meet the criteria described above under “-Overview” and elsewhere in this report. We expect the properties we acquire will be subject to mortgage financing and other indebtedness that we will assume or refinance. Debt service on such indebtedness will have a priority over any distributions with respect to our common stock.
Rental Revenue. The amount of net rental revenue generated by our properties depends primarily on our ability to maintain the occupancy rates of currently leased space and to lease space that becomes available. As of December 31, 2014, our properties were 73% leased. We believe that the average rental rates for our properties are generally equal to the current average quoted market rates. Negative trends in one or more of these factors could adversely affect our rental revenue in future periods. Future economic downturns affecting the Minneapolis-St. Paul metropolitan area or downturns in our tenants’ businesses that impair our ability to renew leases or re-let space or the ability of our tenants to fulfill their lease commitments could adversely affect our revenues. In addition, growth in rental revenue primarily will depend on our ability to acquire additional properties that meet our investment criteria.
Conditions in Our Markets. Our current properties are located in the Minneapolis-St. Paul metropolitan area. Positive or negative changes in economic or other conditions in this area, or areas in our prospective proprieties, including employment and wage rates, natural disasters and other factors, may impact our overall performance.
Operating Expenses. Our operating expenses primarily consist of property taxes, management fees, utilities, insurance and site maintenance costs. As of December 31, 2014, some of our leases required tenants to reimburse us for a share of our operating expenses. Increases or decreases in any unreimbursed operating expenses, either due to the nature of the expenses not requiring reimbursement from our tenants or due to a reduction in leased square footage requiring tenant reimbursement of a portion of our operating expenses, will impact our overall performance. As a public company, we estimate our annual general and administrative expenses will increase due to increased insurance, accounting and other expenses related to SEC reporting and other compliance matters compared to our historic operations prior to operating as a public real estate holding company. Legal fees incurred in 2014 were significant due to the Company’s acquisition activities. We expect legal fees to continue to be primarily associated with such activities and business matters customary to a public real estate company.
Interest Expense. Our interest expense will depend on the amounts we borrow as well as the interest rates charged by our lenders. Our current loan agreements are a mix of both fixed and floating rates, as well as secured and unsecured by our properties. Our aggregate interest expense may increase as we acquire properties and could fluctuate between periods based on the variable rate loan arrangements, if we do not hedge any such interest rate risk.
Critical Accounting Policies and Estimates
Our discussion and analysis of the historical financial condition and results of our operations are based upon our financial statements which have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP.
The preparation of these financial statements in conformity with GAAP requires management to make estimates and assumptions in certain circumstances that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses in the reporting period. Actual amounts may differ from these estimates and assumptions. We have provided a summary of our significant accounting policies in the notes to the consolidated financial statements of our company elsewhere in this report. We have summarized below those accounting policies that require material subjective or complex judgments and that have the most significant impact on our financial condition and results of operations. We evaluate these estimates on an ongoing basis, based upon information currently available and on various assumptions that we believe are reasonable as of the date hereof. Other companies in similar businesses may use different estimation policies and methodologies, which may impact the comparability of our results of operations and financial condition to those of other companies. There have been no significant changes to those policies during the year ended December 31, 2014.
Investment in Real Estate and Fixed Assets
Investment in real estate and fixed assets are carried at cost less accumulated depreciation and amortization. Property such as land, building and improvements includes cost of acquisitions, development, and construction, and tenant allowances and improvements. Maintenance and repairs are expensed as incurred, and major improvements are capitalized. We allocate the cost of an acquisition, including the assumption of liability, to the acquired tangible asset and identifiable intangibles based on their relative fair values. We assess fair value based on estimated cash flow projections that utilize appropriate discount and/or capitalization rates and available market information. Estimates of future cash flows are based on a number of factors including historical operating results, known and anticipated trends, and market economic conditions.
We allocate the cost of an acquisition, including the assumption of liability, to the acquired tangible assets (including land, buildings and personal property) determined by valuing the property as if it were vacant, and identifiable intangibles based on their relative fair values. Acquisitions of real estate are recorded based upon preliminary allocations of the purchase price to management’s assessment of the fair value of tangible and intangible assets and any assumed liabilities acquired which are subject to adjustment as additional information is obtained up to one year after the date of acquisition.
Depreciation is provided using the straight-line method over the estimated useful life of the assets for building, improvements, and furniture and equipment, and the term of the lease for tenant improvements. The estimated useful lives being used are as follows:
Intangible Assets
Upon acquisitions of real estate, the Company assesses the fair value of acquired tangible assets and any significant intangible assets (such as above- and below-market leases and value of acquired in-place leases), and any assumed liabilities, and allocates the purchase price based on these fair value assessments. The Company records intangible assets and liabilities acquired at their estimated fair value apart from goodwill for acquisitions of real estate. The Company amortizes identified intangible assets and liabilities based on the period over which the assets and liabilities are expected to affect the future cash flows of the real estate property acquired. Lease intangibles (such as in-place or above- and below-market leases) are amortized over the term of the related lease. Above and below-market leases are amortized as a reduction in (addition to) rent revenue. Amortization of other intangibles is recorded in depreciation and amortization expense.
Principles of Consolidation
We evaluate the need to consolidate affiliates based on standards set forth in the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810, Consolidation. In determining whether we have a controlling interest in an affiliate and the requirement to consolidate the accounts of that entity, management considers factors such as ownership interest, authority to make decisions, contractual and substantive participating rights of the limited partners and shareholders, as well as whether the entity is a variable interest entity for which we are the primary beneficiary. The accompanying consolidated financial statements include the accounts of Talon Real Estate Holding Corp. (“TREHC”) and Talon OP, our Operating Partnership. Talon OP also consolidates 5130 LLC, an entity in which it has a 49% ownership interest, based on its ability to control the operating and financial decisions of 5130 LLC. All significant intercompany balances have been eliminated in consolidation.
Reclassifications
Certain previously reported amounts have been reclassified to conform to the current financial statement presentation. The historical presentation of periods prior to the Formation Transactions of Talon Real Estate Holding Corp. consisting solely of the surviving operations of 5130 LLC were restated for the recapitalization of TREHC per the Formation Transactions, completed on June 7, 2013 and as amended on November 13, 2013.
Noncontrolling Interest
Interests in the Operating Partnership held by limited partners are represented by Operating Partnership units. The Company's interest in the Operating Partnership was 64.5% of the common units of the Operating Partnership as of December 31, 2014 and 100% as of December 31, 2013. The Operating Partnership’s income is allocated to holders of common units based upon the ratio of their holdings to the total units outstanding during the period. Holders of preferred units receive certain distributions based on a percentage of the liquidation preference. Capital contributions, distributions, syndication costs, and profits and losses are allocated to non-controlling interests in accordance with the terms of the Operating Partnership agreement.
The portion of membership interests in 5130 LLC not held by Talon OP is reported as noncontrolling interest. Capital contributions, distributions, and profits and losses are allocated to the noncontrolling interest based on membership percentages and terms of the operating agreement.
Revenue Recognition
Base rental income is recognized on a straight-line basis over the terms of the related leases, inclusive of leases which provide for scheduled rent increases or rent concessions. Differences between rental income earned and amounts due according to the respective lease agreements are credited or charged to deferred rent receivable, as applicable.
Tenant recoveries related to reimbursement of real estate taxes, insurance, repairs and maintenance and other operating expenses are recognized as revenue in the period the applicable expenses are incurred. Recoveries are billed monthly using estimated operating costs and an additional billing or a refund is made to tenants in the following year after actual operating expenses are determined.
Impairment of Long-Lived Assets
We assess the carrying value of investment property and related intangibles, whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable in accordance with GAAP. Impairment losses are recorded on real estate assets held for investment when indicators of impairment are present and the future undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amount.
Income Taxes
We intend to elect to be taxed as a REIT under the Internal Revenue Code after we meet REIT qualifications but no sooner than with our taxable year ending December 31, 2015. To qualify as a REIT, we must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of our annual REIT taxable income to our shareholders (which is computed without regard to the dividends paid deduction or net capital gain and which does not necessarily equal net income as calculated in accordance with U.S. generally accepted accounting principles, or U.S. GAAP). As a REIT, we generally will not be subject to federal income tax to the extent we distribute qualifying dividends to our shareholders. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax on our taxable income at regular corporate income tax rates and generally will not be permitted to qualify for treatment as a REIT for federal income tax purposes for the four taxable years following the year during which qualification is lost unless the IRS grants us relief under certain statutory provisions. Such an event could materially adversely affect our net income and net cash available for distribution to shareholders. However, we intend to organize and operate in such a manner as to qualify for treatment as a REIT.
The Company accounts for income taxes under FASB guidelines. Deferred income tax assets and liabilities are determined based upon differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Accounting standards require the consideration of a valuation allowance for deferred tax assets if it is “more likely than not” that some component or all of the benefits of deferred tax assets will not be realized. The Company's policy of accounting for uncertain tax positions is to recognize the tax effects from an uncertain tax position in the financial statements, only if the position is more likely than not to be sustained on audit, based on the technical merits of the position.
Accounting Standards Applicable to Emerging Growth Companies
We qualify as an “emerging growth company” pursuant to the provisions of the JOBS Act. Section 102(b)(1) of the JOBS Act provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. We have elected to use the extended transition period for complying with these new or revised accounting standards. Since we will not be required to comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for other public companies, our financial statements may not be comparable to the financial statements of companies that comply with public company effective dates. If we were to elect to comply with these public company effective dates, such election would be irrevocable pursuant to Section 107 of the JOBS Act.
Market Conditions and Outlook
Our recent acquisitions were accomplished utilizing a 721 Exchange tax deferral methodology or “UPREIT” providing several unique advantages over a 1031 exchange or selling to cash buyers. This strategy is advantageous for real estate owners seeking to mitigate and defer their immediate tax obligations, stay invested in real estate, diversify their holdings, and seek potential future growth and liquidity by accepting Talon OP common units which can later be converted 1:1 for Talon common stock under the ticker “TALR” and their capital gains tax obligations are deferred until the common stock is ultimately sold in the public market.
Our strategy is to continue offering these tax-deferred solutions to real estate owners as part of diversifying our shareholder base creating liquidity and shareholder value. We continue to believe office and industrial properties offer the best return on equity metrics as part of our investment strategy. Retail will also be part our overall portfolio with an average overall target portfolio contribution of nearly 20% over the long-term.
The middle corridor of the United States continues to offer higher cap rates compared to the west and east coasts and we will continue to explore additional investment options within this region to continue our mission to provide return on equity targets of 8-15% per asset or portfolio.
Results of Operations
Financial and operating results for the year ended December 31, 2013 included significant costs incurred to recapitalize and operate as a public company and costs of new employees and consultants. The properties owned by the Company in 2013 were still held by the Company in 2014. The financial and operating results for the year ended December 31, 2014 were greatly impacted by the cost incurred to acquire two additional properties..
We expect our revenues, expense reimbursements and each category of expenses will increase on an absolute basis in the future as we seek to acquire additional properties, assume or refinance indebtedness in connection with the acquisitions and build the infrastructure necessary to grow our business and to operate as a publicly traded company.
Our revenues and expenses have changed significantly compared to the same period in the previous year due to recent acquisitions of the property at Bren Road in Minnetonka, Minnesota on May 29, 2014 and the property at 180 5th Street East in St. Paul, Minnesota on July 2, 2014. Since their acquisition, these two properties have generated over $5.9 million in revenues for the year ended December 31, 2014. These two properties had total operating expenses of $3.4 million for the year ended December 31, 2014. We expect our revenues, tenant reimbursements and many expenses will continue to increase on an absolute basis in the future as we seek to acquire additional properties, assume or refinance indebtedness in connection with the acquisitions and build the infrastructure necessary to grow our business. In the near term, we expect to incur higher legal and other professional fees in pursuit of acquisitions.
Comparison of year ended December 31, 2014 to the year ended December 31, 2013
Revenues and Expenses
Rental revenues increased $3,725,709 to $4,158,905 for 2014 compared to $433,196 for 2013. Tenant reimbursements increased $1,897,286 to $2,001,561 for 2014 compared to $104,275 for 2013. The net increase in rental revenues and tenant reimbursements in 2014 compared to the prior year is primarily attributable to the impact of the acquisitions made in 2014.
General and administrative expenses increased $17,174, or 7.4%, to $249,970 for 2014 compared to $232,796 for 2013. The increase in general and administrative expenses is attributable to an entire year of expenses incurred to operate as a publicly held real estate holding corporation compared to less than seven months of similar expenses in 2013 such as insurance and office rent paid by the Company.
Salary and compensation expenses increased by $751,592 to $1,191,542 for 2014, compared to $439,950 in 2013. The increased expenses in 2014 were primarily due to a full year of expenses, an increased number of employees and non-cash stock compensation of approximately $656,600 granted to our directors and employees versus $48,000 granted in the prior year.
