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UNITED STATES
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 JUNE 30, 2002
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Commission File Number 1-14784
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INCOME OPPORTUNITY REALTY INVESTORS, INC.
------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
NEVADA 75-2615944
- ------------------------------- -------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
1800 Valley View Lane, Suite 300, Dallas, Texas, 75234
- --------------------------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
(469) 522-4200
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(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 __.
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Common Stock, $.01 par value 1,438,945
- ---------------------------- ------------------------------
(Class) (Outstanding at July 31, 2002)
1
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
The accompanying Consolidated Financial Statements as of and for the three and
six month periods ended June 30, 2002, have not been audited by independent
certified public accountants, but in the opinion of the management of Income
Opportunity Realty Investors, Inc. ("IORI"), all adjustments (consisting of
normal recurring accruals) necessary for a fair presentation of IORI's
consolidated financial position, consolidated results of operations and
consolidated cash flows at the dates and for the periods indicated, have been
included.
INCOME OPPORTUNITY REALTY INVESTORS, INC.
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2002 2001
---------- ----------
(dollars in thousands,
Assets except per share)
Real estate held for investment................................................. $ 86,331 $ 95,190
Less - accumulated depreciation................................................. (7,152) (7,875)
---------- ----------
79,179 87,315
Notes and interest receivable (including $5,270 in 2002
from related parties).....,................................................... 7,297 505
Allowance for loss.............................................................. (767) --
---------- ----------
6,530 505
Investment in real estate partnerships.......................................... 135 142
Cash and cash equivalents....................................................... 69 66
Other assets (including $5,464 in 2002 from affiliates)......................... 9,780 3,805
---------- ----------
$ 95,693 $ 91,833
========== ==========
Liabilities and Stockholders' Equity
Liabilities
Notes and interest payable...................................................... $ 54,448 $ 54,426
Other liabilities (including $33 in 2002 and $593 in 2001
to affiliates)................................................................ 1,839 2,185
---------- ----------
56,287 56,611
Commitments and contingencies
Stockholders' equity
Common Stock, $.01 par value; authorized 10,000,000 shares;
issued and outstanding 1,438,945 shares in 2002 and 2001...................... 14 14
Paid-in capital................................................................. 63,459 63,459
Accumulated distributions in excess of accumulated earnings..................... (24,067) (28,251)
---------- ----------
39,406 35,222
---------- ----------
$ 95,693 $ 91,833
========== ==========
The accompanying notes are an integral part of these Consolidated Financial
Statements.
2
INCOME OPPORTUNITY REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months For the Six Months
Ended June 30, Ended June 30,
-------------------------- --------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
Property revenue (dollars in thousands, except per share)
Rents .................................. $ 2,531 $ 2,756 $ 5,202 $ 5,425
Property expense
Property operations(including $96 in
2002 and $154 in 2001 to affiliates
and related parties) ................. 1,432 1,335 2,725 2,649
----------- ----------- ----------- -----------
Operating income ....................... 1,099 1,421 2,477 2,776
Other income
Interest ............................... 310 62 348 134
Equity in income (loss) of equity
partnerships ...................... 48 (6) 30 3
----------- ----------- ----------- -----------
358 56 378 137
Other expense
Interest ............................... 1,349 1,379 2,339 2,710
Depreciation ........................... 482 492 982 977
Advisory fee to affiliate .............. 163 234 348 391
Net income fee to affiliate ............ -- -- 411 --
Provision for loss ..................... -- -- 767 --
General and administrative (including
$157 in 2002 and $172 in 2001 to
affiliates and related parties) ... 352 161 637 472
----------- ----------- ----------- -----------
2,346 2,266 5,484 4,550
----------- ----------- ----------- -----------
Net loss from continuing operations ...... (889) (789) (2,629) (1,637)
Discontinued operations:
Income (loss) from operations ........ -- 57 (292) 188
Gain on sale of operations ........... -- -- 7,105 --
----------- ----------- ----------- -----------
-- 57 6,813 188
----------- ----------- ----------- -----------
Net income (loss) .................... $ (889) $ (732) $ 4,184 $ (1,449)
=========== =========== =========== ===========
Earnings (loss) per share
Net loss from continuing operations .. $ (.62) $ (.52) $ (1.83) $ (1.08)
Discontinued operations .............. -- .04 4.73 .12
----------- ----------- ----------- -----------
Net income (loss) ................. $ (.62) $ (.49) $ 2.90 $ (.95)
=========== =========== =========== ===========
Weighted average Common shares used
in computing earnings per share ...... 1,438,945 1,514,045 1,438,945 1,514,045
=========== =========== =========== ===========
The accompanying notes are an integral part of these Consolidated Financial
Statements.
