UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Form 10-QSB
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2005
Commission File Number:
0-25074
PARAGON REAL ESTATE EQUITY AND INVESTMENT TRUST
Maryland | 39-6594066 | |
(State or other jurisdiction of incorporation) 1240 Huron Road, Suite 301, Cleveland, OH (Address of principal executive offices) |
(I.R.S. Employer Identification Number) 44115 (Zip code) |
Issuers telephone number: 216-430-2700
Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange
Act during the past 12 months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to the filing requirements
for the past 90 days. Yes þ
No o
As of May 6, 2005, the issuer had 33,490,615 common shares outstanding, including 2,859,765
common shares held in treasury.
Transitional Small Business Disclosure Format (Check one): Yes o No þ
PARAGON REAL ESTATE EQUITY AND INVESTMENT TRUST AND SUBSIDIARIES
FORM 10-QSB
INDEX
PART I. Financial Information |
||||||||
Item 1. Financial Statements |
||||||||
Page - 2 - | ||||||||
Page - 3 - | ||||||||
Page - 4 - | ||||||||
Page - 5 - | ||||||||
Page - 12 - | ||||||||
Page - 18 - | ||||||||
Page - 19 - | ||||||||
Page - 19 - | ||||||||
Page - 19 - | ||||||||
Page - 19 - | ||||||||
Page - 19 - | ||||||||
Page - 19 - | ||||||||
Page - 20 - | ||||||||
EX - 31.1 Section 302 Certification of Chief Executive Officer |
||||||||
EX - 31.2 Section 302 Certification of Chief Financial Officer |
||||||||
EX - 32.1 CEO/CFO Under 906 of Sarbanes-Oxley Act |
||||||||
EX-31.1 Certification 302-CEO | ||||||||
EX-31.2 Certification 302-CFO | ||||||||
EX-32.1 Certification 906-CEO & CFO |
- 1 -
Paragon Real Estate Equity and Investment Trust and Subsidiaries
Assets |
||||
Investments in real estate: |
||||
Land |
$ | 797,682 | ||
Buildings and improvements |
3,197,967 | |||
Furniture, fixtures and equipment |
24,813 | |||
4,020,462 | ||||
Accumulated depreciation and amortization |
(142,715 | ) | ||
Net investments in real estate |
3,877,747 | |||
Cash and cash equivalents |
1,406,688 | |||
Marketable securities |
85,817 | |||
Restricted cash |
94,372 | |||
Accounts receivable, net |
5,026 | |||
Other assets, net |
115,152 | |||
Total Assets |
$ | 5,584,802 | ||
Liabilities and Shareholders Equity |
||||
Liabilities: |
||||
Mortgage loan payable |
$ | 2,749,920 | ||
Accounts payable and accrued expenses |
217,199 | |||
Security deposits |
60,274 | |||
Total liabilities |
3,027,393 | |||
Minority interest in consolidated subsidiary |
2,167,677 | |||
Commitments and Contingencies |
||||
Shareholders equity: |
||||
Preferred Shares $0.01 par value,
10,000,000 authorized: 278,455 Class A
cumulative convertible shares issued and
outstanding, $10.00 per share liquidation
preference |
2,785 | |||
Common Shares - $0.01 par value,
100,000,000 authorized; 33,490,615 shares
issued and outstanding |
334,906 | |||
Additional paid-in capital |
28,382,203 | |||
Accumulated other comprehensive income, net
unrealized gain on marketable securities |
47,142 | |||
Accumulated deficit |
(25,007,323 | ) | ||
Treasury stock, at cost, 2,859,765 shares |
(800,735 | ) | ||
Unearned compensation and trustees fees |
(2,569,246 | ) | ||
Total shareholders equity |
389,732 | |||
Total Liabilities and Shareholders Equity |
$ | 5,584,802 | ||
The accompanying notes are an integral part of the consolidated financial statements.
- 2 -
Paragon Real Estate Equity and Investment Trust and Subsidiaries
For the three months ended March 31, | ||||||||
2005 | 2004 | |||||||
Revenues |
||||||||
Rental revenue |
$ | 150,775 | $ | 150,602 | ||||
Interest and other |
10,621 | 18,157 | ||||||
Total revenues |
161,396 | 168,759 | ||||||
Expenses |
||||||||
Property, operating and maintenance |
54,355 | 56,353 | ||||||
Property taxes and insurance |
24,485 | 23,215 | ||||||
Depreciation and amortization |
22,242 | 21,431 | ||||||
Interest |
40,486 | 41,667 | ||||||
General and administrative |
458,676 | 239,593 | ||||||
Management fees |
6,812 | 6,866 | ||||||
Total expenses |
607,056 | 389,125 | ||||||
Loss from operations before loss allocated to
minority interest |
(445,660 | ) | (220,366 | ) | ||||
(Income) loss allocated to minority interest |
(168 | ) | 86,896 | |||||
Net loss attributable to Common Shareholders |
$ | (445,828 | ) | $ | (133,470 | ) | ||
Net loss attributable to Common Shareholders per
Common Share: Basic and Diluted |
$ | (0.01 | ) | $ | (0.00 | ) | ||
Weighted average number of Common Shares
outstanding: Basic and Diluted |
33,315,615 | 32,580,976 | ||||||
Comprehensive loss: |
||||||||
Net loss |
$ | (445,828 | ) | $ | (133,470 | ) | ||
Other comprehensive loss: |
||||||||
Unrealized loss on marketable securities |
(4,131 | ) | (24,500 | ) | ||||
Comprehensive loss |
$ | (449,959 | ) | $ | (157,970 | ) | ||
The accompanying notes are an integral part of the consolidated financial statements.
