<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTER ENDED MARCH 31, 1997
Commission File Number 0-10503
-------
CONTINENTAL MORTGAGE AND EQUITY TRUST
------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
California 94-2738844
- -------------------------------- ----------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
10670 North Central Expressway, Suite 300, Dallas, TX 75231
-----------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
(214) 692-4700
-------------------------------
(Registrant's Telephone Number,
Including Area Code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Shares of Beneficial Interest,
no par value 4,026,111
- ------------------------------ ---------------------------------
(Class) (Outstanding at April 30, 1997)
1
<PAGE> 2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
The accompanying Consolidated Financial Statements have not been audited by
independent certified public accountants, but in the opinion of the management
of Continental Mortgage and Equity Trust (the "Trust"), all adjustments
(consisting of normal recurring accruals) necessary for a fair presentation of
consolidated results of operations, consolidated financial position and
consolidated cash flows at the dates and for the periods indicated, have been
included.
CONTINENTAL MORTGAGE AND EQUITY TRUST
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
March 31, December 31,
1997 1996
--------- ------------
(dollars in thousands)
Assets
------
<S> <C> <C>
Notes and interest receivable
Performing .................................................... $ 6,239 $ 6,268
Nonperforming, nonaccruing .................................... 2,008 2,287
--------- ---------
8,247 8,555
Less - allowance for estimated losses ........................... (1,481) (1,481)
--------- ---------
6,766 7,074
Foreclosed real estate held for sale, net of
accumulated depreciation ($725 in 1997 and
1996) ......................................................... 5,738 5,738
Real estate under contract for sale, net of
accumulated depreciation ($1,385 in 1997) ..................... 8,102 --
Real estate held for investment, net of accumulated
depreciation ($16,848 in 1997 and $16,713 in 1996) ............ 224,766 214,460
Investment in marketable equity securities of
affiliates, at market ......................................... 14,697 6,192
Investments in partnerships ..................................... 2,215 2,293
Cash and cash equivalents ....................................... 764 2,961
Other assets (including $319 in 1997 and $650 in
1996 from affiliates) ......................................... 11,518 11,292
--------- ---------
$ 274,566 $ 250,010
========= =========
</TABLE>
The accompanying notes are an integral part of these
Consolidated Financial Statements.
2
<PAGE> 3
CONTINENTAL MORTGAGE AND EQUITY TRUST
CONSOLIDATED BALANCE SHEETS - Continued
<TABLE>
<CAPTION>
March 31, December 31,
1997 1996
--------- ------------
(dollars in thousands)
<S> <C> <C>
Liabilities and Shareholders' Equity
------------------------------------
Liabilities
Notes and interest payable ................................. $ 175,557 $ 160,554
Other liabilities (including $4,485 in 1997 and
$1,318 in 1996 to affiliates) ............................ 12,242 10,273
--------- ---------
187,799 170,827
Commitments and contingencies
Shareholders' equity
Shares of Beneficial Interest, no par value;
authorized shares, unlimited; issued and out-
standing, 4,026,044 shares in 1997 and 4,026,376
shares in 1996 ........................................... 8,068 8,068
Paid-in capital ............................................ 257,159 257,159
Accumulated distributions in excess of accumulated
earnings ................................................. (191,852) (190,931)
Net unrealized gains on marketable equity
securities of affiliates ................................. 13,392 4,887
--------- ---------
86,767 79,183
--------- ---------
$ 274,566 $ 250,010
========= =========
</TABLE>
The accompanying notes are an integral part of these
Consolidated Financial Statements.