Professional fees decreased by $177,332 or 31.2%, to $390,512 for 2014, compared to $567,844 for 2013 The decrease is due primarily to the fact that the Company incurred higher than normal legal expenses in first half of 2013 as we prepared for the Company’s formation as a public real estate holding corporation on June 7, 2013. We expect professional fees to increase as the Company engages in more acquisition activity.
Property operating expenses increased by $2,594,763 to $2,654,787 for 2014, compared to $60,024 for 2013. The increase in property operating expenses compared to the prior year is primarily attributable to the impact of the acquisitions made in 2014.
Real estate taxes and property insurance increased by $813,471 to $957,638 for 2014, compared to $144,167 for 2013. The increase in real estate taxes and insurance compared to the prior year is primarily attributable to the impact of the acquisitions made in 2014.
Depreciation and amortization expense increased by $2,087,148 to $2,339,107 for 2014, compared to $251,959 for 2013. The net increase in depreciation and amortization compared to the prior year is primarily attributable to the impact of the acquisitions made in 2014.
Interest expense increased by $1,667,525 to $1,975,994 for 2014, compared to $308,469 for 2013. The net increase in interest expense compared to the prior year is primarily attributable to the impact of the acquisitions made in 2014.
Funds from Operations and Non-GAAP Reconciliation
The National Association of Real Estate Investment Trusts, or NAREIT, defines funds from operations, or FFO, as net income (loss) available to common shareholders computed in accordance with GAAP, excluding gains or losses from sales of operating real estate assets and extraordinary items, plus depreciation and amortization of operating properties including the add back of real property depreciation, amortization of capitalized lease expenses, tenant allowances or improvements, and the like. We intend to calculate FFO in a manner consistent with the NAREIT definition.
Management intends to use FFO as a supplemental measure to conduct and evaluate our business because there are certain limitations associated with using GAAP net income alone as the primary measure of our operating performance. Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Because real estate values instead have historically risen or fallen with market conditions, management believes that the presentation of operating results for real estate companies that use historical cost accounting is insufficient by itself. In addition, securities analysts, investors, and other interested parties use FFO as the primary metric for comparing the relative performance of equity REITs. There can be no assurance that FFO presented by us is comparable to similarly titled measures of other REITs.
FFO should not be considered as an alternative to net income or other measurements under GAAP as an indicator of our operating performance or to cash flows from operating, investing or financing activities as a measure of liquidity. FFO does not reflect working capital changes, cash expenditures for capital improvements or principal payments on indebtedness.
We define adjusted funds from operations, or AFFO, as FFO excluding the non-cash effects of straight-line rent, amortization of lease inducements and deferred financing costs, depreciation of non-real estate, and non-cash compensation charges. U.S. GAAP requires rental revenues related to non-contingent leases that contain specified rental increases over the life of the lease to be recognized evenly over the life of the lease. This method may result in rental income in the early years of a lease that is higher than actual cash received, creating a deferred rent receivable asset or lower income than actual cash received, creating a deferred rent revenue liability included in our consolidated balance sheet. At some point during the lease, depending on its terms, cash rent payments may exceed or be lower than the straight-line rent which results in the deferred rent receivable asset or liability, respectively, decreasing to zero over the remainder of the lease term. By excluding the non-cash portion of straight-line rental revenue and amortization of lease inducement and deferred financing costs as well as non-cash compensation expense, investors, analysts and our management can compare AFFO between periods.
Below is the calculation of FFO and AFFO and the reconciliation to net income (loss), which we believe is the most comparable GAAP financial measure:
Reconciliation of Net Income Attributable to Talon Real Estate Holding Corp. to Funds From Operations
Reconciliation of Net Income Attributable to Talon Real Estate Holding Corp. to Adjusted Funds From Operations
(1) Noncontrolling units of the Operating Partnership are exchangeable for cash, or at the Company's discretion, for common shares of stock on a one-for-one basis.
(2) Net income is calculated on a per share basis. FFO and AFFO are calculated on a per share and unit basis.
Liquidity and Capital Resources
Liquidity is a measure of our ability to meet potential cash requirements, including commitments to repay borrowings, fund and maintain our operations and assets, acquire properties, make distributions to our shareholders and other general business needs. In the short-term, we have incurred significant expenses related to our formation activities, becoming a public corporation, and preparation for and execution of our acquisition strategy creating a cash shortfall from operations in 2013 and continuing through December 31, 2014.
We recently completed two acquisitions in 2014. On May 29, 2014, we acquired the Minneapolis Mart in Minnetonka, MN. On July 2, 2014, we acquired the building located at 180 5th Street East in St. Paul, Minnesota. Current annual revenues from these two acquisitions represent over $11 million. Although cash flow to the company has improved, the cash flow generated from these latest acquisitions does not adequately meet all of the cash flows required of our current operations.
Our short-term liquidity requirements consist primarily of funds needed to pay for operating expenses and other expenditures directly associated with our properties including the payoff of debts maturing in 2015. The Company and Talon OP are also guarantors of a mortgage entered into by Talon First Trust, LLC in connection with the acquisition of the building located at 180 5th Street East in St. Paul, Minnesota. The mortgage includes a financial covenant requiring both the Company and Talon OP to maintain $30 million of net worth and $3 million of cash and marketable securities throughout the term of the loan after June 30, 2015. Complying with the terms of the financial covenant has created additional needs for liquidity and requires us to raise additional capital. Pursuant to the loan agreement with Bell State Bank & Trust, Talon Bren Road LLC must comply with the debt service coverage ratio ("DSCR") test (see Note 5 of the Financial Statements). As of December 31, 2014, Talon Bren Road LLC was out of compliance with the DSCR test. The Company made an additional principal payment of $258,857 on September 25, 2014 which caused the DSCR to be reduced below the required ratio. Failure to meet the debt service coverage ratio covenant allows the lender to declare an event of default and cause all outstanding unpaid principal balance of the loan and all accrued and unpaid interest to be immediately due. The lender is aware of such noncompliance, and we are seeking modification of the loan agreement and/or waiver of this covenant. However, there is no assurance the lender will agree to such modification and/or waiver, and a declaration of default and acceleration of the loan by the lender could have a material adverse effect on cash flows and results of operations for the period and the year in which the payment would be made. We also require cash to pursue our strategy of near-term growth through acquisition of properties as well as general and administrative expenses operating as a public company.
We currently do not have available cash and cash flows from current operations to provide us with adequate liquidity for the foreseeable future. Our current liabilities exceed our unrestricted cash and we have insufficient cash flow from current operations to pursue our strategy without further financing. As of December 31, 2014, we had unrestricted cash of approximately $147,000 and current liabilities including accounts payable and accrued expenses substantially in excess of the available cash. We therefore will require additional capital and/or increased cash flow from future operations to fund our ongoing business. There is no guarantee that we will be able to raise any required additional capital or generate sufficient cash flow from our current and future operations to fund our ongoing business. If the amount of capital we are able to raise together with our income from operations is not sufficient to satisfy our capital needs, we may be required to cease our operations or alter our growth plans. If we are unable to continue as a going concern, we may have to liquidate our assets and may receive less than the value at which those assets are carried on our consolidated financial statements, and it is likely that investors will lose all or a part of their investment.
Our short-term liquidity requirements consist primarily of funds needed to pay for operating expenses and other expenditures directly associated with our properties and to pursue our strategy of near-term growth through acquisition of properties, including:
·
interest expense and scheduled principal payments on outstanding indebtedness,
·
general and administrative expenses,
·
professional fees,
·
salaries and compensation, and
·
anticipated and unanticipated capital expenditures.
We are currently a party to a purchase agreement to acquire certain property in Mission, Kansas, which will require cash in the near future to complete. We will require debt and/or equity financing to complete the acquisition.
Our long-term liquidity requirements consist primarily of funds to pay for scheduled debt maturities, non-recurring capital expenditures that need to be made periodically and continued expansion of our business through acquisitions. Although we plan to aggressively pursue acquisitions to grow our business, there is no assurance that we will be able to acquire additional properties in the future.
Since our available cash and cash flows from current operations do not provide us with adequate cash to satisfy current liabilities and are not expected to provide us with adequate liquidity for the foreseeable future, we anticipate that we will undertake future debt or equity financings during 2015. Additional financing is necessary for our company to continue as a going concern.
In the future, we anticipate using a number of different sources to finance our liquidity needs, including cash flows from operations, issuance of debt securities or equity securities (which might be common or preferred stock), private financings (such as additional bank credit facilities, which may or may not be secured by our assets), asset sales, seller financing, property-level mortgage debt, or any combination of these sources, to the extent available to us, or other sources that may become available from time to time. Any debt that we incur may be recourse or non-recourse and may be secured or unsecured. Although we have successfully raised equity capital in the past, we cannot be assured that we will be able to continue to be successful in raising capital through issuance of securities. Our ability to obtain needed financing may be impaired by such factors as the capital markets, our status as a new enterprise without significant assets or demonstrated operating history, and/or the loss of key management. There is no guarantee that we will be able to raise any required additional capital or generate sufficient cash flow from our current and proposed operations to fund our ongoing business.
Outstanding Indebtedness
5130 LLC, an entity in which our Operating Partnership owns a 49% interest and that owns an industrial complex located in the Minneapolis-St. Paul metropolitan area, is party to a loan agreement secured by such industrial complex. The loan agreement provides for two term loans, the A loan and the B loan. Both loans can be accelerated under certain circumstances, including if there is an event of default under the loan agreement.
Talon Bren Road, LLC, an entity through which our Operating Partnership acquired the property located at 10301 Bren Road West, Minnetonka, MN on May 29, 2014, is party to a loan agreement secured by such property. It is also a party to two loans to fund the restricted escrow accounts available for the purpose of capital improvements at the building. This property also secures the Talon Bren Road, LLC Mortgage 2 (as defined in the table below) entered into on July 2, 2014 in connection with the acquisition of the property located at 180 5th East Street St. Paul, MN.
Talon First Trust, LLC, an entity through which our Operating Partnership acquired the property located at 180 5th Street East St. Paul, MN on July 2, 2014, is party to a loan agreement secured such property.
The following table summarizes the Company’s notes payable as of December 31, 2014 and 2013.
(1) See Note 5 of the Financial Statements for further disclosure related to this note.
(2) See Note 17 of the Financial Statements for further disclosure related to this note.
Off Balance Sheet Arrangements
As of December 31, 2014, we did not have any off-balance sheet arrangements.
Inflation
As of December 31, 2014, most of our leases required tenants to reimburse us for a share of our operating expenses. As result, we are able to pass on much of any increases to our property operating expenses that might occur due to inflation by correspondingly increasing our expense reimbursement revenues. During 2014 and 2013, inflation did not have a material impact on our revenues or net income.
Recent Accounting Pronouncements
We have evaluated all recent accounting pronouncements and believe that none of them will have a material effect on our consolidated financial statements.
Item 8.
Item 8.
Financial Statements and Supplementary Data
TALON REAL ESTATE HOLDING CORP.
Minneapolis, Minnesota
FINANCIAL STATEMENTS
As of and for the Years Ended
December 31, 2014 and 2013
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders, Audit Committee and Board of Directors
Talon Real Estate Holding Corp.
Minneapolis, MN
We have audited the accompanying consolidated balance sheets of Talon Real Estate Holding Corp. as of December 31, 2014 and 2013, and the related consolidated statements of operations, shareholders’ equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of its internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Talon Real Estate Holding Corp. as of December 31, 2014 and 2013and the results of their operations and cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming that the company will continue as a going concern. As discussed in Note 18 to the consolidated financial statements, the company has suffered recurring losses from operations and is dependent on the success of future capital raises or profitable acquisitions of additional investment properties to sustain operations through at least December 31, 2015. These factors raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 18. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ Baker Tilly Virchow Krause, LLP
Minneapolis, MN
March 31, 2015
TALON REAL ESTATE HOLDING CORP.
CONSOLIDATED BALANCE SHEETS
December 31, 2014 and 2013
See accompanying notes to consolidated financial statements.
TALON REAL ESTATE HOLDING CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years ended December 31, 2014 and 2013
See accompanying notes to consolidated financial statements.
TALON REAL ESTATE HOLDING CORP.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
For the Years Ended December 31, 2014 and 2013
See accompanying notes to consolidated financial statements.
TALON REAL ESTATE HOLDING CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2014 and 2013
See accompanying notes to consolidated financial statements.
TALON REAL ESTATE HOLDING CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of and for the Years Ended December 31, 2014 and 2013
NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION
Organization
We were incorporated as Guide Holdings, Inc. (“Guide”) in the State of Utah on November 1, 2007, for the sole purpose of becoming the holding company of Guidebook, which converted from a Utah limited liability company to a Utah corporation on November 1, 2007. Guidebook was organized in the State of Utah as a limited liability company on June 16, 2003. Guide focused on providing “do-it-yourself” instructional manuals for residential electrical, plumbing, and remodeling applications.