- 3 -
Paragon Real Estate Equity and Investment Trust and Subsidiaries
For the three months ended March 31, | ||||||||
2005 | 2004 | |||||||
Cash flows from operating activities: |
||||||||
Net loss |
$ | (445,828 | ) | $ | (133,470 | ) | ||
Adjustments to reconcile net loss to net cash used in
continuing operations: |
||||||||
Compensation costs and trustees fees incurred
through the issuance of shares |
22,188 | 31,533 | ||||||
Rent expense incurred through the issuance of
restricted shares |
51,500 | 51,500 | ||||||
Depreciation and amortization |
22,242 | 21,431 | ||||||
Income (loss) allocated to minority interest |
168 | (86,896 | ) | |||||
Net change in assets and liabilities: |
||||||||
Accounts receivable, net |
3,251 | 3,471 | ||||||
Restricted cash |
11,813 | 15,670 | ||||||
Other assets, net |
(226 | ) | 242,165 | |||||
Accounts payable and accrued expenses |
(46,170 | ) | (37,627 | ) | ||||
Rents received in advance and security deposits |
5,318 | 790 | ||||||
Net cash (used in) from continuing operations |
(375,744 | ) | 108,567 | |||||
Cash flows from investing activities: |
||||||||
Additions to real estate properties |
(3,579 | ) | (2,996 | ) | ||||
Net cash used in investing activities |
(3,579 | ) | (2,996 | ) | ||||
Cash flows from financing activities: |
||||||||
Payments on mortgage loan |
(13,351 | ) | (12,171 | ) | ||||
Net cash used in financing activities |
(13,351 | ) | (12,171 | ) | ||||
Net increase (decrease) in cash and cash equivalents |
(392,674 | ) | 93,400 | |||||
Cash and cash equivalents |
||||||||
Beginning of period |
1,799,362 | 2,218,674 | ||||||
End of period |
$ | 1,406,688 | $ | 2,312,074 | ||||
Supplemental information to Consolidated Statements of Cash Flows | ||||||||
Interest paid |
$ | 40,486 | $ | 41,667 | ||||
The accompanying notes are an integral part of the consolidated financial statements.
- 4 -
Paragon Real Estate Equity and Investment Trust and Subsidiaries
Notes to Consolidated Financial Statements
(unaudited)
Note 1 Organization
Paragon Real Estate Equity and Investment Trust (the Company, Paragon, we, our, or us) is a real estate company, which primarily acquires, owns and operates multi-family residential real estate properties. As of March 31, 2005, we owned a 1.0% interest in Paragon Real Estate, LP, the operating partnership that owns Richton Trail Apartments (Richton Trail), an apartment complex containing 72 units. Hampton Court Associates owns the remaining 99.0% interest in Paragon Real Estate, LP. Because we are the sole general partner of Paragon Real Estate, LP, we consolidate Richton Trail in our financial statements and show separately amounts for minority interest for Hampton Court Associates, which is the only limited partner. Hampton Court Associates ownership interest in Paragon Real Estate, LP is 813,938 restricted limited partnership units, each redeemable after July 1, 2007 for cash, or at our option, 22.881 of our common shares.
Paragon is also the sole member of Paragon Housing LLC, which is the general partner of River West Apartments Limited Partnership (River West). River West is a single asset entity owning an apartment complex of 30 units. We do not consolidate Paragon Housing LLC with Paragons financial statements because we do not have financial or voting control over the entity, and we do not have sufficient equity at risk for Paragon Housing LLC to finance River West activities without additional subordinated financial support. Our exposure is limited to Paragon Housing LLCs $100 capital contribution in River West, and we and Paragon Housing LLC are not obligated on any of the liabilities of River West.
Note 2 Basis of Presentation
We have prepared the consolidated financial statements without audit pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. However, we believe that the included disclosures are adequate to make the information presented not misleading. In our opinion, all adjustments (consisting solely of normal recurring items) necessary for a fair presentation of our financial position as of March 31, 2005, the results of our operations for the three month periods ended March 31, 2005 and 2004, and of our cash flows for the three month periods ended March 31, 2005 and 2004 have been included. The results of operations for interim periods are not necessarily indicative of the results for a full year. For further information, refer to our consolidated financial statements and footnotes included in the Annual Report on Form 10-KSB for the year ended December 31, 2004.