3
<PAGE> 4
CONTINENTAL MORTGAGE AND EQUITY TRUST
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Three Months
Ended March 31,
--------------------------
1997 1996
----------- -----------
(dollars in thousands,
except per share)
<S> <C> <C>
Revenues
Rents .................................................... $ 13,069 $ 10,707
Interest ................................................. 272 251
----------- -----------
13,341 10,958
Expenses
Property operations ...................................... 7,705 6,210
Interest ................................................. 3,532 2,927
Depreciation ............................................. 1,520 1,137
Advisory fee to affiliate ................................ 444 382
General and administrative ............................... 585 349
----------- -----------
13,786 11,005
----------- -----------
(Loss) from operations ..................................... (445) (47)
Equity in income of partnerships ........................... 47 395
Gain on sale of real estate ................................ -- 378
----------- -----------
Income (loss) before extraordinary gain .................... (398) 726
Extraordinary gain ......................................... -- 697
----------- -----------
Net income (loss) .......................................... $ (398) $ 1,423
=========== ===========
Earnings per share
Income (loss) before extraordinary gain .................... $ (.10) $ .17
Extraordinary gain ......................................... -- .16
----------- -----------
Net income (loss) .......................................... $ (.10) $ .33
=========== ===========
Weighted average shares of beneficial interest
used in computing earnings per share ..................... 4,026,197 4,332,699
=========== ===========
</TABLE>
The accompanying notes are an integral part of these
Consolidated Financial Statements.
4
<PAGE> 5
CONTINENTAL MORTGAGE AND EQUITY TRUST
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Accumulated Unrealized
Distributions Gains on
Shares of in Excess Marketable
Beneficial Interest Paid-in Accumulated Equity Shareholders'
Shares Amount Capital Earnings Securities Equity
--------- ---------- ---------- ---------- ----------- -------------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1,
1997 ............... 4,026,376 $ 8,068 $ 257,159 $ (190,931) $ 4,887 $ 79,183
Fractional shares.... (332) -- -- -- -- --
Distributions ($.13
per share) ......... -- -- -- (523) -- (523)
Unrealized gains on
marketable equity
securities ......... -- -- -- -- 8,505 8,505
Net (loss) .......... -- -- -- (398) -- (398)
--------- ---------- ---------- ---------- ------ ----------
Balance, March 31,
1997 ............... 4,026,044 $ 8,068 $ 257,159 $ (191,852) $13,392 $ 86,767
========= ========== ========== ========== ======= ==========
</TABLE>
The accompanying notes are an integral part of these
Consolidated Financial Statements.
5
<PAGE> 6
CONTINENTAL MORTGAGE AND EQUITY TRUST
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Three Months
Ended March 31,
--------------------
1997 1996
-------- --------
(dollars in thousands)
<S> <C> <C>
Cash Flows from Operating Activities
Rents collected ........................................... $ 12,948 10,589
Interest collected ........................................ 439 177
Interest paid ............................................. (3,370) (2,666)
Payments for property operations .......................... (5,113) (6,254)
General and administrative expenses paid .................. (1,131) (613)
Advisory fee paid to affiliate ............................ (1,033) (382)
Distributions from partnerships' operating cash flow ...... 124 570
Other ..................................................... (314) --
-------- --------
Net cash provided by operating activities ............. 2,550 1,421
Cash Flows from Investing Activities
Acquisitions of real estate ............................... (6,733) (7,529)
Funding of capital improvement escrow ..................... -- (1,500)
Real estate improvements .................................. (584) (268)
Proceeds from sale of real estate ......................... -- 889
Funding of note receivable ................................ -- (1,500)
Collections on notes receivable ........................... 115 22
Distributions from partnership's investing activities ..... -- 9,669
-------- --------
Net cash (used in) investing activities ............... (7,202) (217)
Cash Flows from Financing Activities
Distributions to shareholders ............................. (523) (555)
Repurchase of shares of beneficial interest ............... -- (1,299)
Proceeds from notes payable ............................... 3,803 6,300
Payments on notes payable and margin borrowings ........... (825) (366)
-------- --------
Net cash provided by financing activities ............. 2,455 4,080
-------- --------
Net increase (decrease) in cash and cash equivalents ....... (2,197) 5,284
Cash and cash equivalents, beginning of period ............. 2,961 6,386
-------- --------
Cash and cash equivalents, end of period ................... $ 764 $ 11,670
======== ========
</TABLE>
The accompanying notes are an integral part of these
Consolidated Financial Statements.