INCOME OPPORTUNITY REALTY INVESTORS, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
For the Six Months Ended June 30, 2002
Accumulated
Common Stock Distributions
----------------------- in Excess of
Paid-in Accumulated Stockholders'
Shares Amount Capital Earnings Equity
---------- ---------- ---------- ---------- ----------
(dollars in thousands)
Balance, January 1, 2002.................................. 1,438,945 $ 14 $ 63,459 $ (28,251) $ 35,222
Net income ............................................... -- -- -- 4,184 4,184
---------- ---------- ---------- ---------- ----------
Balance, June 30, 2002 ................................... 1,438,945 $ 14 $ 63,459 $ (24,067) $ 39,406
========== ========== ========== ========== ==========
The accompanying notes are an integral part of these Consolidated Financial
Statements.
4
INCOME OPPORTUNITY REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months
Ended June 30,
----------------------
2002 2001
-------- --------
(dollars in thousands)
Cash flows from Operating Activities
Rents collected .................................................... $ 5,495 $ 6,425
Payments for property operations (including $96 in
2002 and $154 in 2001 to affiliates and related parties)........... (4,019) (3,511)
Interest collected ................................................. 158 135
Interest paid ...................................................... (1,903) (2,700)
Advisory and net income fee to affiliate ........................... (503) (432)
General and administrative expenses paid (including
$172 in 2002 and $164 in 2001 to affiliates) ...................... (613) (436)
Distributions from equity partnerships' operating
cash flow ......................................................... 42 --
Other .............................................................. -- (253)
-------- --------
Net cash used in operating activities .......................... (1,343) (772)
Cash Flows from Investing Activities
Collections on notes receivable .................................... 500 1,000
Funding of notes receivable (including $5,109 in 2002
to related parties) ............................................. (7,109) --
Funding of equity partnerships ..................................... (5) (20)
Real estate improvements ........................................... (317) (819)
Proceeds from sale of real estate .................................. 14,575 --
-------- --------
Net cash provided by investing activities .................... 7,644 161
Cash Flows from Financing Activities
Payments on notes payable .......................................... (23,134) (375)
Proceeds from notes payable ........................................ 23,152 2,974
Deferred financing costs ........................................... (889) (76)
Advance to affiliate ............................................... (3,920) --
Advances from/(payments to) advisor ................................ (1,507) 76
-------- --------
Net cash provided by (used in) financing
activities ................................................... (6,298) 2,599
Net increase in cash and cash equivalents ............................ 3 1,988
Cash and cash equivalents, beginning of period ....................... 66 2,087
-------- --------
Cash and cash equivalents, end of period ............................. $ 69 $ 4,075
======== ========
The accompanying notes are an integral part of these Consolidated Financial
Statements.
5
INCOME OPPORTUNITY REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS - Continued
For the Six Months
Ended June 30,
----------------------
2002 2001
--------- ---------
(dollars in thousands)
Reconciliation of net income (loss) to net cash
used in operating activities
Net income (loss) ........................................ $ 4,184 $ (1,449)
Adjustments to reconcile net income (loss) to net cash
used in operating activities
Depreciation and amortization .......................... 1,290 1,178
Gain on sale of real estate ............................ (7,105) --
Equity income of equity partnerships ................... (30) (3)
Distributions from equity partnerships' operating
cash flow ........................................... 42 --
Provision for loss ..................................... (767) --
Increase in interest receivable ........................ (183) --
Decrease in other assets ............................... 884 120
Increase (decrease) in interest payable ................ (4) 169
Increase (decrease) in other liabilities ............... 346 (787)
--------- ---------
Net cash used in operating activities ............... $ (1,343) $ (772)
========= =========
The accompanying notes are an integral part of these Consolidated Financial
Statements.
6
INCOME OPPORTUNITY REALTY INVESTORS, INC.
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 notes required
by generally accepted accounting principles for complete financial statements.
Operating results for the six month period ended June 30, 2002, are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2002. For further information, refer to the Consolidated Financial
Statements and notes thereto included in IORI's Annual Report on Form 10-K for
the year ended December 31, 2001 (the "2001 Form 10-K").