On June 7, 2013, we entered into a series of transactions (collectively, the “Formation Transactions”) that changed our business organization. On June 7, 2013, we changed our name to Talon Real Estate Holding Corp. (“TREHC”, or “the Company”) and issued 13,540,190 shares of our common stock for the contributions from the holders of a 49% interest in 5130 Industrial Street, LLC (“5130 LLC”) and all the interest in Talon Real Estate, LLC (“Talon RE”) which holds a purchase agreement to acquire the remaining 51% interest in 5130 LLC, for 2,820,810 shares. 5130 LLC was incorporated in the state of Delaware on November 23, 2005 to purchase real estate. Talon RE was incorporated in the state of Minnesota on December 20, 2012 and began operations in 2013 for the purpose of acquiring real estate properties and preparing the Formation Transactions. On June 3, 2013, we entered into a limited partnership agreement of Talon OP, L.P. (“Talon OP”), which we refer to as our Operating Partnership. On June 7, 2013 we contributed our interest in 5130 LLC and Talon RE into Talon OP for equivalent general partnership units as part of the Formation Transactions. 5130 LLC owns an industrial complex consisting of approximately 171,639 square feet located in the Minneapolis-St. Paul metropolitan area. We acquired such interest in this entity in June 2013 from certain parties, including the MG Kaminski Revocable Trust (“The Kaminski Trust”), the beneficiaries of which are the children of MG Kaminski, our Chief Executive Officer. The Kaminski Trust owns the remaining 51% interest in the industrial complex. Talon RE, a wholly owned subsidiary of our Operating Partnership, entered into a contribution agreement to acquire the remaining interest in the entity from The Kaminski Trust, subject to receiving consent to the transfer from the entity’s lender. On June 7, 2013, we entered into a stock purchase agreement pursuant to which our company divested ourselves of our historic “do-it-yourself” instruction manual business by selling all the outstanding shares of The Guidebook Company, Inc., a Utah Corporation and wholly owned subsidiary primarily engaged in such business (“Guidebook”). Guide had 1,600,032 shares of common stock issued and outstanding prior to the Formation Transactions. These shares, along with the shares issued in the Formation Transactions on June 7, 2013, represent the shares issued and outstanding immediately after formation of Talon Real Estate Holding Corp. with a combined total of 15,140,222 shares.
Talon Real Estate Holding Corp, as the general partner of Talon OP, has management responsibility for all the activities of the Operating Partnership. TREHC owned approximately 64.5% and 100% of the Operating Partnership as of December 31, 2014 and 2013, respectively. The Operating Partnership owned 49% of 5130 Industrial Street, LLC, 100% of Talon Bren Road, LLC and 100% of Talon First Trust, LLC as of December 31, 2014. Talon Bren Road, LLC, and Talon First Trust, LLC, both limited liability companies organized under the laws of the state of Delaware, were formed on May 9, 2014 and April 21, 2014, respectively, to purchase real estate.
Basis of Presentation
We are the sole general partner of the Operating Partnership, and, as such, we generally have the exclusive power to manage and conduct the business and affairs of the Operating Partnership, subject to certain limited approval and voting rights of the limited partners. Guidebook, which was sold in connection with the Formation Transactions, is no longer included in our financial statements. The contributions that constitute the Formation Transactions were accounted for as a reverse acquisition and recapitalization, and Talon OP was considered to be the accounting acquirer. Therefore, the historical presentation of our financial statements for periods prior to the Formation Transactions are that of Talon Real Estate Holding Corp. and its subsidiaries on a consolidated basis including the
TALON REAL ESTATE HOLDING CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of and for the Years Ended December 31, 2014 and 2013
NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION (continued)
Operating Partnership with its subsidiaries. Historical presentation of shareholders’ equity of TREHC was restated for common stock issued in the Formation Transactions and retained earnings of TREHC, formerly Guide, in periods prior to the formation were eliminated.
The accompanying consolidated financial statements include the accounts of TREHC and its interest in the Operating Partnership. The limited partners in the Operating Partnership have a redemption option that they may exercise. Upon exercise of the redemption option by the limited partners, the Company has the choice of redeeming the limited partners' interests ("Units") for TREHC common shares of stock on a one-for-one basis, or making a cash payment to the unitholder. The redemption generally may be exercised by the limited partners at any time after the first anniversary of the date of the acquisition of the Units subject to volume restrictions.
NOTE 2 - INVESTMENT IN REAL ESTATE PROPERTIES AND ENTITIES
The Company acquired real estate property through its subsidiary, Talon First Trust, LLC, located at 180 5th Street East, St. Paul, MN on July 2, 2014. The building is primarily leased to tenants for commercial use. The property totals 656,875 net rentable square feet. As of December 31, 2014, the Company had tenants occupying approximately 66% of the rentable space.
The Company acquired real estate property through its subsidiary, Talon Bren Road, LLC, located on 20 acres of land at 10301 Bren Road West, Minnetonka, MN on May 29, 2014. This property is primarily leased to tenants who are wholesale product sales representatives. These leases are subject to a master lease agreement entered into between Talon Bren Road, LLC and Upper Midwest Allied Gifts Association, Inc., a Minnesota nonprofit corporation (“UMAGA”). This property has 164,472 of net rentable square feet. As of December 31, 2014, the Company had tenants occupying approximately 90% of the rentable space.
The Company owns and operates the following real estate properties through its subsidiary, 5130 LLC:
5130 Industrial Street, Maple Plain, MN
1350 Budd Ave, Maple Plain, MN
The properties are primarily leased to tenants for mixed commercial and industrial usage. The properties have a combined 171,639 net rentable square feet. As of December 31, 2014, the Company had tenants occupying approximately 81% of the rentable space.
TALON REAL ESTATE HOLDING CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of and for the Years Ended December 31, 2014 and 2013
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Accounting Estimates
The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America requires management to use estimates and assumptions which affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of revenues and expenses. Significant items subject to such estimates and assumptions include determination of the useful life of property and other long-lived assets, valuation and impairment analysis of property and other long-lived assets, and valuation of the allowance for doubtful accounts. It is at least reasonably possible that these estimates could change in the near term.
Principles of Consolidation
We evaluate the need to consolidate affiliates based on standards set forth in the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810, Consolidation. In determining whether we have a controlling interest in an affiliate and the requirement to consolidate the accounts of that entity, management considers factors such as ownership interest, authority to make decisions, contractual and substantive participating rights of the limited partners and shareholders, as well as whether the entity is a variable interest entity for which we are the primary beneficiary. The accompanying consolidated financial statements include the accounts of Talon Real Estate Holding Corp. (“TREHC”) and Talon OP, our Operating Partnership. Talon OP also consolidates 5130 LLC, an entity in which it has a 49% ownership interest, based on its ability to control the operating and financial decisions of 5130 LLC. All significant intercompany balances have been eliminated in consolidation.
Cash and Cash Equivalents
The Company considers short-term investments with original maturities of 90 days or less to be cash equivalents. The Company believes it is not exposed to any significant credit risk on cash.
Restricted Escrows and Reserves
The Company is required to hold cash in restricted escrow accounts for insurance, real estate taxes and a replacement reserve. The escrows are used to pay periodic charges of real estate taxes and assessments, tenant improvements, and leasing commissions. The balances in the escrow accounts were $1,893,652 and $190,472 as of December 31, 2014 and December 31, 2013, respectively.
TALON REAL ESTATE HOLDING CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of and for the Years Ended December 31, 2014 and 2013
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Rents Receivable
Rents receivable and deferred rent are recorded at their estimated net realizable value. The Company follows a policy of providing an allowance for doubtful accounts, which is based on a review of outstanding receivables, historical collection information, and existing economic conditions. The Company does not require collateral and accounts are considered past due if payment is not made on a timely basis in accordance with our credit terms. Accounts considered uncollectible are written off. Receivables have been reduced by an allowance for doubtful accounts of $10,784 and $5,000 as of December 31, 2014 and 2013, respectively.
Revenue Recognition
Base rental income is recognized on a straight-line basis over the terms of the related lease agreement, inclusive of leases which provide for scheduled rent increases or rent concessions. Differences between rent income earned and base rent amounts due per the respective lease agreements are credited or charged to deferred rent revenue or deferred rent receivable as applicable. When the Company enters into lease modifications or extensions with current tenants, the deferred rent at the time of the extension is amortized over the remaining term of the lease, and the revised terms are considered a new lease.
Tenant recoveries related to reimbursement of real estate taxes, insurance, repairs and maintenance and other operating expenses are billed monthly based on current year estimated operating costs for applicable expenses. An additional billing or a refund is made to tenants in the following year after actual operating expenses are determined.
Deferred Leasing Costs and Tenant Allowance
Direct and indirect costs, including estimated internal costs and leasing commissions, associated with the leasing of real estate investments owned by the Company are capitalized as deferred leasing costs and amortized on a straight-line basis over the term of the related lease. Lease incentive costs, which are payments made on behalf of a tenant to sign a lease, are amortized on a straight-line basis over the respective lease terms as a reduction of rental revenue. Unamortized costs are charged to expense upon the early termination of the lease. Costs associated with unsuccessful leasing opportunities are expensed.
In leasing tenant space, the Company may provide funding to the lessee through a tenant allowance. In accounting for a tenant allowance, the Company determines whether the allowance represents funding for the construction of leasehold improvements and evaluates the ownership, for accounting purposes, of such improvements. If the Company is considered the owner of the leasehold improvements for accounting purposes, the Company capitalizes the amount of the tenant allowance and depreciates it over the shorter of the useful life of the leasehold improvements or the related lease term. If the tenant allowance represents a payment for a purpose other than funding leasehold improvements, or in the event the Company is not considered the owner of the improvements, for accounting purposes, the allowance is considered to be a lease incentive and is recognized over the lease term as a reduction of rental revenue on a straight-line basis. The Company had amortization expense of $5,302 and $6,521 for the years ended December 31, 2014 and 2013, respectively. The Company had accumulated amortization of $5,302 and $0 as of December 31, 2014 and 2013, respectively. Accumulated amortization in 2013 was written-off with the departure of a tenant.
TALON REAL ESTATE HOLDING CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of and for the Years Ended December 31, 2014 and 2013
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Derivative Instruments
The Company records all derivative instruments on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. If the Company does not apply hedge accounting, all changes in the fair value of derivatives are recognized directly in earnings in the period of change. Currently, the Company has not elected hedge accounting treatment and all changes in fair value of the Company’s derivatives are recognized in current period earnings.
Deferred Financing Costs
Costs incurred in connection with obtaining financing are capitalized and are being amortized on a straight-line basis over the financing term and are included in interest expense. The Company had amortization expense of $213,990 and $10,444 for the years ended December 31, 2014 and 2013, respectively. The Company had accumulated amortization of $302,080 and $88,090 as of December 31, 2014 and 2013, respectively.
Real Estate Property and Fixed Assets
Investment in real estate and fixed assets with a useful life of longer than one year are carried at cost less accumulated depreciation and amortization. Property such as land, building and improvements includes cost of acquisitions, development, and construction and tenant allowances and improvements. We allocate the cost of an acquisition, including the assumption of liability, to the acquired tangible assets (including land, buildings and personal property) determined by valuing the property as if it were vacant, and identifiable intangibles based on their relative fair values. Acquisitions of real estate are recorded based upon preliminary allocations of the purchase price to management’s assessment of the fair value of tangible and intangible assets and any assumed liabilities acquired which are subject to adjustment as additional information is obtained up to one year after the date of acquisition. Management’s fair value assessment includes the use of readily accepted fair value techniques such as discounted cash flow analysis and comparable sales analysis including management’s reliance on independent market analysis.
Depreciation is provided using the straight-line method over the estimated useful life of the assets for buildings and improvements, and the term of the lease for tenant improvements. The estimated useful lives being used are as follows:
Repair and maintenance costs are expensed as incurred, whereas expenditures that improve or extend the service lives of assets are capitalized. Disposal and abandonment of improvements are recognized at occurrence as a charge to depreciation.
TALON REAL ESTATE HOLDING CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of and for the Years Ended December 31, 2014 and 2013
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Intangible Assets or Liabilities
Upon acquisitions of real estate, the Company assesses the fair value of acquired tangible assets and any significant intangible assets and liabilities (such as above- and below-market leases and value of acquired in-place leases), and any assumed liabilities, and allocates the purchase price based on these fair value assessments. The Company records intangible assets and liabilities acquired at their estimated fair value apart from goodwill for acquisitions of real estate. The Company amortizes identified intangible assets and liabilities based on the period over which the assets and liabilities are expected to affect the future cash flows of the real estate property acquired. Lease intangibles (such as in-place or above- and below-market leases) are amortized over the term of the related lease. Above and below-market leases are amortized as a reduction in (addition to) rent revenue. The Company amortized $113,034 to rent revenue for above-market leases and $39,213 to rent revenue for below-market leases for the year ended December 31, 2014 and none was amortized in 2013. Amortization of other intangibles is recorded in depreciation and amortization expense.