6
<PAGE> 7
CONTINENTAL MORTGAGE AND EQUITY TRUST
CONSOLIDATED STATEMENTS OF CASH FLOWS - Continued
<TABLE>
<CAPTION>
For the Three Months
Ended March 31,
----------------------
1997 1996
--------- ---------
(dollars in thousands)
<S> <C> <C>
Reconciliation of net income (loss) to net cash
provided by operating activities
Net income (loss).................................. $ (398) 1,423
Adjustments to reconcile net income (loss) to net
cash provided by operating activities
Gain on sale of real estate....................... - (378)
Extraordinary gain................................ - (697)
Depreciation...................................... 1,520 1,134
Equity in (income) of partnerships................ (47) (395)
(Increase) decrease in interest receivable........ 192 (71)
Decrease in other assets.......................... 265 84
Increase (decrease) in other liabilities.......... 871 (443)
Increase in interest payable...................... 23 194
Distributions from partnerships' operating cash
flow.......................................... 124 570
--------- ---------
Net cash provided by operating activities......... $ 2,550 $ 1,421
========= =========
Noncash investing and financing activities
Notes payable from acquisition of real estate.... $ 2,700 $ -
Mortgage note receivable from sale of real estate - 750
Unrealized gain on marketable equity securities.. 8,505 1,003
</TABLE>
The accompanying notes are an integral part of these
Consolidated Financial Statements.
7
<PAGE> 8
CONTINENTAL MORTGAGE AND EQUITY TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The accompanying Consolidated Financial Statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. Operating results for the three month period ended March 31, 1997
are not necessarily indicative of the results that may be expected for the year
ending December 31, 1997. Dollar amounts in tables are in thousands. For
further information, refer to the Consolidated Financial Statements and Notes
thereto included in the Trust's Annual Report on Form 10-K for the year ended
December 31, 1996 ("1996 Form 10-K").
NOTE 2. INVESTMENTS IN PARTNERSHIPS
The Trust's investments in partnerships accounted for using the equity method
consisted of the following at March 31, 1997:
<TABLE>
<S> <C>
Sacramento Nine ("SAC 9")............. $ 112
Indcon, L.P. ("Indcon")............... 2,103
-------------
$ 2,215
=============
</TABLE>
The Trust and National Income Realty Trust ("NIRT") are partners in SAC 9, the
Trust having a 30% interest in the partnership's earnings, losses and
distributions. The Trust and NIRT are also partners in Income Special
Associates ("ISA"), a joint venture partnership in which the Trust has a 60%
interest in earnings, losses and distributions. ISA in turn owns a 100%
interest in Indcon. The partnership agreements require the consent of both the
Trust and NIRT for any material changes in the operations of the partnerships'
properties, including sales, refinancings and changes in property management.
The Trust, as a noncontrolling partner, accounts for its investment in the
partnerships using the equity method.
Set forth below is summarized results of operations for the partnerships the
Trust accounts for using the equity method for the three months ended March 31,
1997:
<TABLE>
<S> <C>
Rents................................... $ 455
Depreciation............................ (115)
Property operations..................... (113)
Interest expense........................ (99)
-------------
Net income.............................. $ 128
=============
</TABLE>
NOTE 3. MORTGAGE NOTES RECEIVABLE
As more fully discussed in NOTE 5. "NOTES PAYABLE," ten of the Company's
mortgage notes receivable, with a combined principal balance of $2.8 million at
March 31, 1997, were pledged as additional collateral on a $4.0 million loan,
primarily secured by the AMOCO Building.
8
<PAGE> 9
CONTINENTAL MORTGAGE AND EQUITY TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTE 4. REAL ESTATE
In January 1997, the Trust purchased the Lost Timbers Apartments, a 180 unit
apartment complex in Houston, Texas, for $3.5 million. The Trust paid $800,000
in cash and assumed the existing mortgage of $2.7 million. The mortgage bears
interest at a variable rate, currently 9.29% per annum, adjusted semi-annually,
requires monthly payments of principal and interest of $22,704, also adjusted
semi-annually and matures in June 1999. The Trust paid a real estate brokerage
commission of $125,000 to Carmel Realty, Inc. ("Carmel Realty"), an affiliate
of Basic Capital Management, Inc. ("BCM"), the Trust's advisor, and an
acquisition fee of $35,000 to BCM based on the $3.5 million purchase price of
the property.
In February 1997, the Trust purchased the Watters Road land, 103 acres of
undeveloped land on State Highway 121 in Collin County, Texas, for $1.7 million
in cash. The Trust paid a real estate brokerage commission of $68,000 to
Carmel Realty and an acquisition fee of $17,000 to BCM based on the $1.7
million purchase price of the property.