Note 3 Summary of Significant Accounting Policies
Use of Estimates in the Preparation of Financial Statements
In order to conform with generally accepted accounting principles, management, in preparation of our consolidated financial statements, is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of March 31, 2005, and the reported amounts of revenues and expenses for the three month periods ended March 31, 2005 and 2004. Actual results could differ from those estimates. Significant estimates include the valuation of investments in real estate, marketable securities and deferred taxes, and these significant estimates, as well as other estimates and assumptions, which may change in the near term.
- 5 -
Investments in Real Estate
Our investments in real estate assets are reported at the lower of cost or estimated net realizable value.
We periodically review our properties for impairment and provide for a provision if impairments are determined. First, to determine if impairment may exist, we review our properties and identify those, if any, which have had either an event of change or event of circumstances warranting further assessment of recoverability. Then, we estimate the fair value of those properties on an individual basis based on an independent appraisal, capitalizing the expected net operating income, or applying various other valuation factors. Such amounts are then compared to the propertys depreciated cost to determine whether an impairment exists.
In accordance with Financial Accounting Standard No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (FAS 144), impairment of investments in real estate exists when the carrying amount of the investments exceeds its fair value and is non-recoverable. Fair value of these assets is the amount an asset could be bought or sold in a current transaction between willing parties.
Depreciation expense is computed using the straight-line method based on the following useful lives:
Years | ||||
Building and improvements |
40 | |||
Furniture, fixtures and equipment |
3-7 |
Expenditures for ordinary maintenance and repairs are expensed to operations as incurred and significant renovations and improvements that improve or extend the useful life of the asset are capitalized and depreciated over their estimated useful life.
When a property is sold or retired, the costs and related accumulated depreciation are removed from the accounts and the resulting gain or loss, together with the related historical operating results, are included in discontinued operations.
Cash and cash equivalents
Cash and cash equivalents include all cash and liquid investments that mature three months or less from when they are purchased. Cash equivalents are reported at cost, which approximates fair value. We maintain our cash in bank accounts in amounts that may exceed federally insured limits at times. We also maintained cash of approximately $18,000 at March 31, 2005 in a money market account that was not federally insured. Cash of approximately $94,000 is classified as restricted at March 31, 2005 because approximately $33,000 is held in an escrow account of the mortgage lender for the payment of property taxes and insurance and approximately $61,000 is in a separate bank account for security deposits of our residential tenants.
Accounts Receivable
Our accounts receivable of approximately $5,000 are reported net of an allowance for bad debts of approximately $10,000 at March 31, 2005 for Richton Trail.
Other Assets
As of March 31, 2005, other assets include prepaid expenses of approximately $68,000 and deferred financing costs incurred to obtain and secure mortgage debt financing of approximately $55,000. Other assets are carried at cost, less accumulated amortization.
The deferred financing costs are being amortized over the life of the mortgage loan payable on a straight-
- 6 -
line basis. Accumulated amortization related to deferred financing costs as of March 31, 2005 was approximately $8,000.
Revenue Recognition
Revenues from rental property are recognized when due from tenants. Leases are generally for terms of one year or less.
Stock Based Compensation
At March 31, 2005, we had one stock-based employee compensation plan. During the three months ended March 31, 2005, we cancelled 150,000 common share options under this plan in connection with the resignation of an employee in 2004. We did not issue any common share options during the three months ended March 31, 2005. During the three months ended March 31, 2004, we issued 450,000 common share options and 900,000 restricted share grants. We account for the plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. In accordance with APB Opinion No. 25, no stock-based employee compensation cost would be reflected in net loss for options granted, as all options granted under the plan have an exercise price equal to the market value of the underlying common shares on the date of grant. Stock based employee compensation cost of approximately $22,000 is reflected in net loss for the three months ended March 31, 2005, and approximately $32,000 for the three months ended March 31, 2004. The following table illustrates the effect on net loss and loss per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, as amended, to stock-based employee compensation.
For the three month periods ended | ||||||||
March 31, | ||||||||
2005 | 2004 | |||||||
Net loss attributable to Common Shareholders |
$ | (445,828 | ) | $ | (133,470 | ) | ||
Add: Stock-based employee compensation
expense included in reported net
loss, net of related tax effects |
22,188 | 31,533 | ||||||
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for all
awards, net of related tax effects |
(34,563 | ) | (39,408 | ) | ||||
Pro forma net loss attributable to Common
Shareholders |
$ | (458,203 | ) | $ | (141,345 | ) | ||
Net loss attributable to Common
Shareholders per Common Share: |
||||||||
Basic and Diluted as reported |
$ | (0.01 | ) | $ | (0.00 | ) | ||
Basic and Diluted pro forma |
$ | (0.01 | ) | $ | (0.00 | ) | ||
Income Taxes
Because we are no longer a Real Estate Investment Trust (REIT) for federal income tax purposes, we account for income taxes using the liability method under which deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities using enacted tax rates in effect for the period in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Although we are eligible to re-elect REIT status as of January 1, 2005, we intend to take advantage of our tax loss carryforwards before electing to be a REIT again.