Recent Accounting Pronouncements
In April 2014, the FASB issued ASU No. 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity (“ASU 2014-08”). This newly issued accounting standard amends the definition of a discontinued operation in ASC 205-20 and requires an entity to provide additional disclosures about disposal transactions that do not meet the discontinued-operations criteria. ASU 2014-08 is effective prospectively for all disposals (except disposals classified as held for sale before the adoption date) or components initially classified as held for sale in periods beginning on or after December 15, 2014, with early adoption permitted; and was adopted by the Company effective January 1, 2014. The adoption of this standard did not have a material impact on the Company’s financial position, results of operation or cash flows.
In May 2014, the FASB issued new accounting guidance related to revenue recognition. This new standard will eliminate all industry-specific guidance and replace all current U.S. GAAP guidance on the topic. The new revenue recognition standard provides a unified model to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration for which the entity expects to be entitled in exchange for those goods or services. This guidance will be effective for the Company beginning January 1, 2017 and can be applied either retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. We are currently assessing the impact on the Company’s consolidated financial statements.
In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40). The amendments in this Update provide guidance in U.S. GAAP about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. The amendments require management to assess an entity’s ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in U.S. auditing standards. Specifically, the amendments (1) provide a definition of the term substantial doubt, (2) require an evaluation every reporting period including interim periods, (3) provide principles for considering the mitigating effect of management’s plans, (4) require certain disclosures when substantial doubt is alleviated as a result of consideration of management’s plans, (5) require an express statement and other disclosures when substantial doubt is not alleviated, and (6) require an assessment for a period of one year after the date that the financial statements are issued (or available to be issued).The amendments in this Update are effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. Early application is permitted.
TALON REAL ESTATE HOLDING CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of and for the Years Ended December 31, 2014 and 2013
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
The Company currently has disclosed certain matters relative to going concern in Note 18 but presently has not yet adopted the new guidance.
In February 2015, the FASB issued ASU 2015-02, Amendments to the Consolidation Analysis ("ASU 2015-02"). This amends ASC 810, Consolidation (ASC "810"), to improve targeted areas of consolidation guidance by simplifying the requirements of consolidation and placing more emphasis on risk of loss when determining a controlling financial interest. ASU 2015-02 is effective for the annual period ending after December 15, 2015, and subsequent interim and annual periods with early adoption permitted. The adoption of ASU 2015-02 is not expected to have a material impact on the Company's consolidated financial statements.
Impairment of Long-Lived Assets
Long-lived assets, such as real estate property, and purchased intangible assets subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. An impairment loss would be recognized when the estimated future cash flows from the use and eventual disposition of the asset are less than the carrying amount of that asset. The Company did not recognize any impairment losses for either of the years ended December 31, 2014 or 2013.
Income Taxes
The Company accounts for income taxes under FASB ASC 740-10-30 which results in the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the book carrying amounts and the tax basis of assets and liabilities. Deferred income tax assets and liabilities are measured using the enacted tax rates and laws that will be in effect when the temporary differences and carryforwards are expected to reverse. Accounting standards require the consideration of a valuation allowance for deferred tax assets if it is “more likely than not” that some component or all of the benefits of deferred tax assets will not be realized.
The Company's policy of accounting for uncertain tax positions is to recognize the tax effects from an uncertain tax position in the financial statements, only if the position is more likely than not to be sustained on audit, based on the technical merits of the position. For tax positions meeting the more likely than not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized, upon ultimate settlement with the relevant tax authority. The Company has examined the tax positions taken in its tax returns and determined that there are no uncertain tax positions. As a result, the Company has recorded no uncertain tax liabilities in its consolidated balance sheet.
The Company is no longer subject to U.S. federal, state or local income tax examinations by tax authorities for the years before 2010. The Company is not currently under examination by any taxing jurisdiction. In the event of any future tax assessments, the Company has elected to record the income tax penalties as general and administrative expense and any related interest as interest expense in the Company's consolidated statements of operations.
Stock-based Compensation
The Company has granted restricted stock to employees under an approved employee equity incentive plan and to Directors under a director compensation plan. Granted shares are considered issued and outstanding as of the date of the grants. Stock-based compensation is expensed on a straight-line basis over the vesting period and is valued at the fair value on the date of the grant. The Company has recognized $656,623 and $47,995 of compensation expense for the years ended December 31, 2014 and 2013, respectively.
TALON REAL ESTATE HOLDING CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of and for the Years Ended December 31, 2014 and 2013
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
The Company has also issued common stock in exchange for goods or services of non-employees. These shares are either fully vested at date of grant or vest over a certain period during which services are provided. The Company expenses the fair market value of the services over the period in which they are received.
No stock was issued in exchange for goods or services of non-employees in the year ended December 31, 2014 and stock valued at $50,000 was issued for an equivalent value of services received in the year ended December 31, 2013. These membership units were contributed to the Company in exchange for shares of common stock as part of the Formation Transactions.
Noncontrolling Interest
Interests in the Operating Partnership held by limited partners are represented by partnership common units of the Operating Partnership. The Company's interest in the Operating Partnership was 64.5% of the common units of the Operating Partnership as of December 31, 2014 and 100% as of December 31, 2013. The Operating Partnership’s income is allocated to holders of units based upon the ratio of their holdings to the total units outstanding during the period. Capital contributions, distributions, syndication costs, and profits and losses are allocated to non-controlling interests in accordance with the terms of the Operating Partnership agreement.
The portion of membership interests in 5130 LLC not held by Talon OP is reported as noncontrolling interest. Capital contributions, distributions, and profits and losses are allocated to the noncontrolling interest based on membership percentages and terms of the operating agreement.
Net Income (Loss) or Earnings Per Share
Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing net income by the weighted average common and potential dilutive common shares outstanding in accordance with the treasury stock method.
The following is a reconciliation of the denominator of the basic net earnings per common share computation to the denominator of the diluted net earnings per common share computation for each of the periods presented:
TALON REAL ESTATE HOLDING CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of and for the Years Ended December 31, 2014 and 2013
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Reclassifications
Certain previously reported amounts have been reclassified to conform to the current financial statement presentation. The historical financials of Talon Real Estate Holding Corp. consisting solely of the surviving operations of 5130 LLC were restated for the recapitalization of TREHC per the Formation Transactions, as amended, completed on June 7, 2013.
NOTE 4 - TENANT LEASES
The Company leases various commercial and industrial space to tenants over terms ranging from month-to-month to ten years. Some of the leases have renewal options for additional terms. The leases expire at various dates from December 2014 to October 2020. Some leases provide for base monthly rentals and reimbursements for real estate taxes and common area maintenance.
The Company has the following future minimum base rentals on non-cancellable leases as of December 31, 2014:
NOTE 5 - NOTES PAYABLE
The following table summarizes the Company’s notes payable.
(1) See Note 17 for further disclosure related to this note.
TALON REAL ESTATE HOLDING CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of and for the Years Ended December 31, 2014 and 2013
NOTE 5 - NOTES PAYABLE (continued)
The Company is required to make the following principal payments on our outstanding notes payable for each of the five succeeding fiscal years and thereafter as follows:
The Company is required to periodically fund and maintain escrow accounts to make future real estate tax and insurance payments, as well as to fund certain capital expenditures.
The Company’s mortgage assumed by Talon Bren Road, LLC in connection with the acquisition of the property at Bren Road includes a restrictive covenant that requires Talon Bren Road, LLC to maintain a minimum debt service coverage (“DSCR”) before distributions of 1.35:1.00 and after distributions of 1:05:1.00 as of the last day of each calendar year. As of December 31, 2014, Talon Bren Road LLC was out of compliance with the DSCR test. The Company made an additional principal payment of $258,857 on September 25, 2014 which caused the DSCR to be reduced to 1.18 for the year ended December 31, 2014 which is below the required ratio. Had the DSCR been calculated using only scheduled monthly principal and interest due excluding the additional pay down of debt, the DSCR would have been in compliance with a ratio of 1.78 for the year ended December 31, 2014. Failure to meet the debt service coverage ratio covenant allows the lender to declare an event of default under the terms of the loan agreement. The lender is aware of such noncompliance, and we are seeking modification of the loan agreement and/or waiver of this covenant.
The Company’s mortgage entered into by Talon First Trust, LLC in connection with the property at 180 5th Street East, St. Paul, Minnesota includes a financial covenant that requires the Company to maintain a net worth that equals or exceeds $30 million and cash and marketable securities equal to or greater than $3 million after June 30, 2015 and throughout the remaining term of the loan, but allows the Company 30 days following any failure in which to satisfy this financial covenant or provide an individual or entity acceptable to lender as another guarantor on the loan and of the environmental indemnity obligations. Failure to satisfy the covenant would constitute an event of default under the terms of the loan. The Company (as well as its subsidiary, Talon OP, L.P.) is a guarantor of the loan entered into by Talon First Trust, LLC and an indemnitor of Talon First Trust, LLC’s environmental obligations in connection with the property at 180 5th Street East, St. Paul, Minnesota.
TALON REAL ESTATE HOLDING CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of and for the Years Ended December 31, 2014 and 2013
NOTE 7 - TRANSACTIONS WITH RELATED PARTIES
The Company engaged in services with related parties due to common ownership during the periods presented, which are described below.
On December 30, 2013, the Company issued an unsecured promissory note to one of its directors. The note provided for a $100,000 loan to the Company with with a 14% interest rate. No interest expense was recognized in 2013. On March 25, 2014, the Company issued a second unsecured promissory note to the same director. The note provided for an additional $100,000 loan to the Company with the same terms as the original note in 2013. On August 12, 2014, the Company entered into a new unsecured promissory note with the same director. The note provided for a $500,000 loan to the Company with the same terms as the original note. Significant portions of the proceeds of this note were used to retire the two previous notes to this director. All unpaid principal and accrued interest for this note is due and payable on June 30, 2015. The Company paid $14,527 of interest on the notes for the year ended December 31, 2014. The note agreement provides that the Company will not make any distributions, dividends or payments to any of their equity shareholders other than to preferred unit holders.
The Company had a general services and maintenance agreement with Outside Services & Storage LLC, a related party, which terminated at the end of May 2013. The total cost of these services was $0 for the year ended December 31, 2014 and $20,912 for the year ended December 31, 2013. The Company also had a lease agreement with Outside Services & Storage LLC, which ended on July 31, 2013. This agreement allowed Outside Services & Storage LLC to occupy 17,841 square feet of the industrial building located at 5130 Industrial Street and 24,000 square feet at 1350 Budd Ave at below market rental rates. The Company received no lease payments from this related party in 2014 or 2013. Related party revenue is recognized when received.
The Company had a management agreement with Kasa Real Estate LLC, a related party, which terminated at the end of May 2013. The management fees were $0 and $8,433 for the years ended December 31, 2014 and 2013, respectively.
TALON REAL ESTATE HOLDING CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of and for the Years Ended December 31, 2014 and 2013
NOTE 8 - CONCENTRATIONS
The Company has three tenants that rent approximately 29% of the Company’s total rentable space as of December 31, 2014 with base rent representing 60% of total base rent revenues for the year ended December 31, 2014. For the same period in 2013, two tenants rented approximately 50% of the total rentable space as of December 31, 2013 with base rent representing 59% of total base rent revenues for the year ended December 31, 2013. The largest tenant rents approximately 8.4% of the rentable space and represents 25% of total base rent revenues for the year ended December 31, 2014. The Company had one tenant who accounted for 72% of the total outstanding rents receivable balance as of December 31, 2014 and a different tenant who accounted for 88% of the total outstanding rents receivable balance as of December 31, 2013.
NOTE 9 - RESTRICTED ESCROWS AND RESERVES
According to the terms of the Company's notes payable agreements (Note 5), the Company is required to make monthly and quarterly deposits to various escrow and reserve accounts for the payment of real estate taxes, tenant improvements and leasing commissions. The balances in these restricted escrows and reserve accounts are as follows:
NOTE 10 - COMMITMENTS AND CONTINGENCIES
On June 7, 2013, prior to the Formation Transactions, Talon RE, entered into a contribution agreement with the remaining interest holder of 5130 LLC pursuant to which it will acquire the remaining 51% interest in 5130 LLC in exchange for 2,820,810 shares of our common stock, subject to receiving consent to the transfer from 5130 LLC’s lender.