Also in February 1997, the Trust purchased the Jefferson Building, a 71,877
square foot office building in Washington, D.C., for $13.2 million. The Trust
paid $4.1 million in cash and obtained new mortgage financing of $9.1 million.
The mortgage bears interest at 8.0% per annum, requires monthly payments of
principal and interest of $70,000 and matures in March 1999. The Trust paid a
real estate brokerage commission of $319,000 to Carmel Realty and a $132,000
acquisition fee to BCM based on the $13.2 million purchase price of the
property.
NOTE 5. NOTES PAYABLE
In March 1997, the Trust obtained mortgage financing secured by the previously
unencumbered AMOCO Building, an office building in New Orleans, Louisiana and
by ten mortgage notes receivable, with a combined principal balance of $2.8
million at March 31, 1997, in the amount of $4.0 million. The Trust received
net cash of $3.8 million after payment of various closing costs associated with
the financing. The mortgage bears interest at 9.0% per annum, requires monthly
payments of principal and interest of $35,989 and matures in March 1999. The
Trust may borrow up to an additional $2.5 million for completion of tenant
improvements or upon reaching certain income and occupancy levels of the
property. The Trust paid BCM a mortgage brokerage and equity refinancing fee
of $40,000 based on the $4.0 million mortgage.
NOTE 6. COMMITMENTS AND CONTINGENCIES
The Trust is involved in various lawsuits arising in the ordinary course of
business. Management of the Trust is of the opinion that the outcome of these
lawsuits would have no material impact on the Trust's financial condition,
results of operations or liquidity.
9
<PAGE> 10
CONTINENTAL MORTGAGE AND EQUITY TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTE 7. SUBSEQUENT EVENTS
In April 1997, the Trust completed the sale of Tollhill West, a 159,546 square
foot office building in Dallas, Texas, that was under contract for sale at
March 31, 1997. The property was sold for $14.8 million in cash, the Trust
receiving net cash of $9.8 million after the payoff of $5.0 million in existing
mortgage debt and the payment of various closing costs associated with the
sale. The Trust paid Carmel Realty a real estate brokerage commission of
$244,000 based on the $14.8 million sales price of the property. The Trust
will recognize a gain on the sale of approximately $5.0 million.
Also in April 1997, the Trust purchased the OPUBCO land, 156 acres of
undeveloped land in Collin County, Texas, for $3.0 million. In conjunction
with the purchase, the Trust obtained mortgage financing secured by the land
and by two other parcels of land in the amount of $4.2 million. The Trust
received net cash of $1.3 million. The mortgage bears interest at 9.5% per
annum, requires monthly payments of interest only and matures in April 2000.
The Trust paid a real estate brokerage commission of $109,000 to Carmel Realty
and an acquisition fee of $30,000 to BCM based on the $3.0 million purchase
price of the land.
Also in April 1997, the Trust refinanced the mortgage debt secured by the
Willo-Wick Apartments in Pensacola, Florida in the amount of $3.3 million. The
Trust received net cash of $311,000 after the payoff of $2.8 million in
existing mortgage debt and the payment of various closing costs associated with
the refinancing. The new mortgage bears interest at 9.13% per annum, requires
monthly payments of principal and interest of $27,988 and matures in May 2007.
The Trust paid BCM a mortgage brokerage and equity refinancing fee of $33,000
on the new $3.3 million mortgage.
----------------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Introduction
Continental Mortgage and Equity Trust (the "Trust") was formed to invest in
real estate through acquisitions, leases and partnerships and in mortgage loans
on real estate, including first, wraparound and junior mortgage loans. The
Trust was organized on August 27, 1980 and commenced operations on December 3,
1980.
Liquidity and Capital Resources
Cash and cash equivalents aggregated $764,000 at March 31, 1997, compared with
$3.0 million at December 31, 1996. The principal reasons for the decrease in
cash are discussed in the paragraphs below.
10
<PAGE> 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
The Trust's principal sources of cash have been and will continue to be
property operations, proceeds from property sales, and principal payments on
mortgage notes receivable and borrowings. The Trust expects that net cash
provided by operating activities and from anticipated external sources, such as
property sales, financings and refinancings, will be sufficient to meet the
Trust's various cash needs, including, but not limited to, debt service
obligations, shareholder distributions and property maintenance and
improvements.
