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TALR > SEC Filings for TALR > Form 10-Q on 13-May-2014All Recent SEC Filings

Show all filings for TALON REAL ESTATE HOLDING CORP.

Form 10-Q for TALON REAL ESTATE HOLDING CORP.


13-May-2014

Quarterly Report

Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the financial statements and related notes included elsewhere in this report. This discussion and analysis contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under "Risk Factors" in our Current Report on Form 10-K for the year ended December 31, 2013. Forward-looking statements speak only as of the date they are made, and we undertake no obligation to update them in light of new information or future events.

Overview

We are a real estate investment company focused on investing in office, industrial and retail properties located in significant metropolitan areas in the central and southwestern United States. We currently own a 49% interest in an entity that owns an industrial complex consisting of 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. As of March 31, 2014, the property owned by this entity was 90% leased.

We plan to aggressively pursue additional properties for our portfolio. We initially plan to target properties between 10,000 and 500,000 square feet 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 options for which we can provide advantageous solutions.

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.

Formation Transactions

On June 7, 2013, we entered into:

a subscription agreement with Talon OP, L.P., a Minnesota limited partnership ("Talon OP"), pursuant to which our company acquired 1,600,032 general partnership interests of Talon OP in exchange for $1.00,

a contribution agreement with the holders of a 49% interest in 5130 Industrial Street, LLC ("5130 LLC"), the owner of an industrial complex consisting of approximately 171,639 square feet located in the Minneapolis-St. Paul metropolitan area, pursuant to which our company acquired such interest in exchange for an aggregate of 2,710,190 shares of our common stock,

a contribution agreement, with the members of Talon Real Estate, LLC, a Minnesota limited liability company ("Talon RE"), which holds a purchase agreement to acquire the controlling interest in 5130 LLC, pursuant to which our company acquired all of the interests of Talon RE in exchange for an aggregate of 10,830,000 shares of our common stock,

a contribution agreement with Talon OP pursuant to which our company contributed all our interests in 5130 LLC to Talon OP in exchange for 2,710,190 general partnership interests of Talon OP, and

a contribution agreement with Talon OP pursuant to which our company contributed all our interests in Talon RE to Talon OP in exchange for 10,830,000 general partnership interests of Talon OP (collectively, the "Formation Transactions").

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.

On June 7, 2013, prior to the Formation Transactions, Matthew G. Kaminski ("MG Kaminski"), entered into a subscription agreement with Talon OP pursuant to which MG Kaminski acquired one limited partnership interest of Talon OP in exchange for $0.01.


Following the Formation Transactions, our company is the sole general partner of Talon OP, which holds substantially all our assets and through which we conduct our operations. The contributions that constitute the Formation Transactions are being accounted for as a reverse acquisition and recapitalization, and Talon OP is considered to be the accounting acquirer.

Talon OP Limited Partnership Agreement

On June 3, 2013, we entered into that certain limited partnership agreement of 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 our Current Report on Form 8-K dated June 7, 2013. A description of the limited partnership agreement is provided therein under "Description of the Partnership Agreement of Our Operating Partnership." This description of the limited partnership agreement does not purport to be complete and is qualified in its entirety by reference to the limited partnership agreement, which is attached as Exhibit 10.9 to our Current Report on Form 8-K dated June 7, 2013.

Substantially all of our assets will be held by, and our operations will be 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. Because we plan to conduct substantially all of our operations through our Operating Partnership, we intend to be considered an Umbrella Partnership Real Estate Investment Trust, or 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.

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.


Investments in Real Estate and Fixed Assets

Investments 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.

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:

Building 25 years Building Improvements 15 years Tenant Improvements 1-10 years Equipment 3 years

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

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 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.

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 real estate investment trust, or REIT, no sooner than the calendar year in which we qualify to be taxed as such under the Internal Revenue Code. 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 Jumpstart Our Business Startups Act, or 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.