- 7 -
At March 31, 2005, we have net operating losses, and at December 31, 2004, we had net operating losses totaling approximately $11.0 million and capital losses of approximately $0.6 million. While these losses created a deferred tax asset, a valuation allowance was applied against the asset because of the uncertainty of whether we will be able to use these loss carryforwards, which will expire in varying amounts through the year 2024.
We are also subject to certain state and local income, excise and franchise taxes. The provision for state and local taxes has been reflected in general and administrative expense in the consolidated statements of operations and has not been separately stated due to its insignificance.
Fair Value of Financial Instruments
Our financial instruments include cash and cash equivalents, marketable securities and a mortgage loan. The fair values of the financial instruments were not materially different from their carrying or contract values at March 31, 2005.
Segment Disclosure
Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information requires that a public company report financial and descriptive information about its reportable operating segments. Generally, financial information is required to be reported on the basis that it is used internally for evaluating segment performance and deciding how to allocate resources to segments. Management views the Company as a single segment, which acquires, owns and operates rental real estate.
Note 4 Marketable Securities
Our investments in marketable securities are available-for-sale, as of March 31, 2005, and represent 10,000 common shares of Stellent, Inc. (Stellent) and 100 common shares of Century Realty Trust (Century).
As of March 31, 2005, our marketable securities had a fair market value of approximately $86,000 (based upon the NASDAQ closing quote of $8.41 per share for Stellent and $17.18 per share for Century on March 31, 2005). We recorded an unrealized loss on marketable securities during 2005 of approximately $4,000, resulting in a balance of approximately $47,000 in shareholders equity for unrealized gain on marketable securities.
The NASDAQ closing quote on May 6, 2005 was $6.98 per common share of Stellent and $16.27 per common share of Century.
We recognize gain or loss on the sale of marketable securities based upon the first-in-first-out method.
Note 5 Mortgage Loan Payable
The mortgage loan payable secured by our residential real estate property has a balance at
March 31, 2005 of approximately $2.7 million at a fixed interest rate of 5.87% for a term of 10
years with monthly principal and interest payments of approximately $18,000 based on a 25-year
amortization schedule.
Note 6 Equity
During the first quarter of 2004, 935 preferred shares were converted to 3,224 common shares, at a conversion rate of 3.448 common shares for each preferred share. No other preferred shares were converted through March 31, 2005.
- 8 -
Effective January 2, 2004, we issued a total of 900,000 restricted common shares 450,000 common share options at a price of $0.27 per share to three of our officers. The market value of the restricted common shares on the date of grant was $198,000. The options vest ratably over three years after issuance and expire after five years from the date of issuance. During the fourth quarter of 2004, 300,000 restricted common shares were cancelled and in the first quarter of 2005, 150,000 common share options were cancelled.
Effective February 16, 2004, 50,000 restricted common shares (issued during 2003) were cancelled.
Effective March 4, 2004 and 2005, a total of 500,000 restricted common shares are issuable to our landlord for office space and related services for the twelve months ended March 4, 2004 and 2005.
Effective June 15, 2004, we issued a total of 200,000 restricted common shares and 100,000 common share options at a price of $0.18 per share to our four independent trustees, who are not executive officers of Paragon, as part of their compensation for serving on Paragons board and committees. The market value of the restricted common shares on the date of grant was $36,000. The options vest one year after issuance and expire 90 days after leaving Paragons board.
Effective July 19, 2004, we committed to issue a total of 1.0 million restricted common shares to a new officer of the Company. The initial grant of 500,000 restricted shares will vest half of the shares in four years and the second half in five years. Additional grants of 125,000 restricted common shares will be made annually for the next four years beginning on the anniversary date of his employment with vesting effective four years after each grant date.
Effective December 1, 2004 we issued 100,000 restricted common shares to a new employee of the Company. Half of the shares will vest in four years and the second half will vest in five years. The market value of the 100,000 restricted common shares issued on the date of grant was $13,000.
Note 7 Loss Per Share
The Company has adopted the Statement of Financial Accounting Standards No. 128, Earnings Per Share (EPS) for all periods presented herein. Net loss per weighted average Common Share outstandingbasic and net loss per weighted average Common Share outstandingdiluted are computed based on the weighted average number of Common Shares outstanding for the period. The weighted average number of Common Shares outstanding for the three months ended March 31, 2005 and March 31, 2004 were 33,315,615 and 32,580,976, respectively. Common share equivalents of approximately 23.5 million and 23.6 million as of March 31, 2005 and March 31, 2004, respectively, include outstanding convertible preferred shares, warrants, stock options and limited partnership units, and are not included in net loss per weighted average Common Share outstandingdiluted as they would be anti-dilutive.