The Trust's cash flow from property operations (rents collected less payments
for expenses applicable to rental income) increased from $4.3 million in the
first quarter of 1996 to $7.8 million in the first quarter of 1997. Of this
net increase, $1.6 million is the result of the Trust acquiring fourteen
additional income producing properties during 1996 and 1997. The remainder of
the increase is due to increased rental and occupancy rates and lower operating
expenses at the Trust's apartment complexes and commercial properties. These
increases are partially offset by the sale of five apartment complexes in 1996.
The Trust's management believes that the Trust's cash flow from property
operations will continue to increase as the Trust continues to benefit from the
properties acquired in the last nine months of 1996 and first three months of
1997.
In January 1997, the Trust purchased the Lost Timbers Apartments, a 180 unit
apartment complex in Houston, Texas, for $3.5 million. The Trust paid $800,000
in cash and assumed the existing mortgage of $2.7 million.
In February 1997, the Trust purchased the Watters Road land, 103 acres of
undeveloped land on State Highway 121 in Collin County, Texas, for $1.7 million
in cash.
Also in February 1997, the Trust purchased the Jefferson Building, a 71,877
square foot office building in Washington, DC, for $13.2 million. The Trust
paid $4.1 million in cash and obtained new mortgage financing of $9.1 million.
The Trust derived the cash portions of these acquisitions from its cash on hand
at December 31, 1996 and short term advances totaling $4.2 million from the
Trust's advisor. Such advances were repaid from the proceeds of borrowings
secured by previously unencumbered properties and sales proceeds of properties
sold in March and April 1997, as discussed below.
In March 1997, the Trust obtained mortgage financing secured by the previously
unencumbered AMOCO Building, an office building in New Orleans, Louisiana, and
by ten mortgage notes receivable with a combined principal balance of $2.8
million at March 31, 1997, in the amount of $4.0 million. The Trust received
net cash of $3.8 million after payment of various closing costs associated with
the financing.
11
<PAGE> 12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
In April 1997, the Trust completed the sale of Tollhill West, a 159,546 square
foot office building in Dallas, Texas, that was under contract for sale at
March 31, 1997. The office building was sold for $14.8 million in cash, the
Trust receiving net cash of $9.8 million after the payoff of $5.0 million in
existing mortgage debt and the payment of various closing costs associated with
the sale.
Also in April 1997, the Trust purchased the OPUBCO land, 156 acres of
undeveloped land in Collin County, Texas, for $3.0 million. In conjunction
with the purchase, the Trust obtained mortgage financing secured by the land
and by two other parcels of land in the amount of $4.2 million. The Trust
received net cash of $1.3 million.
Also in April 1997, the Trust refinanced the mortgage debt secured by the
Willo-Wick Apartments in Pensacola, Florida in the amount of $3.3 million. The
Trust received net cash of $311,000 after the payoff of $2.8 million in
existing mortgage debt and the payment of various closing costs associated with
the refinancing.
The Trust's Board of Trustees has authorized the Trust to repurchase a total of
1,465,000 of its shares of beneficial interest, of which 19,371 shares remain
to be purchased as of March 31, 1997. Through March 31, 1997, the Trust had
repurchased 1,445,629 of its shares at a total cost to the Trust of $7.7
million, none of which were purchased in the first quarter of 1997.
In February 1997, the Trust's Board of Trustees declared the Trust's regular
quarterly distribution of $.13 per share. The distribution was paid on March
31, 1997, totaling $524,000, to shareholders of record on March 14, 1997.
The Trust's management reviews the carrying value of the Trust's mortgage notes
receivable and properties at least annually and whenever events or a change in
circumstances indicate that impairment may exist. Impairment is considered to
exist if, in the case of a property, the future cash flow from the property
(undiscounted and without interest) is less than the carrying amount of the
property. For notes receivable impairment is considered to exist if it is
probable that all amounts due under the terms of the note will not be
collected. In those instances where impairment is found to exist, a provision
for loss is recorded by a charge against earnings. The Trust's mortgage note
receivable review includes an evaluation of the collateral property securing
such note. The property review generally includes selective property
inspections, a review of the property's current rents compared to market rents,
a review of the property's expenses, a review of maintenance requirements, a
review of the property's cash flow, discussions with the manager of the
property and a review of properties in the surrounding area.