The Company entered into a property lease agreement relating to rental of office space. This non-cancellable lease has a remaining term of 53 months. The lease is subject to periodic adjustments for operating expenses. The future minimum rental payments for this lease are as follows:
TALON REAL ESTATE HOLDING CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of and for the Years Ended December 31, 2014 and 2013
NOTE 10 - COMMITMENTS AND CONTINGENCIES (continued)
The Company entered into a Contribution Agreement dated May 29, 2014 with Bren Road, LLC, the contributor of the property acquired through our subsidiary, Talon Bren Road, LLC. The agreement provides for any deficit in achieving $1,560,000 of net operating income (“NOI”) per year for the first three years to be funded by Bren Road, LLC. The Company may deliver a “NOI Payment Notice” to Bren Road, LLC if it determines in its reasonable discretion that there will be a NOI Deficit related to any deficit quarter. The Company recognized $188,724 of income under this agreement for the year ended December 31, 2014.
The Company entered into a consulting agreement dated May 29, 2014 with Gerald Trooien (“Consultant”). This agreement provides for consulting services to Talon Bren Road, LLC for $43,750 per month payable beginning August 15, 2014 and continuing for 59 months thereafter. The agreement will terminate upon the occurrence of any of the following:
a. redemption or conversion of all limited partnership units held by Bren Road, LLC
b. sale by Bren Road of any of its partnership units in Talon OP
c. payment to Bren Road of any dividends in respect to Bren Road’s interest in Talon
d. the Company qualifies as a real estate investment trust (REIT)
The consulting agreement provides for a reduction of the monthly consulting fees upon receipt of funds from a subsequent mortgage financing. The Company had recognized $131,250 of accrued expenses for this contingency based on the likelihood of expenses to be incurred that could be reasonably estimated at the time of acquisition. This contingent liability was included as part of the purchase price fair value allocation of the tangible and intangible assets acquired on May 29, 2014 and currently has a balance of $0.
The dispute with the lender and loan servicer of 5130 LLC on its two mortgage notes payable (the “Notes”) regarding the current status of the Notes and the accounting for historical payments made on the Notes has been resolved. The Company had previously accrued $75,041 for this contingency. In November 2014, the Company had reached a settlement with the lender and loan servicer. In connection with the settlement, the Company expensed an additional $19,971 for costs related to resolving the dispute. No adjustments were required to be made on the principal balance of the notes and the loans have been deemed current by the lender as of December 31, 2014.
TALON REAL ESTATE HOLDING CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of and for the Years Ended December 31, 2014 and 2013
NOTE 11 - RESTRICTED STOCK
The Company has granted restricted stock to employees under an approved employee equity incentive plan and to Directors under a director compensation plan. The 2013 Equity Incentive Plan dated June 7, 2013 (the “Plan”) allows up to 1,500,000 shares to be issued and granted to employees, non-employee directors, and consultants and automatically increases on January 1 of each year by three percent of the outstanding shares of common stock as of December 31 of the immediately preceding year. Employee awards granted in 2013 vest monthly over 36 months provided the recipient remains an employee or consultant of the Company. Awards granted in 2014 vest either immediately, monthly over a three year period, or monthly over a five year period. The Non-Employee Director Compensation Plan allows shares of restricted common stock to be granted to board members and is included under the Plan. The 2013 board member awards vest one-third of the shares on the date of grant, one-third on January 1 of the year following the date of grant, and one-third on January 1 of the second year following the date of grant, provided the recipient remains a member of the board as of the vesting date. The 2014 awards vested immediately in March of 2014.
As of December 31, 2014, the Company had granted 921,300 shares to employees and 360,000 shares to Directors under the Plan.
The following table sets forth a summary of restricted stock:
Total unrecognized compensation expense related to the outstanding restricted stock as of December 31, 2014 and 2013 were $702,007 and $132,005, respectively, which are expected to be recognized over a weighted average period of 16 months. The Company recognized $656,623 and $47,995 of stock-based compensation expense for the years ended December 31, 2014 and 2013, respectively, that is included in salary and compensation in the consolidated statements of operations. The Company used 0% for both the discount factor and forfeiture rate for determining the fair value of restricted stock. The Company has limited history to determine forfeiture trends and the Company considers the discount rate to be immaterial.
TALON REAL ESTATE HOLDING CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of and for the Years Ended December 31, 2014 and 2013
NOTE 12 - INCOME TAXES
Deferred income tax assets and liabilities are determined based upon differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The Company does not expect to pay any federal or state income tax for 2014 because it projects losses to exceed operating income in 2014. Accounting standards require the consideration of a valuation allowance for deferred tax assets if it is “more likely than not” that some component or all of the benefits of deferred tax assets will not be realized. Realization of deferred tax assets is dependent upon the generation of sufficient future taxable income. Management has determined that sufficient uncertainty exists regarding realizability of its net deferred tax assets and has provided a full valuation allowance of $1,156,732 and $336,050 against the net deferred tax assets as of December 31, 2014 and 2013, respectively. The net change in the total valuation allowance was an increase of $820,950 and $336,050 for the years ended December 31, 2014 and 2013, respectively. Based on these requirements no provision or benefit for income taxes has been recorded for deferred taxes. There were no unrecognized tax benefits at the end of the reporting period.
The Company calculated its estimated annualized effective tax expense rate at 0% for December 31, 2014. The Company had no income tax expense based on its pre-tax loss for the years ended December 31, 2014 and 2013.
Deferred tax assets (liabilities) consist of the following components as of:
The statutory income tax rate reconciliation for continuing operations to the effective rate is as follows:
At December 31, 2014, the Company had net operating loss carryforwards for federal purposes of $3,260,000 and $2,765,000 for state income tax purposes that are available to offset future taxable income and begin to expire in the year 2029. At December 31, 2013, the Company had net operating loss carryforwards for federal purposes of $848,050 and $737,445 for state income tax purposes that are available to offset future taxable income and begin to expire in the year 2029.
The future utilization of federal net operating loss carryforwards is subject to certain limitations under Section 382 of the Internal Revenue Code. This section generally relates to a 50 percent change in ownership of a company over a three-year period. The issuance of additional shares could result in an “ownership change” under Section 382. Therefore, the ability to apply our net operating losses in the future may become limited.
TALON REAL ESTATE HOLDING CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of and for the Years Ended December 31, 2014 and 2013
NOTE 13 - INTANGIBLE ASSETS AND LIABILITIES
The Company's identified intangible assets and liabilities at December 31, 2014 and December 31, 2013 were as follows:
The effect of amortization of acquired intangible assets was approximately $1,484,716 for the year ended December 31, 2014. Above-market leases, included in intangible assets, are amortized as a reduction in rent revenue and totaled $113,034 for the year ended December 31, 2014. Amortization of below-market leases as an addition to rent revenue was $39,213 for the year ended December 31, 2014. There was no amortization of any intangible assets for the year ending December 31, 2013. In-place leases, and above and below-market leases had a weighted average amortization period of 4.5 years in the year acquired.
The estimated annual amortization of acquired intangible assets and liabilities for each of the five succeeding fiscal years is as follows:
NOTE 14 - HEDGING ACTIVITIES
The Company may use derivative instruments as part of its interest rate risk management strategy to minimize significant unanticipated earnings fluctuations that may arise from variable interest rates associated with existing borrowings. On July 2, 2014, the Company entered into an interest rate cap contract for the notional amount of $33 million with a strike rate of 2.5% on one month LIBOR as a hedge for a floating rate debt entered into on that date. The interest rate cap expires on July 5, 2016. The interest rate cap was issued at approximate market terms and thus no fair value adjustment was recorded at inception and the rate cap had no value as of December 31, 2014. The Company did not elect hedge accounting treatment for the rate cap and as such, changes in fair value are recorded directly to earnings.
TALON REAL ESTATE HOLDING CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of and for the Years Ended December 31, 2014 and 2013
NOTE 15 - MANDATORILY REDEEMABLE PREFERRED OPERATING PARTNERSHIP UNITS
On July 2, 2014, the Company issued 30,000 preferred units, at a price of $100 per unit, totaling $3,000,000. These preferred unit holders are entitled to distributions at a rate of 6% per annum of their liquidation preference amount of $100 per unit which are cumulative from the date of issuance and are payable monthly (to the extent there are sufficient distributable proceeds). On and after July 2, 2020, the Company shall redeem the units, in whole, at the liquidation preference price of $100 per unit, plus accrued and unpaid distributions. There were no accumulated, undeclared preferred payments outstanding as of December 31, 2014. The preferred units have been classified as a liability in the consolidated balance sheet as the preferred liquidation preference amount is mandatorily redeemable in specific amounts at specific dates in the future. The liquidation preference amount totaled $3,000,000 as of December 31, 2014.
NOTE 16 - ACQUISITIONS
Acquisitions of real estate are recorded based upon preliminary allocations of the purchase price to management’s assessment of the fair value of tangible and intangible assets and any assumed liabilities acquired. The process of allocating property costs to its components involves a considerable amount of subjective judgments to be made by Company management and preliminary estimates of fair values of assets and liabilities acquired are subject to adjustment as additional information is obtained and finalized by management up to one year after the date of acquisition. The company will finalize the amounts recognized as information necessary to complete the analysis is obtained. Amounts for certain contingent liabilities, and certain tangible and intangible assets and liabilities remain subject to change. These estimates were based on assumptions the Company believes to be reasonable, however, actual results may differ from these estimates.
On May 29, 2014, Talon OP entered into a contribution agreement with Bren Road, LLC and acquired through Talon Bren Road, LLC, a Delaware limited liability company that is wholly owned by Talon OP, the Minneapolis Mart building and certain other assets located at 10301 Bren Road West, Minnetonka, MN. The consideration for this property consists of (i) the assumption by Talon Bren Road, LLC of a secured loan of Bren Road, LLC with an aggregate principal amount of $11.5 million and a fixed interest rate of 4.65% which matures on May 28, 2019, and (ii) 5,200,000 common units of Talon OP. The acquisition closed on May 29, 2014. The Company recognized approximately $1,615,000 in revenue and $912,000 in net income before interest, depreciation and amortization expense from this property since acquisition through December 31, 2014.
The consideration for the acquisition of the property located at Bren Road as of the acquisition date consisted of the following:
TALON REAL ESTATE HOLDING CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of and for the Years Ended December 31, 2014 and 2013
NOTE 16 - ACQUISITIONS (continued)
The Company has preliminarily allocated the total cost of the acquisition as follows:
On July 2, 2014, Talon OP, L.P. (“Talon OP”) entered into a contribution agreement with various parties and acquired the First Trust Center building and certain other assets located at 180 5th Street East, St. Paul, MN through Talon First Trust, LLC, a wholly-owned subsidiary of Talon OP. The consideration for this property consisted of (i) $32 million of cash, financed via a mortgage loan (ii) 30,000 preferred units of Talon OP and (iii) 4 million common units of Talon OP. The acquisition closed on July 2, 2014. The Company recognized approximately $4,256,000 in revenue and $1,577,000 in net income before interest, depreciation and amortization expense from this property since acquisition through December 31, 2014.
The consideration for the acquisition of the property located at 180 5th Street East as of the acquisition date consisted of the following:
TALON REAL ESTATE HOLDING CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of and for the Years Ended December 31, 2014 and 2013
NOTE 16 - ACQUISITIONS (continued)
The Company has preliminarily allocated the total cost of the acquisition as follows:
The following unaudited pro forma information presents a summary of consolidated results of operations of the Company as if the acquisitions of the properties located at Bren Road and 180 5th Street East had occurred at January 1, 2013, the beginning of the earliest period presented. The unaudited pro forma condensed consolidated financial information is presented for informational purposes only. The pro forma information is not necessarily indicative of what the financial position or results of operations actually would have been had the acquisitions been completed on the dates indicated. In addition, the unaudited pro forma condensed consolidated financial information does not purport to project the future financial position or operating results of the Company after completion of the acquisition.
(1) Net income (loss) includes the effects of depreciation and amortization expense of $4,731,010 and $4,747,211 for the years ended December 31, 2014 and 2013, respectively, based on preliminary allocations of the purchase price from management’s assessment of the fair value of tangible and intangible assets and any assumed liabilities in connection with the acquisitions.
NOTE 17 - SUBSEQUENT EVENTS
The Company has evaluated subsequent events for matters that require recognition or disclosure in the Company’s financial statements through the date these financial statements were issued.
TALON REAL ESTATE HOLDING CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of and for the Years Ended December 31, 2014 and 2013
NOTE 17 - SUBSEQUENT EVENTS (continued)
On January 12, 2015, the Company entered into an unsecured promissory note with an unrelated party. The note provides for a $250,000 loan to the Company with an annual interest rate of 14% payable at maturity on June 30, 2015. This is in addition to a note entered into on October 7, 2014 in the same amount, with the same party. Both notes totaling $500,000 are due with principal and accrued interest on June 30, 2015.
On January 23, 2015, Talon OP entered into a purchase agreement with Hoopeston I, L.L.C. and Broadmoor Place Associates, LLC to acquire a building and certain other assets located at 5799 Broadmoor Street, Mission, KS for a purchase price of $11,580,000. The property consists of a building of approximately 115,811 rentable square feet located in Mission, KS 66202. The acquisition is expected to close subject to the satisfaction of customary closing conditions.