For the three months ended March 31, | ||||||||
2005 | 2004 | |||||||
Numerator |
||||||||
Net loss attributable to Common Shareholders |
$ | (445,828 | ) | $ | (133,470 | ) | ||
Denominator |
||||||||
Weighted average Common Shares outstanding
at March 31, 2005 and March 31, 2004,
respectively: Basic and Diluted |
33,315,615 | 32,580,976 | ||||||
Basic and Diluted EPS |
||||||||
Net loss attributable to Common
Shareholders - Basic and Diluted |
$ | (0.01 | ) | $ | (0.00 | ) | ||
- 9 -
Note 8 Commitments and Contingencies
Liquidity
As of March 31, 2005, our unrestricted cash resources were approximately $1,407,000 and our
marketable securities available for sale were approximately $86,000. Our marketable securities
primarily represented 10,000 common shares of Stellent. The NASDAQ closing quote on
May 6, 2005 was $6.98 per common share of Stellent.
Our management team and board of trustees have formulated a value-added business strategy focused on acquiring well located, underperforming multi-family residential properties and repositioning them through renovation, leasing, improved management and branding. Management has been pursuing this strategy by actively seeking and reviewing multi-family residential companies, portfolios and properties, including affordable housing projects. While we made offers to some of the sellers, low interest rates for debt financing have had the effect of increasing sale prices for these types of properties. We are currently engaged in discussions with potential sellers, but have not entered into any definitive purchase agreements for any of these properties. There can be no assurance that we will be able to enter into a definitive purchase agreement or that we will be able to close a transaction if an agreement is signed. Even if our management is successful in closing a transaction, investors may not value the transaction in the same manner as we did, and investors may not value a portfolio of the same type of properties as highly as they would value portfolios consisting of diverse properties.
We are dependent on our existing cash and Stellent shares to meet our liquidity needs because cash from operations is not sufficient to meet our operating requirements. Because the cash flow from our properties is not expected to fully fund our future liquidity requirements, we have reduced our material future obligations, which include a mortgage on the apartment complex and the salaries of our five employees. The debt service payment is being funded from the cash flow of the property secured by the mortgage, and the current monthly salary for each employee is only $5,000 or less. When we need additional resources for due dilligence to review potential acquisitions, we use independent contractors. During the first quarter of 2005, we used three independent contractors at a cost of $4,000 to $5,000 per month for each contractor.
We historically have financed our long-term capital needs, including acquisitions, as follows:
| Borrowings from new loans; | |||
| Additional equity issuances of our common and preferred shares; and | |||
| Proceeds from the sales of our real estate and technology segment. |
There can be no assurance that any of the alternatives will be adopted, or if adopted, will be successful.
Legal Proceedings
In the normal course of business, we may be involved in legal actions arising from the ownership and administration of our properties. In our opinion, the liabilities, if any, that may ultimately result from such legal actions are not expected to have a materially adverse effect on our consolidated financial position, operations or liquidity. We are not currently involved in any legal actions.
- 10 -
Note 9 Related Party Transactions
Richton Trail Acquisition and Management Fees
Effective July 1, 2003, we closed the acquisition of our residential apartment complex, Richton Trail, following approval by our shareholders of the transaction on June 30, 2003. Our operating partnership, Paragon Real Estate, LP, acquired the residential complex along with the associated mortgage from Hampton Court Associates, LP (Hampton Court), a partnership controlled by James C. Mastandrea, its general partner and our Chairman, Chief Executive Officer and President. In consideration for transferring Richton Trail, Hampton Court received 813,938 restricted limited partnership units of Paragon Real Estate, LP. Each unit is redeemable after four years for cash, or, at our option, 22.881 of our common shares.
Mr. Mastandrea also owns two companies that provide services to Richton Trail. Mid Illinois Realty
Corp. manages Richton Trail and MDC Realty Corp. is reimbursed, at cost, for Richton Trails
payroll related costs. The related management fees included for the three months ended
March 31, 2005 were approximately $7,000 and for the three months ended March 31, 2004 were
approximately $7,000. Reimbursement, at cost, for the payroll related costs paid and accrued for
the three months ended March 31, 2005 was approximately $16,000 and for the three month period
ended March 31, 2004 was approximately $15,000. As Paragon acquires more properties, we intend to
use local third party management companies until we are able to provide management services
internally for our properties.
Medical Insurance Reimbursement
Paragon was reimbursing MDC Realty Corp. for medical insurance, at cost, for one of its executive officers. The amount paid or accrued for the three months ended March 31, 2005 was $0 and for the three months ended March 31, 2004 was approximately $1,400.
- 11 -
ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Overview
Paragon Real Estate Equity and Investment Trust (the Company, Paragon, we, our, or us) is a real estate company with its primary focus on acquiring, owning and operating multi-family residential real estate. As of March 31, 2005, we owned a 1.0% interest in Paragon Real Estate, LP, the operating partnership that owns Richton Trail Apartments (Richton Trail), an apartment complex containing 72 units. Hampton Court Associates owns the remaining 99.0% interest in Paragon Real Estate, LP. Because we are the sole general partner of Paragon Real Estate, LP, we consolidate Richton Trail in our financial statements and show separately amounts for minority interest for Hampton Court Associates, which is the only limited partner. Hampton Court Associates ownership interest in Paragon Real Estate, LP is 813,938 restricted limited partnership units, each redeemable after July 1, 2007 for cash, or at our option, 22.881 of our common shares.