Certain balances for 2001 have been reclassified to conform to the 2002
presentation.
On January 1, 2002, IORI adopted Statement 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets" ("SFAS No. 144"). The Statement superceded
Statement 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of" ("SFAS No. 121") and Accounting Principles
Board Opinion No. 30, "Reporting the Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions" ("APB 30"), for business
segments that are to be disposed. SFAS 144 retains the requirements of SFAS No.
121 relating to the recognition and measurement of an impairment loss and
resolves certain implementation issues resulting from SFAS No. 121. The adoption
of SFAS No. 144 did not have a material impact on the consolidated financial
position or results of operations of IORI.
In April 2002, the FASB issued Statement 145, "Rescission of FASB Statements No.
4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Correction"
("SFAS No. 145"). Statement 4, "Reporting Gains and Losses from Extinguishment
of Debt" ("SFAS No. 4"), required that gains and losses from the extinguishment
of debt that were included in the determination of net income be aggregated and,
if material, classified as an extraordinary item. The provisions of SFAS No. 145
related to the rescission of SFAS No. 4 will require IORI to reclassify prior
period items that do not meet the extraordinary classification. The provisions
of SFAS No. 145 that relates to the rescission of SFAS No. 4 become effective in
fiscal years beginning after May 15, 2002. The adoption of SFAS No. 145 is not
expected to have a material impact on the consolidated financial position or
results of operations of IORI.
7
INCOME OPPORTUNITY REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 1. BASIS OF PRESENTATION (Continued)
In June 2002, the FASB issued SFAS No. 146, "Accounting for costs Associated
with Exit or Disposal Activities," which addresses accounting for restructuring
and similar costs. SFAS No. 146 supersedes previous accounting guidance,
principally Emerging Issues Task Force ("EITF") Issue No. 94-3. IORI will adopt
the provisions of SFAS No. 146 for restructuring activities initiated after
December 31, 2002. SFAS No. 146 requires that the liability for costs associated
with an exit or disposal activity be recognized when the liability is incurred.
Under EITF No. 94-3, a liability for an exit cost was recognized at the date of
a company's commitment to an exit plan. SFAS No. 146 also establishes that the
liability should initially be measured and recorded at fair value. Accordingly,
SFAS No. 146 may affect the timing of recognizing future restructuring costs as
well as the amount recognized.
NOTE 2. REAL ESTATE
In January 2002, IORI sold the 124,059 sq. ft. Daley Corporate Center in San
Diego, California, for $15.5 million, receiving net cash of $8.1 million after
paying off $6.6 million in mortgage debt and the payment of various closing
costs. A gain of $7.1 million was recognized on the sale.
NOTE 3. NOTES AND INTEREST RECEIVABLE
In January 2002, IORI purchased 100% of the outstanding common shares of
Rosedale Corporation ("Rosedale"), a wholly-owned subsidiary of American Realty
Investors, Inc. ("ARI"), a related party, for $5.1 million cash. Rosedale owns
the 83,331 sq. ft. Rosedale Towers Office Building in Roseville, Minnesota. ARI
has guaranteed that the asset shall produce at least a 12% return annually of
the purchase price for a period of three years from the purchase date. If the
asset fails to produce the 12% return, ARI shall pay IORI any shortfall. In
addition, if the asset fails to produce the 12% return for a calendar year, IORI
may require ARI to repurchase the shares of Rosedale for the purchase price.
Management has classified this related party transaction as a note receivable
from ARI. In the first quarter of 2002, after reviewing the property's fair
value after costs to sell, even though ARI has guaranteed the 12% return, IORI
recognized a provision for loss on the note receivable of $767,000.
In February 2002, IORI funded a $2.0 million mortgage loan as a participation
agreement with Transcontinental Realty Investors, Inc. ("TCI"), a related party.
The loan is secured by a second lien on a retail center in Montgomery County,
Texas. The note receivable bears
8
INCOME OPPORTUNITY REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 3. NOTES AND INTEREST RECEIVABLE (Continued)
interest at 16.0% per annum, requires monthly interest only payments of $47,000
and matured in February 2002. In February 2002, the loan was extended until
April 2002. In April 2002, IORI extended the loan until July 2002, receiving
$8,500 as an extension fee. In July 2002, the loan was extended until September
2002, receiving $8,500 as an extension fee. Also in July 2002, IORI received a
$500,000 principal paydown on the note. IORI and TCI will receive 57% and 43%,
respectively, on the remaining principal and interest payments.