Results of Operations

There was no change in properties owned by the company for the three months ended March 31, 2014 compared to the same period in the prior year.

We expect our revenues, tenant expense reimbursements and many 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. In the near term, we expect to incur higher legal and other professional fees in pursuit of these acquisitions.


Three months ended March 31, 2014 compared to three months ended March 31, 2013

Revenues and Expenses

Rental revenues increased $10,103 or 11%, to $102,204 for the three months ended March 31, 2014 compared to $92,101 for the same period of the prior year. The increase in rental revenues over the same period in the prior year is primarily attributable to the impact of an increase in the straight-line adjustment of deferred rent for a new tenant in March 2014. Expense reimbursements for the first three months of 2014 remained relatively consistent to the same period in the prior year.

General and administrative expenses increased $114,920 or 825%, to $128,853 for the three months ended March 31, 2014 compared to $13,933 for the same period of the prior year. The increase in general and administrative expenses is attributable to expenses incurred to operate as a publicly held real estate holding corporation such as corporate insurance and office rent, which it did not incur in the first three months of 2013. There was also an increase in accrued expenses of $63,000 for the three months ended March 31, 2014 for the loss contingency related to the 5130 LLC lender dispute described in Note 7 of the financial statements.

Salary and compensation expenses increased $568,379 for the three months ended March 31, 2014 compared to $26,086 for the same period of the prior year. The increased expenses in 2014 were due to an increased number of employees plus non-cash stock compensation of approximately $456,000 granted to our directors and employees. In the previous year, our operations consisted solely of 5130 LLC with one employee in the first three months.

Professional fees decreased $68,942 or 55%, for the three months ended March 31, 2014 compared to $126,357 for the same period of the prior year. The Company incurred higher than normal legal expenses in first quarter of 2013 as we prepared for the Company's formation as a public real estate holding corporation on June 7, 2013.

Property operating expenses decreased $11,468 or 38%, to $18,409 for the three months ended March 31, 2014 compared to $29,877 for the same period of the prior year. The decrease in property operating expenses is attributable to higher repairs and maintenance and snow removal expense in 2013.

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, and after adjustments for unconsolidated partnerships and joint ventures. 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 used by 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 and amortization of lease inducements and deferred financing costs, depreciation of non-real estate, and excluding the effects of 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 results in rental income in the early years of a lease that is higher than actual cash received, creating a straight-line rent receivable asset included in our consolidated balance sheet. At some point during the lease, depending on its terms, cash rent payments exceed the straight-line rent which results in the straight-line rent receivable asset 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


                                                       Three Months     Three Months
                                                          Ended            Ended
                                                        March 31,        March 31,
In thousands (except per share)                            2014             2013

Net (Loss) Income attributable to Talon Real Estate
Holding Corp.                                         $        (807)   $        (176)
Adjustments:
Depreciation and Amortization                                    59               61
Adjustments:
Non-real estate depreciation                                     (2)               -
Amortization of deferred financing costs                         (3)              (3)
Noncontrolling interest of depreciation and
amortization                                                    (29)             (30)
Net depreciation and amortization                                25               28
Funds From Operations (FFO)                           $        (782)   $        (148)
Basic and diluted FFO loss per share                  $       (0.05)   $       (0.01)

Adjusted funds from operations:
Funds from operations                                          (782)            (148)
Adjustments:
Straight-line rents in excess of, or less than,
contract rents                                                   (5)               3
Non-real estate depreciation                                      2                -
Amortization of deferred financing costs, net of
noncontrolling interest                                           1                1
Non-cash stock compensation charges                             456                -
Adjusted Funds From Operations (AFFO)                          (328)            (144)
Basic and diluted AFFO loss per share                         (0.02)           (0.01)

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 our acquisition strategy creating a cash shortfall from operations in 2013 and the three months ended March 31, 2014.


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 March 31, 2014, we had unrestricted cash of $15,348 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.

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, 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.

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 the year.
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 . . .

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