12
<PAGE> 13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Results of Operations
For the quarter ended March 31, 1997, the Trust had a net loss of $398,000,
compared to net income of $1.4 million for the quarter ended March 31, 1996,
which included a gain on sale of real estate and an extraordinary gain totaling
$1.1 million. Fluctuations in these and other components of the Trust's
revenues and expenses between the 1996 and 1997 periods are discussed below.
Rents increased from $10.7 million for the three months ended March 31, 1996 to
$13.1 million for the three months ended March 31, 1997. Of this increase,
$3.1 million is attributable to the acquisition of four apartment complexes and
eight commercial properties in 1996 and an additional $390,000 is attributable
to the acquisition of one apartment complex and one commercial property in
1997. The remainder of the increase is due to increased rental and occupancy
rates at the Trust's apartment complexes and commercial properties. These
increases are partially offset by a decrease of $1.2 million due to the sale of
five apartment complexes in 1996 and a decrease of $456,000 due to the loss of
a property to foreclosure in 1996.
Interest income was $251,000 for the three months ended March 31, 1996 compared
to $272,000 for the three months ended March 31, 1997. This increase is due to
the receipt of an interest payment on a note receivable upon which the Trust
had ceased recognizing interest income in 1996. Interest income in the
remaining quarters of 1997 is expected to be slightly lower than that of the
first quarter.
Property operating expenses increased from $6.2 million for the three months
ended March 31, 1996 to $7.7 million for the three months ended March 31, 1997.
Of this increase, $1.9 million is due to the acquisition of four apartment
complexes and eight commercial properties in 1996 and an additional $218,000 is
due to the acquisition of one apartment complex and one commercial property in
1997. These increases are partially offset by a decrease of $686,000 due to
the sale of five apartment complexes in 1996 and a decrease of $291,000 due to
the loss of a property to foreclosure in 1996.
Interest expense increased from $2.9 million for the three months ended March
31, 1996 to $3.5 million for the three months ended March 31, 1997. Of this
increase, $777,000 is due to interest expense recorded on mortgages secured by
ten properties, encumbered by debt, acquired in 1996 and two properties
acquired in 1997. An additional $180,000 is due to interest expense recorded
on borrowings in 1996 and 1997, secured by mortgages on two previously
unencumbered apartment complexes and two previously unencumbered commercial
properties and the refinancing of seven existing mortgages in 1996 where the
loan balance was increased. These increases are partially offset by a decrease
of $340,000 due to the sale of three apartment complexes encumbered by debt in
1996 and a decrease of $165,000 due to the loss of a property to foreclosure in
1996. Interest expense is expected to increase in the remaining
13
<PAGE> 14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Results of Operations (Continued)
quarters of 1997, as a result of a full year of interest expense on properties
acquired or refinanced in 1996 and the properties acquired in the first quarter
of 1997.
Depreciation expense increased from $1.1 million for the three months ended
March 31, 1996 to $1.5 million for the same period in 1997. This increase is
due to the acquisition of four apartment complexes and eight commercial
properties in 1996 and one apartment complex and one commercial property in
1997. Depreciation is expected to increase during the remaining quarters of
1997, as a result of a full year of depreciation on the properties acquired in
1996 and the properties acquired in the first quarter of 1997.
Advisory fee to affiliate increased from $383,000 for the three months ended
March 31, 1996 to $444,000 for the three months ended March 31, 1997. This
increase is due to an increase in the Trust's gross assets, the basis for the
advisory fee, as a result of the acquisition of thirteen properties in 1996 and
three properties in 1997. The advisory fee is expected to continue to increase
as the Trust makes additional property acquisitions.
General and administrative expenses increased from $349,000 for the three
months ended March 31, 1996 to $585,000 for the three months ended March 31,
1997. This increase is primarily attributable to a increase in legal fees,
primarily related to the Olive litigation.
The Trust's equity in earnings of partnerships was $395,000 for the three
months ended March 31, 1996 as compared to $47,000 for the three months ended
March 31, 1997. Included in equity earnings of partnerships for the three
months ended March 31, 1996 is a $370,000 gain on sale of real estate, the
Trust's equity share of the gain recognized by Indcon, L.P. ("Indcon"), a joint
venture partnership, on the sale of 25 of its industrial warehouses. Excluding
such gain, the Trust's equity in earnings of partnerships would have been
income of $25,000 for the three months ended March 31, 1996.