In April 2002, a mortgage loan with a principal balance of $500,000 was paid
off, including accrued but unpaid interest.
NOTE 4. NOTES AND INTEREST PAYABLE
In April 2002, IORI sold all of its residential properties to partnerships
controlled by Metra Capital, LLC ("Metra"). These properties include: the 60
unit Brighton Court, the 92 unit Del Mar, the 68 unit Enclave, the 280 unit
Meridian, the 57 unit Signature, and the 114 unit Sinclair, located in Midland,
Texas, and the 106 unit Treehouse, located in San Antonio, Texas. Innovo Realty,
Inc., a subsidiary of Innovo Group, Inc. ("Innovo") is a limited partner in the
partnerships that purchased the properties. Joseph Mizrachi, a director of ARI,
a related party, controls approximately 11.67% of the outstanding common stock
of Innovo. The sale constituted 23.39% of the total assets of IORI as of
December 31, 2001. The sales price for the properties totaled $26.2 million.
IORI received $5.4 million in cash after the payoff of $16.1 million in debt and
various closing costs. Management has determined to account for this sale as a
refinancing transaction, in accordance with SFAS No. 66, "Accounting for Sales
of Real Estate." IORI will continue to report the assets and the new debt
incurred by the Metra partnerships on the IORI financial statements. The new
debt on the properties totals $21.4 million, bears interest at 7.57% per annum,
requires monthly interest only payments of $135,000 and matures in May 2012.
IORI also received $5.2 million of 8% non-recourse, non-convertible Series A
Preferred Stock ("Preferred Shares") of Innovo.
The dividend on the Preferred Shares will be funded entirely and solely through
member distributions from cash flows generated by the operation and subsequent
sale of the sold properties. In the event the cash flows for the properties are
insufficient to cover the 8% annual dividend, Innovo will have no obligation to
cover any shortfall.
9
INCOME OPPORTUNITY REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 4. NOTES AND INTEREST PAYABLE (Continued)
The Preferred Shares have a mandatory redemption feature, and are redeemable
from the cash proceeds received by Innovo from the operation and sale of the
properties. All member distributions that are in excess of current and accrued
8% dividends, must be used by Innovo to redeem the Preferred Shares. Since
redemption of these shares is subject to the above future events, management has
elected to record no basis in the Preferred Shares.
NOTE 5. OPERATING SEGMENTS
Significant differences among the accounting policies of the operating segments
as compared to the Consolidated Financial Statements principally involve the
calculation and allocation of general and administrative expenses. Management
evaluates the performance of each of the operating segments and allocates
resources to each of them based on their net operating income and cash flow.
Items of income that are not reflected in the segments are interest, and income
(loss) of equity partnerships which totaled $358,000 and $378,000 for the three
and six months ended June 30, 2002 and $56,000 and $137,000 in the three and six
months ended June 30, 2001. Expenses that are not reflected in the segments are
general and administrative expenses, advisory and net income fees, provision for
losses, and discontinued operations which totaled $515,000 and $2.5 million for
the three and six months ended June 30, 2002, and $395,000 and $863,000 for the
three and six months ended June 30, 2001. Excluded from operating segment assets
are assets of $16.5 million at June 30, 2002, and $11.1 million at June 30,
2001, which are not identifiable with an operating segment. There are no
intersegment revenues and expenses and all business is conducted in the United
States.
Presented below is the operating income of each operating segment for the three
and six months ended June 30, 2002 and 2001, and each segment's assets at June
30.