Paragon is also the sole member of Paragon Housing LLC, which is the general partner of River West Apartments Limited Partnership (River West). River West is a single asset entity owning an apartment complex of 30 units. We do not consolidate Paragon Housing LLC with Paragons financial statements because we do not have financial or voting control over the entity, and we do not have sufficient equity at risk for Paragon Housing LLC to finance River West activities without additional subordinated financial support. Our exposure is limited to Paragon Housing LLCs $100 capital contribution in River West, and we and Paragon Housing LLC are not obligated on any of the liabilities of River West.
Paragon has developed a value-added business plan that is primarily focused on acquiring well located, under-performing multi-family residential properties, including affordable housing complexes, and repositioning them through renovation, leasing, improved management, and branding. This strategy, while unique to public companies, is common among private companies on both a local and limited regional basis. Paragons investments will be in properties, portfolios and companies with value-added programs. Paragon intends to raise equity through public and private offerings. We may also use joint venture structures for property and portfolio acquisitions, and tax-deferred operating partnership units for acquisitions of companies.
Brief History
Paragon was formed on March 15, 1994 as a Maryland real estate investment trust (REIT). We operated as a traditional REIT by buying, selling, owning and operating commercial and residential properties through December 31, 1999.
In February 2000, former management of the Company purchased a software technology company. As a result of the operations of the technology company commencing in 2000, the Company did not meet the Internal Revenue Code qualifications to be a REIT for federal tax purposes. In July 2001, former management sold the software technology company, but continued marketing the software product. In 2002, the Company discontinued the operations of the technology segment. Although Paragon is no longer a REIT for federal tax purposes, we can elect REIT status effective for 2005. We intend to take advantage of our tax loss carryforwards before electing to be a REIT again.
Forward-Looking Information
The following is a discussion of our results of operations for the three month periods ended March 31, 2005 and 2004 and financial condition, including:
| Explanation of changes in the results of operations in the Consolidated Statements of Operations for the three month period ended March 31, 2005 compared to the three month period ended March 31, 2004. |
- 12 -
| Our critical accounting policies and estimates that require our subjective judgment and are important to the presentation of our financial condition and results of operations. | |||
| Our primary sources and uses of cash for the three month period ended March 31, 2005, and how we intend to generate cash for long-term capital needs. | |||
| Our current income tax status. |
This report on Form 10-QSB contains forward-looking statements for the purposes of the Securities Act of 1933 and the Securities Exchange Act of 1934 and may involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance, and achievements of the Company to be materially different from results, performance or achievements expressed or implied by such forward-looking statements. Although the Company believes that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, there can be no assurance that these expectations will be realized. The Company assumes no obligation to update or supplement forward-looking statements that become untrue because of subsequent events. Factors that could cause actual results to differ materially from managements current expectations include, but are not limited to, changes in general economic conditions, changes in local real estate conditions (including rental rates and competing properties), changes in the economic conditions affecting industries which employ tenants residing in our property, failure to lease unoccupied units or to re-lease occupied units upon expiration of leases in accordance with our projections, changes in prevailing interest rates, the cost or general availability of equity and debt financing, failure to acquire properties in accordance with our value added strategy, unanticipated costs associated with the acquisition and integration of our acquisitions, our ability to obtain adequate insurance for terrorist acts, demand for tenant services beyond those traditionally provided by landlords, and potential liability under environmental or other laws. For further information, refer to our consolidated financial statements and footnotes included in the Annual Report on Form 10-KSB for the year ended December 31, 2004.
The following discussion and analysis should be read in conjunction with the financial statements and notes thereto appearing elsewhere herein.
Results of Operations
Comparison of the Three Month Periods Ended March 31, 2005 and 2004
Revenues from Operations
Rental revenue was approximately $151,000 for each of the three month periods ended March 31, 2005 and 2004 and was comprised entirely of Richton Trail.
Interest and other revenue decreased by approximately $7,000 to approximately $11,000 for the three month period ended March 31, 2005 compared to the three month period ended March 31, 2004. The decrease is primarily due to the decrease in cash and cash equivalents between the periods. Cash was used during 2004 and 2005 to fund the operation of the Company while we implement our value-added acquisition strategy.
Expenses from Operations
Total expenses increased from approximately $389,000 for the three month period ended March 31, 2004 to approximately $607,000 for the three month period ended March 31, 2005, a net increase of $218,000.
Richton Trail is included in operations for each of the three month periods ended March 31, 2005 and 2004, and the expenses between these two periods were approximately the same for property, operating and maintenance; property taxes and insurance; depreciation and amortization; interest; and management fees.
- 13 -
General and administrative expenses increased from approximately $240,000 for the three month period ended March 31, 2004 to approximately $459,000 for the three month period ended March 31, 2005. The increase of approximately $219,000 resulted from due diligence being performed on potential transactions, including legal fees of approximately $149,000, other general consulting costs of $60,000, and other miscellaneous items of approximately $10,000 including travel costs for visiting the properties.
Loss from operations before minority interest
As a result of the above, loss from operations before loss allocated to minority interest increased from approximately $220,000 for the three month period ended March 31, 2004 to approximately $446,000 for the three month period ended March 31, 2005.