For the three months ended March 31,1996, the Trust recognized a gain on the
sale of real estate of $378,000 on the sale of Rivertree Apartments in February
1996. No such gain was recognized in 1997.
For the three months ended March 31, 1996, the Trust recognized an
extraordinary gain of $697,000, its equity share of an insurance settlement
from a fire loss on one of Indcon's industrial warehouses. No such gain was
recognized in 1997.
Tax Matters
As more fully discussed in the Trust's 1996 Form 10-K, the Trust has elected
and in the opinion of the Trust's management, qualified to be taxed as a Real
Estate Investment Trust ("REIT") as defined under
14
<PAGE> 15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Tax Matters (Continued)
Sections 856 through 860 of the Internal Revenue Code of 1986, as amended, (the
"Code"). To continue to qualify for federal taxation as a REIT under the Code,
the Trust is required to hold at least 75% of the value of its total assets in
real estate assets, government securities and cash and cash equivalents at the
close of each quarter of each taxable year. The Code also requires a REIT to
distribute at least 95% of its REIT taxable income plus 95% of its net income
from foreclosure property, as defined in Section 857 of the Code, on an annual
basis to shareholders.
Inflation
The effects of inflation on the Trust's operations are not quantifiable.
Revenues from property operations fluctuate proportionately with increases and
decreases in housing costs. Fluctuations in the rate of inflation also affect
the sales values of properties and, correspondingly, the ultimate gains to be
realized by the Trust from property sales. To the extent that inflation
affects interest rates, the Trust's earnings from short-term investments and
the cost of new borrowings as well as its existing variable rate borrowings
will be affected.
Environmental Matters
Under various federal, state and local environmental laws, ordinances and
regulations, the Trust may be potentially liable for removal or remediation
costs, as well as certain other potential costs relating to hazardous or toxic
substances (including governmental fines and injuries to persons and property)
where property-level managers have arranged for the removal, disposal or
treatment of hazardous or toxic substances. In addition, certain environmental
laws impose liability for release of asbestos-containing materials into the
air, and third parties may seek recovery from the Trust for personal injury
associated with such materials.
The Trust's management is not aware of any environmental liability relating to
the above matters that would have a material adverse effect on the Trust's
business, assets or results of operations.
----------------------------------_____
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Olive Litigation. In February 1990, the Trust, together with Income
Opportunity Realty Investors, Inc., National Income Realty Trust and
Transcontinental Realty Investors, Inc., three real estate entities with, at
the time, the same officers, directors or trustees and advisor
15
<PAGE> 16
ITEM 1. LEGAL PROCEEDINGS (Continued)
as the Trust, entered into a settlement of a class and derivative action
entitled Olive et al. v. National Income Realty Trust et al. pending before the
United States District Court for the Northern District of California and
relating to the operation and management of each of the entities (the "Olive
Litigation"). On April 23, 1990, the court granted final approval of the terms
of a Stipulation of Settlement.
On May 4, 1994, the parties entered into a Modification of Stipulation of
Settlement dated April 27, 1994 (the "Olive Modification") that settled
subsequent claims of breaches of the settlement that were asserted by the
plaintiffs and that modified certain provisions of the April 1990 settlement.
The Olive Modification was preliminarily approved by the court on July 1, 1994,
and final court approval was entered on December 12, 1994. The effective date
of the Olive Modification was January 11, 1995.
The Court retained jurisdiction to enforce the Modification, and during August
and September 1996, the Court held evidentiary hearings to assess compliance
with the terms of the Modification by various parties. The Court issued no
ruling or order with respect to the matters addressed at the hearings.
Separately, in 1996, legal counsel for the plaintiffs notified the Trust's
Board of Trustees that he intends to assert that certain actions taken by the
Board of Trustees breached the terms of the Olive Modification. On January 27,
1997, the parties entered into an Amendment to the Modification, effective
January 9, 1997 (the "Amendment"), which was submitted to the Court for
approval on January 29, 1997. The Amendment provides for the settlement of all
matters raised at the evidentiary hearings and by plaintiffs' counsel in his
notices to the Trust's Board of Trustees. On May 2, 1997, a hearing was held
for the Court to consider approval of the Amendment. As of May 7, 1997, the
Court had not issued an order either approving or disapproving the Amendment.