On February 10, 2015, the Company entered into a promissory note with US Income Partners, LLC, known as USIP, to borrow up to $2,000,000 in aggregate principal with an interest rate of 16% and a maturity date of March 1, 2016. The note requires monthly payments of interest only. The loan is secured by a second mortgage on the property at 10301 Bren Road West, Minnetonka, MN held by Talon Bren Road, LLC, a wholly owned subsidiary of Talon OP. The loan documents contain events of default that are customary for loans of this type. The obligations of Talon OP under the loan are guaranteed by both the Company and an unrelated party. In consideration for providing the guaranty, the Company issued the third party guarantor 460,000 shares of its common stock. Proceeds from the USIP note were used to pay off the note referred to as Talon Bren Road, LLC Mortgage 2 in Note 5 which was secured by the same property.
NOTE 18 - GOING CONCERN
Liquidity is a measure of our ability to meet potential cash requirements, including commitments to repay borrowings, fund and maintain our operations and assets, acquire properties, make distributions to our shareholders and other general business needs. In the short-term, we have incurred significant expenses related to our formation activities, becoming a public corporation, and preparation for our acquisition strategy creating a cash shortfall from operations in 2013 and 2014.
Our short-term liquidity requirements consist primarily of funds needed to pay for operating expenses and other expenditures directly associated with our properties and to pursue our strategy of near-term growth through acquisition of properties as well as general and administrative expenses operating as a public company.
We currently do not have available cash and cash flows from current operations to provide us with adequate liquidity for the foreseeable future. Our current liabilities exceed our unrestricted cash and we have very limited cash flow from current operations. As of December 31, 2014, we had unrestricted cash of $147,157 and current liabilities including accounts payable and accrued expenses substantially in excess of the available cash. We therefore will require additional capital and/or increased cash flow from future operations to fund our ongoing business. In addition, as of December 31, 2014, we are not in compliance with the financial covenants under our loan agreement for Talon Bren Road LLC, however, we are seeking modification of the loan agreement and/or waiver of this covenant with Bell State Bank & Trust. There is no assurance the lender will agree to such modification and/or waiver and may accelerate the loan which would have a material adverse effect on our cash flows. We may also be unable to borrow or obtain sufficient funds for repayment on terms acceptable to us or at all, and our ability to obtain future financing may also be impacted negatively.
TALON REAL ESTATE HOLDING CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of and for the Years Ended December 31, 2014 and 2013
NOTE 18 - GOING CONCERN (continued)
There is no guarantee that we will be able to raise any required additional capital or generate sufficient cash flow from our current and future operations to fund our ongoing business. If the amount of capital we are able to raise together with our income from operations is not sufficient to satisfy our capital needs, we may be required to cease our operations or alter our growth plans. If we are unable to continue as a going concern, we may have to liquidate our assets and may receive less than the value at which those assets are carried on our consolidated financial statements, and it is likely that investors will lose all or a part of their investment.
Although we plan to aggressively pursue acquisitions to grow our business, we are not a party to any agreement to purchase any additional properties (other than the remaining 51% interest in 5130 LLC) and there is no assurance that we will be able to acquire additional properties in the future or obtain the necessary financing to acquire such properties.
Since our available cash and cash flows from current operations do not provide us with adequate cash to satisfy current liabilities and do not provide us with adequate liquidity for the foreseeable future, we anticipate that we will undertake future debt or equity financings in 2014.
In the future, we may use a number of different sources to finance our liquidity needs, including cash flows from operations, issuance of debt securities or equity securities (which might be common or preferred stock), private financings (such as additional bank credit facilities, which may or may not be secured by our assets), asset sales, seller financing, property-level mortgage debt, or any combination of these sources, to the extent available to us, or other sources that may become available from time to time. Any debt that we incur may be recourse or non-recourse and may be secured or unsecured. We may incur substantial costs in pursuing future capital financing, including investment banking fees, legal fees, accounting fees, and other costs. Although we have successfully raised equity capital in the past, we cannot be assured that we will be able to continue to be successful in raising capital through issuance of securities. Our ability to obtain needed financing may be impaired by such factors as the capital markets, our status as a new enterprise without significant assets or demonstrated operating history, and/or the loss of key management. There is no guarantee that we will be able to raise any required additional capital or generate sufficient cash flow from our current and proposed operations to fund our ongoing business.
Item 9.
Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A.
Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2014, the end of the period covered by this Annual Report on Form 10-K. This evaluation was done under the supervision and with the participation of management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”). Disclosure controls and procedures means controls and other procedures that are designed to provide reasonable assurance that information required to be disclosed in the reports that we file or submit under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”), such as this Annual Report on Form 10-K, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (“SEC”). Disclosure controls and procedures include, without limitation, controls and procedures designed such that information is accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. Based on this evaluation, our CEO and CFO have concluded that as of December 31, 2014, our disclosure controls and procedures were effective.
Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act as a process designed by, or under the supervision of, our principal executive and principal financial officer and effected by our board of directors, management and other personnel, 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 and includes those policies and procedures that:
·
pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets;
·
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and
·
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our 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.
Under the supervision and with the participation of management, including our principal executive and financial officers, we assessed the effectiveness of our internal control over financial reporting as of December 31, 2014, based on criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013).
Based on this assessment, management concluded that we maintained effective internal control over financial reporting as of December 31, 2014 based on the specified criteria.
This annual report does not include an attestation report of the company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the company’s independent registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the company, as a smaller reporting company, to provide only management’s report in its annual report.
Changes in Internal Control over Financial Reporting
There were no other changes in our internal control over financial reporting during the most recent fiscal quarter ended December 31, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B.
Other Information
None.
PART III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance
The information required by this item with respect to executive officers is contained in Item 1 of this Annual Report on Form 10-K under the heading “Executive Officers.”
Directors
The following table sets forth certain information regarding each of our directors:
Name
Age
Position
Director
Since
MG Kaminski
Chief Executive Officer and Chairman of the Board of Directors
June 2013
Neil Brown
Director and Chairman of the Audit Committee
June 2013
Frank Elsenbast
Director and Chairman of the Governance and Nominating Committee
June 2013
Curtis Marks
Director and Chairman of the Compensation Committee
June 2013
Our board of directors has established an audit committee, a compensation committee and a governance and nominating committee. Mr. Brown, Mr. Marks, and Mr. Elsenbast are members of each of our committees.
NEIL BROWN has served as our Director since June 7, 2013. Mr. Brown served as Chief Financial Officer of Sawtooth Asset Management, Inc. from January 2014 to October 2014. Previously, Mr. Brown served in various executive roles at TCF Financial Corporation, a national bank holding company based in Minnesota, including Chief Risk Officer from January 2012 to November 2012, President and Chief Operating Officer from 2007 to 2011 and Executive Vice President and Chief Financial Officer from 1998 to 2006. Prior to joining TCF, Mr. Brown was an audit partner at KPMG in Minneapolis. Mr Brown also serves as a director of N.A. Corporation and NimbeLink Corporation. Mr. Brown’s qualifications to serve on our board of directors include, among other skills and qualifications, his financial accounting and risk management expertise and his experience in the management of publicly-traded companies developed during his service at TCF.
FRANK ELSENBAST has served as our Director since June 7, 2013. Mr. Elsenbast also serves as the Chief Financial Officer and Chief Operating Officer at Zelle Hofmann Voelbel & Mason LLP, a national law firm focused in the areas of complex business litigation and dispute resolution. Previously, Mr. Elsenbast was the Chief Financial Officer of LodgeNet Interactive Corporation, an interactive media and connectivity services provider and a publicly traded company. In that role, Mr. Elsenbast was responsible for finance, investor relations, accounting, credit, information technology, facilities and contract administration. Prior to joining LodgeNet in 2010, Mr. Elsenbast was the Chief Financial Officer of ValueVision Media, a multichannel electronic retailer. Mr. Elsenbast’s qualifications to serve on our board of directors include, among other skills and qualifications, his capabilities in financial understanding, investor relations and debt financing as well as his experience with public companies as Chief Financial Officer of LodgeNet Interactive Corporation and ValueVision Media.
CURTIS MARKS has served as our Director since June 7, 2013. Mr. Marks also serves as the President and Chief Executive Officer of Click Boarding LLC, an on-boarding software company he founded. Mr. Marks has built and sold numerous companies, the most recent being Verifications Inc., an international employment screening company that provides services to 48% of Fortune 100 companies. Mr. Marks primarily focuses on strategic planning, acquisitions, and developing business partners. Prior to Verifications Inc., Mr. Marks served as Chief Executive Officer of Automated Telemarketing Services Inc., a software reseller. Mr. Marks also has extensive experience owning and working with technology-focused companies in various industries. Mr. Marks’ qualifications to serve on our board of directors include, among other skills and qualifications, his management and operational experience as well as his experience in founding, building, and owning various companies.
Audit Committee of our Board of Directors
Mr. Brown, Mr. Marks, and Mr. Elsenbast comprise our audit committee. The purpose of our audit committee is to oversee the accounting and financial reporting processes of our company and the audits of the financial statements of our company. Our audit committee’s function is one of oversight and, in that regard, our audit committee meets with our management and our independent registered public accounting firm to review and discuss our financial reporting and our controls regarding accounting and risk of material loss.
All of our directors, except for MG Kaminski are “independent” as that term is defined in Rule 5605(a) of the Nasdaq Stock Market Marketplace Rules, which is the standard for independence we have chosen for purposes of the disclosure required in this report by SEC rules (even though our common stock is not listed on the Nasdaq Stock Market) and as that term is defined by Section 301 of the Sarbanes-Oxley Act of 2002. Our board of directors has determined that Mr. Brown, the chair of our audit committee, is an “audit committee financial expert” as defined by SEC regulations.
Code of Ethics
We have adopted a code of business conduct applicable to our directors, officers (including our principal executive officer and principal financial officer) and employees. The Code of Business Conduct is available on our website at www.talonreit.com under the Corporate Governance section. We plan to post on our website at the address described above any future amendments or waivers of our Code of Conduct.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 and the regulations promulgated thereunder require directors and certain officers and persons who own more than ten percent of our common stock to file reports of their ownership of our common stock and changes in their ownership with the SEC. To our knowledge, all reports required to be filed under Section 16(a) of the Securities and Exchange Act of 1934 were filed on a timely basis during 2014.
Item 11.
Item 11.
Executive Compensation
This section contains a discussion of the material elements of the compensation program covering our chief executive officer and chief financial officer named in the Summary Compensation Table elsewhere in this report, who are referred to in this report as the named executives.
Executive Compensation Objectives
The goal of our executive compensation program is to attract and retain motivated individuals who will lead our company to achieve long-term success and growth in shareholder value. In pursuit of this goal, we shall seek executive compensation commensurate with the level of job responsibility, individual performance and company performance and to align the interest of the named executives with those of our shareholders. We seek to motivate current and long-term performance through cash and equity incentive awards and to remain competitive with the compensation of other leading employers who compete with us for talent.
Compensation Committee Process
Our Compensation Committee consists of our three independent directors, Mr. Brown, Mr. Marks, and Mr. Elsenbast, that meet periodically to review compensation for each executive officer. The chairman of the committee, Mr. Marks, served as President and Chief Executive Officer of an international employment screening and on-boarding company which he founded in 1989 and provides services to 48% of Fortune 100 companies. The committee members will consider all elements of compensation and utilize their experience and judgment in determining the total compensation elements appropriate for each executive consistent with our compensation objectives. The compensation committee has determined that our compensation programs do not create inappropriate or excessive risk that is likely to have a material adverse effect on the company.
Our compensation committee consults with our management, and our chief executive officer makes recommendations to the committee regarding compensation of our executive officers. Our chief executive officer participates in the compensation committee’s deliberations regarding compensation for executive officers other than our chief executive officer, although all determinations are made by the committee. The compensation committee’s charter provides that our chief executive officer may not be present during the committee’s voting or deliberations regarding the chief executive officer’s compensation, and he does not participate in such voting or deliberations.
Determining Executive Compensation for the Year Ended December 31, 2014
Our executive compensation program for 2014 consisted of three main elements:
·
Base salary
·
Equity awards
·
Other benefits
We have a long-term equity incentive program that we have used in the past to encourage the creation of long-term value for our shareholders, retain our key executives and build equity ownership among participants in the program. We believe stock grants can align the interests of the named executives with those of our shareholders and enhance retention of key executives and provide value only if the employee remains with our company until his or her stock grants vest. We did not grant any equity awards to our chief executive officer in 2014.