Loss allocated to minority interest
Loss allocated to minority interests changed from approximately $87,000 of loss allocated for the three month period ended March 31, 2004 to an allocation of approximately zero for the three month period ended March 31, 2005. This is primarily as a result of fewer costs being allocated for the three month period ended on March 31, 2005 compared to the same period in 2004.
Net loss attributable to Common Shareholders
Based on the above, the net loss attributable to Common Shareholders increased from approximately $133,000 for the three month period ended March 31, 2004 to approximately $446,000 for the three month period ended March 31, 2005.
Critical Accounting Policies and Estimates
Our Consolidated Financial Statements are prepared in accordance with generally accepted accounting principles, which require us to make certain estimates and assumptions. A summary of our significant accounting policies is provided in Note 3 to our Consolidated Financial Statements. The following section is a summary of certain aspects of those accounting policies that both require our most subjective judgment and are most important to the presentation of our financial condition and results of operations. It is possible that the use of different estimates or assumptions in making these judgments could result in materially different amounts being reported in our Consolidated Financial Statements.
Impairment of Long-Lived Assets
We recognize an impairment loss on a real estate asset if the assets carrying amount exceeds its fair value and is non-recoverable. First, to determine if impairment may exist, we review our properties and identify those, if any, which have had either an event of change or event of circumstances warranting further assessment of recoverability. Next, we estimate the fair value of those properties on an individual basis through either independent appraisals or by capitalizing the expected net operating income, among various other factors. These amounts are then compared to the propertys depreciated cost to determine whether an impairment exists. We compute the expected net operating income using certain estimates and assumptions for revenues and expenses. As a result, these estimates and assumptions impact the amount of impairment loss that we recognize.
Real Estate Investments
When we acquire real estate properties, we allocate the components of these acquisitions using relative fair values computed using our estimates and assumptions. These estimates and assumptions affect the amount of costs allocated between land and different categories of building improvements. The allocations impact depreciation expense and gain or loss recorded on sale of real estate. When we
- 14 -
acquired Richton Trail, we allocated 80% of the acquisition price to building and 20% to land, based on our judgment of the relative values of the two components and as supported by standard industry practice. The acquisition price was from a market appraisal.
Valuation Allowance of Deferred Tax Asset
We account for income taxes using the liability method under which deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities using enacted tax rates in effect for the period in which the differences are expected to affect taxable income. As of March 31, 2005, we have net operating losses and at December 31, 2004, we had net operating losses totaling approximately $11.0 million and capital losses of approximately $0.6 million. While these losses created a deferred tax asset of approximately $4.8 million, a valuation allowance of $4.8 million was applied against this asset because of the uncertainty of whether we will be able to use these loss carryforwards, which will expire in varying amounts through the year 2024.
Liquidity and Capital Resources
Cash provided by operations, equity transactions, and borrowings from affiliates and lending institutions have generally provided the primary sources of liquidity to Paragon. Historically, we have used these sources to fund operating expenses, satisfy our debt service obligations and fund distributions to shareholders. In 2003, as part of the one-time incentive exchange offer for holders of preferred shares to convert to common shares, our shareholders approved eliminating the preferred dividend, which allows us to use that cash for current operations and future growth of the Company.
Cash Flows
As of March 31, 2005, our unrestricted cash resources were approximately $1,407,000 and our marketable securities available for sale were approximately $86,000, comprised primarily of 10,000 common shares of Stellent, Inc. The NASDAQ closing quote on May 6, 2005 was $6.98 per common share of Stellent, Inc. We are dependent on our existing cash resources and Stellent, Inc. shares to meet our liquidity needs because cash from operations is not sufficient to meet our operating requirements.
During the three month period ended March 31, 2005, we utilized cash for (i) our continuing operations of approximately $376,000 including increased due diligence on potential transactions of approximately $219,000; (ii) additions to real estate properties of approximately $4,000; and (iii) payments on the mortgage loan payable of approximately $13,000. As a result, our cash balance decreased by approximately $393,000 from approximately $1,799,000 at December 31, 2004 to approximately $1,407,000 at March 31, 2005.
Future Obligations
Because the cash flow from our properties is not expected to fully fund our future liquidity requirements, we reduced our material future obligations, which include the mortgage on the apartment complex and the employment contracts for our executive officers.