The Amendment provides for the addition of three new unaffiliated members to
the Trust's Board of Trustees and sets forth new requirements for the approval
of any transactions with certain affiliates until April 28, 1999. In addition,
the Trust, IORI, TCI and their shareholders released the defendants from any
claims relating to the plaintiffs' allegations and matters which were the
subject of the evidentiary hearings. The plaintiffs' allegations of any
breaches of the Modification shall be settled by mutual agreement of the
parties or, lacking such agreement, by an arbitration proceeding.
Under the Amendment, all shares of the Trust owned by Gene E. Phillips or any
of his affiliates shall be voted at all shareholders' meetings held until April
28, 1999 in favor of all new Board members added under the Amendment. The
Amendment also requires that, until April 28, 1999, all shares of the Trust
owned by Gene E. Phillips or his affiliates in excess of forty percent (40%) of
the Trust's outstanding shares shall be voted in proportion to the votes cast
by all non-affiliated shareholders of the Trust.
16
<PAGE> 17
ITEM 5. OTHER INFORMATION
On October 25, 1996, the Trust's Board of Trustees approved a proposal to
convert the Trust from a California business trust into a Nevada corporation.
The Trust's Board of Trustees believes that the change from a California
business trust to a Nevada corporation will afford the Trust greater legal
certainty in matters of corporate governance and indemnification and therefore
greater predictability in the conduct of its business as a corporation under
Nevada law. The Trust has filed a Proxy Statement/Prospectus with the
Securities and Exchange Commission providing for a special meeting of the
Trust's shareholders. At such meeting the Trust's shareholders will vote on
this proposal. Approval requires the vote of a majority of the Trust's
outstanding shares of beneficial interest. As of April 30, 1997 the Trust's
advisor and its affiliates held shares representing approximately 53.9% of the
Trust's outstanding shares. Under the Olive Amendment (see Part II, ITEM 1.
"LEGAL PROCEEDINGS") the Trust's advisor and its affiliates have discretionary
authority to vote their shares on this matter, up to 40% of the Trust's shares
outstanding. A date for the special meeting of the Trust's shareholders to
vote on the incorporation proposal has not been set.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit
Number Description
27.0 Financial Data Schedule
(b) Reports on Form 8-K as follows:
None
17
<PAGE> 18
SIGNATURE PAGE
Pursuant to the requirements 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.
CONTINENTAL MORTGAGE AND EQUITY TRUST
Date: May 7, 1997 By: /s/ Randall M. Paulson
------------------------- -----------------------------------
Randall M. Paulson
President
Date: May 7, 1997 By: /s/ Thomas A. Holland
------------------------- -----------------------------------
Thomas A. Holland
Executive Vice President and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
18
<PAGE> 19
CONTINENTAL MORTGAGE AND EQUITY TRUST
EXHIBITS TO
QUARTERLY REPORT ON FORM 10-Q
For the Three Months Ended March 31, 1997
<TABLE>
<CAPTION>
Exhibit Page
Number Description Number
- ------- --------------------------------------------------- ------
<S> <C> <C>
27.0 Financial Data Schedule. 20
</TABLE>
19
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<CASH> 764
<SECURITIES> 14,697
<RECEIVABLES> 8,247
<ALLOWANCES> 1,481
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 257,564
<DEPRECIATION> 18,958
<TOTAL-ASSETS> 274,566
<CURRENT-LIABILITIES> 0
<BONDS> 175,557
0
0
<COMMON> 0
<OTHER-SE> 86,767
<TOTAL-LIABILITY-AND-EQUITY> 274,566
<SALES> 0
<TOTAL-REVENUES> 13,069
<CGS> 0
<TOTAL-COSTS> 7,705
<OTHER-EXPENSES> 1,520
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 3,532
<INCOME-PRETAX> (398)
<INCOME-TAX> 0
<INCOME-CONTINUING> (398)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (398)
<EPS-PRIMARY> (.10)
<EPS-DILUTED> (.10)
</TABLE>