Elements of Executive Officer Compensation for the Year Ended December 31, 2014
Base Salary
Base salary is a set amount of cash compensation that is not variable in nature. Base salaries for the executive officers are reviewed annually by the compensation committee, but are not automatically increased if the committee believes that the executive’s total compensation opportunity from all elements of compensation is appropriate in light of our compensation objectives. Adjustments are based on each executive officer’s performance for the prior year; his or her experience, expertise and position within our company; overall company performance; and compensation levels for comparable positions at other companies in the retail industry with whom our company competes, as reported in external compensation sources. Although the compensation committee uses comparative data as a tool to assess reasonableness and competitiveness of base salaries, the members of the committee also exercised their subjective judgment in view of our compensation objectives.
The aggregate base salaries earned by the named executives in fiscal 2014 are listed in the Summary Compensation Table below. Our compensation committee did not approve any increases in base salary for executive officers in 2014.
Mr. Kaminski has a base annual salary of $23,660 for 2013 and 2014.
Equity Awards
Equity incentive award compensation is a key component of our company’s executive compensation strategy. The 2013 Equity Incentive Plan (“the 2013 Plan”) allows us to grant stock options, stock appreciation rights (or SARs), restricted stock, stock units, other stock-based awards and cash incentive awards. Each award will be evidenced by an agreement with the award recipient setting forth the terms and conditions of the award, except for awards that involve only the immediate issuance of unrestricted shares of our common stock. Awards under the 2013 Plan will have a maximum term of ten years from the date of grant. The compensation committee may provide that the vesting or payment of any award will be subject to the attainment of specified performance measures in addition to the satisfaction of any continued service requirements, and the compensation committee will determine whether such measures have been achieved. The compensation committee may generally amend the terms of any award previously granted, except that no stock option or SAR may be amended to decrease its exercise price or in any other way be “repriced” without the approval of our shareholders, and no award may be amended in a way that materially impairs the rights of a participant without the participant’s consent (unless the amendment is necessary to comply with applicable law or stock exchange rules or any compensation recovery policy adopted by our board of directors or the compensation committee). Under the 2013 Plan, our compensation committee may structure any “full value award” (an award other than an option, SAR or cash incentive award) or any cash incentive award in a manner designed to qualify the award as performance-based compensation that is not subject to the $1,000,000 limitation on the federal income tax deductibility of compensation paid to any covered executive officer that is imposed by Section 162(m) of the Code.
In 2014, the Company awarded 260,000 shares of restricted stock of which 60,000 shares vested immediately on grant date in March 2014 with the remaining 200,000 to vest over 60 months to our chief financial officer under the 2013 Plan.
Other Benefits
The compensation committee believes that we must offer a competitive benefits program to attract and retain our executive officers. During 2014, we provided medical and other benefits to our executive officers that are generally available to our other employees.
Other Agreements and Policies
Employment Agreements
MG Kaminski
We are party to an employment agreement with MG Kaminski, our Chief Executive Officer. The initial term of the agreement is for three years beginning on June 7, 2013, and the agreement will automatically renew for additional one-year terms unless terminated by us or Mr. Kaminski by providing at least 90 days written notice of termination prior to the end of the then-current term. Pursuant to the agreement, Mr. Kaminski received $23,660 in annual base salary for 2013. Thereafter, his base salary will be determined by our board of directors or the compensation committee and reviewed annually. Mr. Kaminski received a base salary of $23,660 for 2014. Mr. Kaminski is eligible to receive bonus compensation in the form of cash and stock in the discretion of our board of directors or the compensation committee if he meets or exceeds performance goals mutually agreed upon by him and us. Such bonus compensation will be determined by our board of directors or the compensation committee on an annual basis. No bonus compensation was paid to Mr. Kaminski in 2014. As of the date of this report, we have not agreed on any performance goals for 2015 with Mr. Kaminski.
Mr. Kaminski’s employment agreement requires he not disclose our confidential information during the term of the agreement or thereafter. He also is prohibited from competing with us or soliciting any of our employees during the term of his employment with us and for a period of one year following termination of his employment.
Eun Stowell
We are party to an employment agreement with Eun Stowell, our Chief Financial Officer. The initial term of the agreement is for three years beginning on June 7, 2013, and the agreement will automatically renew for additional one-year terms unless terminated by us or Ms. Stowell by providing at least 90 days written notice of termination prior to the end of the then-current term. Pursuant to the agreement, Ms. Stowell’s annual base salary is $200,000 for 2013 and will be reviewed annually and may be adjusted by us from time to time. Ms. Stowell received a base salary of $200,000 in 2014. Ms. Stowell is eligible to receive bonus compensation in the form of cash and stock in the discretion of our board of directors or compensation committee if she meets or exceeds performance goals mutually agreed upon by her and us. Such bonus compensation will be determined by our board of directors or compensation committee on an annual basis. As of the date of this report, we have not agreed on any performance goals for 2015 with Ms. Stowell.
Pursuant to the agreement, we issued Ms. Stowell 120,000 restricted shares of our common stock. These shares vest in 36 equal monthly installments following the date of grant.
Ms. Stowell’s employment agreement requires her not disclose our confidential information during the term of the agreement or thereafter. She also is prohibited from competing with us or soliciting any of our employees during the term of her employment with us and for a period of one year following termination of her employment.
Equity Award Approval Policy
Our board of directors has adopted a policy regarding the approval of equity awards under the 2013 Plan. Equity awards are determined annually by a meeting of the compensation committee or by written action.
Tax Deductibility of Compensation
Section 162(m) of the Internal Revenue Code imposes a $1 million limit on the amount that a public company may deduct for compensation paid to the company’s chief executive officer or its other four most highly paid executive officers. This limitation does not apply to compensation that meets the requirements under Section 162(m) for “qualifying performance-based” compensation (i.e., compensation paid only if the individual’s performance meets pre-established objective goals based on performance criteria approved by shareholders). We believe that all executive compensation in 2013 is deductible under current federal income tax laws. We believe there may be circumstances in which our interests are best served by maintaining flexibility in the way compensation is provided, whether or not compensation is fully deductible under Section 162(m). We also believe that the amount of any loss of a tax deduction under Section 162(m) will be insignificant to our company’s overall tax position.
Compensation Committee Report
The compensation committee of our board of directors has discussed and reviewed the Compensation Discussion and Analysis with management. Based upon this review and discussion, the compensation committee recommended to the board of directors that the Compensation Discussion and Analysis be included in this Annual Report.
The Compensation Committee
Curtis Marks (chair)
Neil Brown
Frank Elsenbast
Summary Compensation Table
The following table shows, for our named executives, information concerning compensation earned for services in all capacities during fiscal 2014 and 2013. No compensation was earned in 2012.
(1)
Values expressed represent the actual compensation cost recognized by our company during the years presented for stock awards granted and utilizing the assumptions discussed in Note 11 to our company’s financial statements for 2014.
(2)
Consists of the amounts paid for insurance and other employee benefits for the benefit of the named executives.
Grants of Plan-Based Awards
The following table sets forth certain information concerning awards granted under the 2013 Plan to the named executive officers during 2014.
(1)
60,000 shares vest immediately on the grant date and the remaining 200,000 vest in 60 equal monthly installments.
Outstanding Equity Awards at Fiscal Year-End
The following table sets forth certain information concerning outstanding awards granted under the 2013 Plan to the named executive officers during 2014.
(1)
Market value of shares determined using the price of the OP units exchanged for the acquisition of our property in St. Paul, MN on July 2, 2014 since the stock has not been traded on the Over the Counter Bulletin Board since that date through December 31, 2014 and OP units are exchangeable 1:1 for Talon common stock.
Potential Payments Upon Termination or Change-in-Control
Employment Agreement Provisions
The employment agreements we currently have in place with Ms. Stowell contains the following provisions regarding potential payments upon termination:
If Ms. Stowell’s employment with us is terminated during the term by us for any reason other than cause, or by Ms. Stowell for good reason, then we will pay Ms. Stowell a lump sum payment equal to 100% of her annual base salary as of the termination date. “Cause” is defined in the agreement to include: (1) an intentional act of fraud, embezzlement, theft or any other material violation of law; (2) intentional damage to us or our subsidiaries’ assets; (3) the willful and continued failure to substantially perform required duties for us (other than as a result of incapacity due to physical or mental illness); or (4) willful conduct that is demonstrably and materially injurious to us. “Good reason” is defined in the agreement to include: (1) a material breach by us of any terms and conditions of Ms. Stowell’s employment agreement; or (2) a material reduction of Ms. Stowell’s salary. Ms. Stowell is required to sign a release of claims in connection with receiving any payments described in this paragraph.
Change in Control
Unless otherwise provided in an award agreement, if a change in control, as defined below, occurs that involves a sale of all or substantially all of our assets or a merger, consolidation, reorganization or statutory share exchange involving our company, our board of directors or compensation committee are to take one or more of the following actions with respect to outstanding awards under the 2013 Plan:
·
Arrange for the surviving or successor entity to continue, assume or replace some or all of the outstanding awards under the 2013 Plan.
·
Accelerate the vesting and exercisability of outstanding awards prior to and conditioned upon the occurrence of the event and provide that unexercised options and SARs will be terminated at the effective time of the event.
·
Cancel any outstanding award in exchange for payment to the holder of the amount of the consideration that would have been received in the event for the number of shares subject to the award, less the aggregate exercise price (if any) of the award.
·
Provide that if an award is continued, assumed or replaced in connection with such an event and if within 18 months after the event a participant experiences an involuntary termination of service other than for cause, the participant’s outstanding awards will vest in full, will immediately become fully exercisable and will remain exercisable for one year following termination.
·
Make adjustments to awards as described below under the caption “Adjustment of Awards.”
Director Compensation for 2014
The following table shows information concerning compensation provided to each of our non-employee directors for services provided during 2014.
(1)
Valuation for restricted stock awards is based on the compensation cost we recognized during the year for financial statement purposes under generally accepted accounting principles for awards granted utilizing the assumptions noted in Note 11 to our financial statements for 2014.
(2)
Mr. Brown has 20,000 shares of restricted common stock that remain unvested at December 31, 2014. All 20,000 shares vest on January 1, 2015 and compensation expense of $12,000 related to these shares has already been recognized in 2014 pursuant to our accounting policy.
(3)
Mr. Elsenbast has 20,000 shares of restricted common stock that remain unvested at December 31, 2014. All 20,000 shares vest on January 1, 2015 and compensation expense of $12,000 related to these shares has already been recognized in 2014 pursuant to our accounting policy.
(4)
Mr. Marks has 20,000 shares of restricted common stock that remain unvested at December 31, 2014. All 20,000 shares vest on January 1, 2015 and compensation expense of $12,000 related to these shares has already been recognized in 2014 pursuant to our accounting policy.
As of June 7, 2013, we adopted our director compensation plan. Under the plan, in addition to reimbursing directors for their out-of-pocket expenses in connection with attending meetings of our board of directors and board committees, we granted each non-employee director 60,000 shares of restricted common stock upon election to the board, with 20,000 shares vesting on the date of grant and the balance vesting in two equal amounts on January 1 of the calendar years following the date of grant. On March 5, 2014, we granted Mr. Brown and Mr. Elsenbast 20,000 additional shares each and Mr. Marks 140,000 shares that vested immediately on date of grant. We recognized $225,000 of stock compensation expense related to these shares. We provided no other compensation to our employee directors for service on our board of directors or committees of the board.
Compensation Committee Interlocks and Insider Participation
None of our executive officers serve as a member of the board of directors or compensation committee of any entity that has any of its executive officers serving as a member of our board of directors or compensation committee.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
Outstanding Equity Awards
The following table provides information as of December 31, 2014 for our 2013 Equity Incentive Plan under which securities may be issued:
(1)
The weighted-average price of stock grants was determined using the price at which our common stock last traded on the Over the Counter Bulletin Board prior to the stock awards granted on June 7, 2013 and the price at which our stock was last issued prior to the stock awards granted on March 5, 2014.
Security Ownership of Principal Shareholders and Management
The following table sets forth certain information regarding the ownership of our common stock as of March 15, 2015 by each shareholder whom we know to be the beneficial owner of more than 5% of our common stock, each director, each named executive officer, and all executive officers and directors as a group. At the close of business on March 15, 2015, there were 17,203,522 shares of common stock issued and outstanding, each of which is entitled to one vote.
Unless otherwise indicated, the listed beneficial owner has sole voting power and investment power with respect to such shares and the mailing address for each person listed in the table is 5500 Wayzata Blvd., Suite 1070, Minneapolis, Minnesota 55416.
*
Less than one percent.
(1)
Includes 2,820,810 shares issuable to The Kaminski Trust in connection with our anticipated acquisition of the remaining 51% interest in 5130 LLC and 209,190 shares owned by The Kaminski Trust for which MG Kaminski and his wife, Brenda H. Kaminski, serve as trustee. Also includes 7,000,000 shares owned by First Tracks, LLC which is wholly owned by Ms. Kaminski. Mr. Kaminski may be deemed to have shared voting and investment power over the shares held by the First Tracks, LLC, but disclaims beneficial ownership of such shares.