| The mortgage is being paid by the cash flow from Richton Trail. The property has been well maintained and managed, and has had historical occupancy in the range of 95% to 100%. So long as Richton Trail maintains approximately 85% occupancy, it will generate the cash flow needed to pay its current expenses and the mortgage debt service. We intend to keep the property as close to 100% occupancy as possible and do not foresee any market conditions that would show a decline in occupancy or rents during the coming year. Also, no major improvements are planned at the property through December 31, 2005. | |||
| As of March 31, 2005, we had five employees, and each employees monthly salary is $5,000 or less. The Company has the benefit of highly qualified employees in the real estate industry |
- 15 -
and other areas of expertise, for salaries that are well below market levels. Several of them have previous experience in a publicly traded company. As the Company grows and appreciates in value, our employees expect to share in the growth of the Company and to earn higher levels of compensation. Our employees will also share in the growth of the Company along with our other shareholders, because each has a significant number of common shares. |
Long Term Liquidity and Operating Strategies
We historically have financed our long-term capital needs, including acquisitions, as follows:
| Borrowings from new loans; | |||
| Additional equity issuances of our common and preferred shares; and | |||
| Proceeds from the sales of our real estate and technology segment. |
During the first half of 2003, we put into place a new management team and shareholders elected five new Trustees. Paragon has developed a value-added business plan that is primarily focused on acquiring well located, under-performing multi-family residential properties, including affordable housing complexes, and repositioning them through renovation, leasing, improved management, and branding. This strategy, while unique to public companies, is common among private companies on both a local and limited regional basis. Paragons investments will be in properties, portfolios and companies with value-added programs. Paragon intends to raise equity through public and private offerings. We will also use joint venture structures for property and portfolio acquisitions, and tax-deferred operating partnership units for acquisitions of companies. Failure to obtain external sources of capital or to find sellers willing to exchange their properties for tax-deferred partnership units will materially and adversely affect our strategy and our operations, liquidity and financial results. Paragons investment advantages, compared to private companies, include our potential ability to access capital and to offer sellers a tax-deferred exit alternative to exchange their properties for partnership units with opportunities for both liquidity and share appreciation. Our cash resources are sufficient to meet our projected overhead for approximately eighteen months while identifying and reviewing potential acquisitions.
Current Tax Status
At March 31, 2005, we have a net operating loss, and at December 31, 2004, we had net operating losses totaling approximately $11.0 million and capital losses of approximately $0.6 million. While these losses created a deferred tax asset, a valuation allowance was applied against the asset because of the uncertainty of whether we will be able to use these loss carryforwards, which will expire in varying amounts through the year 2024. Although we can elect REIT status effective for 2005, we intend to take advantage of our tax loss carryforwards before electing to be a REIT again.
We, and certain of our subsidiaries, are also subject to certain state and local income, excise and franchise taxes. The provision for state and local taxes has been reflected in general and administrative expense in the consolidated statements of operations and has not been separately stated due to its insignificance.
Interest Rates and Inflation
For the past several years, interest rates have declined, and many financial experts and economists have agreed that interest rates reached bottom in 2003. Lower interest rates have led to higher selling prices for established real estate properties, the type that we intend to buy. Purchasers of properties have been able to place a larger amount of debt on their acquisitions because the lower interest rates have lowered the monthly mortgage payments. Interest rates started to increase during 2004, but asking prices for multi-family residential properties have not decreased. The interactions between an increase in interest rates and a decrease in selling prices of properties cannot be measured with any certainty. Paragon continues to pursue its value-added business plan during 2005. The economics of
- 16 -
transactions, including price, current cash flow, existing debt, cost of new funds for acquiring the properties, and potential for increased value, will be reviewed very closely prior to making any acquisitions.
We were not significantly affected by inflation during the periods presented in this report due primarily to the relative low nationwide inflation rates.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that have, or are likely to have, a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
- 17 -
ITEM 3. CONTROLS AND PROCEDURES
As of March 31, 2005, the date of this report, James C. Mastandrea, our Chairman of the Board, Chief Executive Officer and President, and John J. Dee, our Chief Financial Officer and Senior Vice President, evaluated the effectiveness of the design and operation of the Companys disclosure controls and procedures pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934. Based upon this evaluation, Messrs. Mastandrea and Dee concluded that, as of March 31, 2005, our disclosure controls and procedures are effective to ensure that material information relating to the Company and our consolidated subsidiaries is recorded, processed, summarized and reported in a timely manner.
Further, there were no significant changes in the internal controls or, to our knowledge, in other factors that could significantly affect such controls subsequent to March 31, 2005.
- 18 -
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In the normal course of business, we may be involved in legal actions arising from the ownership and administration of our properties. In our opinion, the liabilities, if any, that may ultimately result from such legal actions are not expected to have a materially adverse effect on our consolidated financial position, operations or liquidity. We are not currently involved in any legal actions.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS
Exhibits
Exhibit | ||
Number | Exhibit Description | |
31.1
|
Section 302 Certification pursuant to the Sarbanes-Oxley Act of 2002 Chief Executive Officer | |
31.2
|
Section 302 Certification pursuant to the Sarbanes-Oxley Act of 2002 Chief Financial Officer | |
32.1
|
CEO/CFO Certification under Section 906 of Sarbanes-Oxley Act of 2002. |
- 19 -
SIGNATURES
In accordance with the requirements of the Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Paragon real estate equity and investment trust | ||||
By: | /s/ James C. Mastandrea | |||
Date: May 6, 2005
|
James C. Mastandrea | |||
Chief Executive Officer | ||||
Paragon real estate equity and investment trust | ||||
By: | /s/ John J. Dee | |||
Date: May 6, 2005
|
John J. Dee | |||
Chief Financial Officer |
- 20 -