(2)
Includes 120,000 shares of restricted common stock that will vest ratably over 36 months, commencing July 7, 2013 and 200,000 shares that will vest ratably over 60 months, commencing April 7, 2014.
(3)
Includes 20,000 shares of restricted common stock to vest on January 1, 2015.
(4)
Includes 20,000 shares of restricted common stock to vest on January 1, 2015.
(5)
Includes 20,000 shares of restricted common stock to vest on January 1, 2015.
(6)
First Tracks, LLC is wholly owned by Brenda H. Kaminski, the wife of MG Kaminski. The address for First Tracks, LLC is 80 South Eighth Street, Minneapolis, Minnesota, 55402.
(7)
Includes 500,000 shares owned by the First Tracks, LLC Irrevocable Trust FBO Mikhail Gregory Kaminski, 500,000 shares owned by the First Tracks, LLC Irrevocable Trust FBO Kylie Elizabeth Kaminski, 500,000 shares owned by the First Tracks, LLC Irrevocable Trust FBO Katrina Johanna Kaminski, and 500,000 shares owned by the First Tracks, LLC Irrevocable Trust FBO Colette Christine Kaminski (the “Kaminski Kid Trusts”), all for which Thomas F. Dougherty serves as the trustee. The address for Mr. Dougherty is 80 South Eighth Street, Minneapolis, Minnesota, 55402. Mr. Dougherty may be deemed to have shared voting and investment power over the shares held by the Kaminski Kid Trusts, but disclaims beneficial ownership of such shares.
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence
Our company was a participant in a transaction with a related person described below during fiscal year 2014. All such transactions entered into since the date of adoption of our related person transaction approval policy described below were approved by the audit committee in accordance with such policy.
·
On December 30, 2013, the Company entered into an unsecured loan agreement with Curtis Marks, one of its directors. The note provides for a $100,000 loan to the Company with an annual interest rate of 14% payable at maturity on May 15, 2014.
·
On March 25, 2014, the Company issued a second unsecured promissory note to Mr. Marks. The note provided for an additional $100,000 loan to the Company with the same terms as the original note in 2013.
·
On August 12, 2014, the Company entered into a new unsecured promissory note with Mr. Marks. The note provided for a $500,000 loan to the Company with the same terms as the original note. Proceeds from this note were used in part to retire the two previous notes to Mr. Marks.
Review, Approval or Ratification of Related Person Transactions
On June 7, 2013, our board of directors adopted a written related person transaction approval policy which sets forth our company’s policies and procedures for the review and approval of any transaction required to be reported in our filings with the SEC. This policy applies to any financial transaction, arrangement or relationship (including any indebtedness or guarantee of indebtedness) or any series of similar transactions, arrangements or relationships in which we are a participant and in which a related person has a direct or indirect interest where such person’s interest in the transaction(s), in aggregate, involves at least $120,000 in value in a fiscal year of the Company. In order for the transaction, arrangement or relationship to be subject to this policy, there must a financial aspect to the transaction, which may, for example, involve payments between us and the related person or otherwise providing value to one of the parties.
“Related Persons” include:
·
all directors and executive officers of the Company;
·
any nominee for director of the Company;
·
any immediate family member of a director, nominee for director or executive officer of the Company; and
·
any beneficial owner of more than 5% of any class of the Company’s voting securities, or an immediate family member of such holder.
“Immediate family members” include children, stepchildren, parents, stepparents, spouses, siblings, mothers- and fathers-in-law, sons- and daughters-in-law, bothers- and sisters-in-law and any other person (other than a tenant or employee) sharing the household of one of the individuals listed above.
An “indirect” interest of a Related Person in a transaction includes a Related Person serving as an officer or general partner of, or being a significant investor or equity holder in, an entity that is a party to a transaction with the Company.
The following transactions are exempt from this policy:
·
payment of compensation by the Company to a Related Person for the Related Person’s service to the Company in the capacity or capacities that give rise to the person’s status as a “Related Person;”
·
transactions available to all employees or all stockholder of the Company on the same terms; and
·
transactions, which when aggregated with the amount of all other transactions between the Company and the Related Person or any entity in which the Related Person has an interest, involve less than $120,000 in a fiscal year of the Company.
The Audit Committee of the Board of Directors of the Company (the “Committee”) is to approve any Related Person Transaction subject to this policy before commencement of the Related Person Transaction or if applicable, before stockholder approval of the Related Person Transaction. The Related Person Transaction should be presented to the Committee by an executive officer of the Company requesting that the Committee consider the Related Person Transaction at its next meeting.
The Committee will analyze the following factors, in addition to any other factors the Committee deems appropriate, in determining whether to approve a Related Person Transaction:
·
whether the terms are fair to the Company;
·
whether the transaction is material to the Company;
·
the role the Related Person has played in arranging the Related Person Transaction;
·
the structure of the Related Person Transaction; and
·
the interests of all Related Persons in the Related Person Transaction.
A Related Person Transaction will only be approved by the Committee if the Committee determines that the Related Person Transaction is beneficial to the Company and the terms of the Related Person Transaction are fair to the Company.
Director Independence
All of our directors, except for MG Kaminski are “independent” as that term is defined in Rule 5605(a) of the Nasdaq Stock Market Marketplace Rules, which is the standard for independence we have chosen for purposes of the disclosure required in this report by SEC rules (even though our common stock is not listed on the Nasdaq Stock Market).
Item 14.
Item 14.
Principal Accounting Fees and Services
In addition to reimbursement for certain out-of-pocket expenses, the following table presents the aggregate fees billed for professional services by Baker Tilly Virchow Krause, L.L.P. in 2013 and 2014 for these various services:
* Fees related to review of Form S-3 Filings
(1) Audit Fees are the aggregate fees billed for professional services rendered by the principal accountant for the audit of the registrant's annual financial statements and review of financial statements included in the registrant's Form 10-Q or services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements for those fiscal years.
(2) Audit-Related Fees are the aggregate fees billed for assurance and related services by the principal accountant that are reasonably related to the performance of the audit or review of the registrant's financial statements and are not reported under "Audit". No audit-related fees were billed in 2014.
Approval of Independent Registered Public Accounting Firm Services and Fees.
The Audit Committee Charter requires that our audit committee approve the retention of our independent registered public accounting firm for any non-audit service and consider whether the provision of these non-audit services by our independent registered public accounting firm is compatible with maintaining our independent registered public accounting firm’s independence, prior to engagement for these services. Our audit committee actively monitors the relationship between audit and non-audit services provided. All of the services listed under the heading Audit-Related Fees were pre-approved by our audit committee.
PART IV
Item 15.
Item 15.
Exhibits, Financial Statement Schedules
The following documents are filed as a part of this Annual Report on Form 10-K:
(a) Financial Statements: The financial statements filed as a part of this report are listed in Part II, Item 8.
(b) Financial Statement Schedules: The schedules are either not applicable or the required information is presented in the consolidated financial statements or notes thereto.
(c) Exhibits: The exhibits incorporated by reference or filed as a part of this Annual Report on Form 10-K are listed in the Exhibit Index immediately following the signatures to this report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: March 31, 2015
TALON REAL ESTATE HOLDING CORP.
By:
/s/ MG Kaminski
MG Kaminski
Chief Executive Officer
Each of the undersigned hereby appoints MG Kaminski and Eun Stowell, and each of them (with full power to act alone), as attorneys and agents for the undersigned, with full power of substitution, for and in the name, place and stead of the undersigned, to sign and file with the Securities and Exchange Commission under the Securities Act of 1934, any and all amendments and exhibits to this annual report on Form 10-K and any and all applications, instruments, and other documents to be filed with the Securities and Exchange Commission pertaining to this annual report on Form 10-K or any amendments thereto, with full power and authority to do and perform any and all acts and things whatsoever requisite and necessary or desirable. 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 indicated on March 31, 2015.
Name and Signature
Title
/s/ MG Kaminski
Chief Executive Officer and Director (principal executive officer)
MG Kaminski
/s/ Eun Stowell
Chief Financial Officer (principal financial and accounting officer)
Eun Stowell
/s/ Neil W. Brown
Director
Neil W. Brown
/s/ Curtis Marks
Director
Curtis Marks
/s/ Frank Elsenbast
Director
Frank Elsenbast
EXHIBIT INDEX1
10.6
Form of Indemnification Agreement**
8-K
000-53917
June 7, 2013
10.6
10.7
Non-Employee Director Compensation Policy**
8-K
000-53917
June 7, 2013
10.7
10.8
Loan Agreement, dated March 22, 2007, by and between 5130 Industrial Street, LLC and Merrill Lynch Mortgage Lending, Inc.
8-K
000-53917
June 7, 2013
10.8
10.9
Limited Partnership Agreement of Talon OP, L.P.
8-K
000-53917
June 7, 2013
10.9
10.10
Common Stock Purchase Agreement dated as of August 20, 2013 by and among Talon Real Estate Holding Corp. and the purchasers listed on Exhibit A thereto
8-K
000-53917
August 20, 2013
10.1
10.11
First Amendment, dated November 13, 2013, to Contribution Agreement dated June 7, 2013
10-Q
000-53917
September 30, 2013
10.1
10.12
Common Stock Purchase Agreement dated as of December 30, 2013 by and among the Company and the purchasers listed on Exhibit A thereto
8-K
000-53917
December 30, 2013
10.1
10.13
Promissory Note to Curtis Marks from the Company, dated December 30, 2013
8-K
000-53917
December 30, 2013
10.2
10.14
Promissory Note to Curtis Marks from the Company, dated March 25, 2014
8-K
000-53917
March 26, 2014
10.1
10.15
Contribution Agreement between Talon OP, L.P. and Bren Road, LLC, dated May 29, 2014.
8-K
000-53917
June 3, 2014
10.1
X
10.16
Assignment and Assumption Agreement and Consent between Bren Road, LLC, Talon Bren Road, LLC, and Bell State Bank & Trust, dated May 29, 2014.
8-K
000-53917
June 3, 2014
10.2
X
10.17
Promissory Note between Talon Bren Road, LLC and Bell State Bank & Trust, dated May 29, 2014.
8-K
000-53917
June 3, 2014
10.3
X
10.18
Loan Agreement between Bren Road, LLC and Bell State Bank & Trust, dated May 29, 2014, as amended.
8-K
000-53917
June 3, 2014
10.4
X
10.19
Mortgage, Assignment of Leases and Rents, Security Agreement, and Fixture Filing between Bren Road, LLC and Bell State Bank & Trust, dated May 29, 2014, as amended.
8-K
000-53917
June 3, 2014
10.5
10.20
Contribution Agreement between Talon OP, L.P. and the Contributors identified on Exhibit A thereto, dated July 2, 2014.
8-K
000-53917
July 9, 2014
10.1
10.21
Promissory Note between Talon First Trust, LLC and RCC Real Estate, Inc., dated July 2, 2014.
8-K
000-53917
July 9, 2014
10.2
10.22
Reserve and Security Agreement between Talon First Trust, LLC and RCC Real Estate, Inc., dated July 2, 2014.
8-K
000-53917
July 9, 2014
10.3
10.23
Mortgage, Assignment of Leases and Rents, Security Agreement, and Fixture Filing between Talon First Trust, LLC and RCC Real Estate, Inc., dated July 2, 2014.
8-K
000-53917
July 9, 2014
10.4
10.24
Promissory Note between Talon Bren Road, LLC and Jackson I, LLC, dated July 2, 2014.
8-K
000-53917
July 9, 2014
10.5
10.25
Mortgage and Security Agreement and Future Financing Statement between Talon Bren Road, LLC and Jackson I, LLC, dated July 2, 2014.
8-K
000-53917
July 9, 2014
10.6
10.26
Promissory Note to Curtis Marks from the Company, dated August 12, 2014.
10-Q
000-53917
August 14, 2014
10.6
10.27
Loan Modification Agreement by and among Jackson I, LLC, 4330 LLC, 3014-20 LLC, Fairfield Apartments, LLC, Lakes Area Properties, LLC and Talon Bren Road, LLC, effective as of September 25, 2014.
8-K
000-53917
October 2, 2014
10.1
16.1
Letter from HJ & Associates, LLC dated June 7, 2013
8-K
000-53917
June 7, 2013
16.1
21.1
Subsidiaries of the Registrant
23.1
Consent of Baker Tilly Virchow Krause LLP
24.1
Power of Attorney (included on signature page)
31.1
Certification of Principal Executive Officer pursuant to Rules 13a-14(a) under the Securities Exchange Act of 1934, as amended
31.2
Certification of Principal Financial Officer pursuant to Rules 13a-14(a) under the Securities Exchange Act of 1934, as amended
X
32.1
Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Sec. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
X
Interactive Data Files Pursuant to Rule 405 of Regulation S-T
X
** Indicates management contract or compensatory plan or arrangement.