Three Months Ended Commercial
June 30, 2002 Properties Apartments Land Total
- ------------------------------------- ---------- ---------- ---------- ----------
Rents ............................... $ 1,191 $ 1,340 $ -- $ 2,531
Property operating expenses ......... 680 681 71 1,432
---------- ---------- ---------- ----------
Operating income (loss) ............. $ 511 $ 659 $ (71) $ 1,099
========== ========== ========== ==========
Interest ............................ $ 425 $ 550 $ 374 $ 1,349
Depreciation ........................ 358 124 -- 482
Real estate improvements ............ -- -- 88 88
Assets .............................. 33,051 21,359 24,769 79,179
10
INCOME OPPORTUNITY REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 5. OPERATING SEGMENTS (Continued)
Six Months Ended Commercial
June 30, 2002 Properties Apartments Land Total
- ------------------------------------- ---------- ---------- ---------- ----------
Rents ............................... $ 2,553 $ 2,649 $ -- $ 5,202
Property operating expenses ......... 1,360 1,230 135 2,725
---------- ---------- ---------- ----------
Operating income (loss) ............. $ 1,193 $ 1,419 $ (135) $ 2,477
========== ========== ========== ==========
Interest ............................ $ 874 $ 809 $ 656 $ 2,339
Depreciation ........................ 730 252 -- 982
Real estate improvements ............ 41 -- 276 317
Assets .............................. 33,051 21,359 24,769 79,179
Commercial
Property Sales: Properties Total
---------- ----------
Sales prices ........................ $ 15,500 $ 15,500
Cost of sales ....................... 8,395 8,395
---------- ----------
Gain on sale ........................ $ 7,105 $ 7,105
========== ==========
Three Months Ended Commercial
June 30, 2001 Properties Apartments Land Total
- ------------------------------------- ---------- ---------- ---------- ----------
Rents ............................... $ 1,457 $ 1,299 $ -- $ 2,756
Property operating expenses ......... 687 637 11 1,335
---------- ---------- ---------- ----------
Operating income (loss) ............. $ 770 $ 662 $ (11) $ 1,421
========== ========== ========== ==========
Interest ............................ $ 521 $ 376 $ 482 $ 1,379
Depreciation ........................ 363 129 -- 492
Real estate improvements ............ 455 -- -- 455
Assets .............................. 41,964 21,866 22,087 85,917
Six Months Ended Commercial
June 30, 2001 Properties Apartments Land Total
- ------------------------------------- ---------- ---------- ---------- ----------
Rents ............................... $ 2,767 $ 2,515 $ 143 $ 5,425
Property operating expenses ......... 1,360 1,276 13 2,649
---------- ---------- ---------- ----------
Operating income .................... $ 1,407 $ 1,239 $ 130 $ 2,776
========== ========== ========== ==========
Interest ............................ $ 1,010 $ 745 $ 955 $ 2,710
Depreciation ........................ 721 256 -- 977
Real estate improvements ............ 819 -- -- 819
Assets .............................. 41,964 21,866 22,087 85,917
NOTE 6. DISCONTINUED OPERATIONS
Effective January 1, 2002, IORI adopted Financial Accounting Standards No. 144,
"Accounting for the Impairment or Disposal of Long-Lived
11
INCOME OPPORTUNITY REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 6. DISCONTINUED OPERATIONS (Continued)
- -------------------------------
Assets" ("SFAS 144"), which established a single accounting model for the
impairment or disposal of long-lived assets including discontinued operations.
This statement requires that the operations related to properties that have been
sold, or properties that are intended to be sold, be presented as discontinued
operations in the statement of operations for all periods presented, and the
properties intended to be sold are to be designated as "held for sale" on the
balance sheet. Adoption of SFAS 144 did not have a material effect on IORI's
financial statements. However, in the event of a future asset sale, IORI is
required to then reclassify portions of previously reported earnings to
discontinued operations and to present assets as held for sale and the related
liability separately in the consolidated balance sheet.
For the three and six months ended June 30, 2002 and 2001, income from
discontinued operations relates to one property that IORI sold during the first
six months of 2002. The following table summarizes revenue and expense
information for the properties sold and held for sale.
For the Three Months For the Six Months
Ended June 30, Ended June 30,
----------------------- ---------------------
2002 2001 2002 2001
--------- --------- --------- --------
Revenue
Rental...................................................... $ -- $ 533 $ 128 $ 1,115
Property Operations......................................... -- 207 348 372
------- ------- ------- -------
Operating income.......................................... -- 326 (220) 743
Expenses
Interest.................................................... -- 168 72 354
Depreciation................................................ -- 101 -- 201
------- ------- ------- -------
Total expenses............................................ -- 269 72 555
Net income (loss) from discontinued operations before
gains on sale of real estate............................. -- 57 (292) 188
Gain on sale of operations.................................... -- -- 7,105 --
------- ------- ------- -------
Net income from discontinued operations....................... $ -- $ 57 $ 6,813 $ 188
======= ======= ======= =======
Discontinued operations have not been segregated in the consolidated statement
of cash flows. Therefore, amounts for certain captions will not agree with
respective consolidated statements of operations.
NOTE 7. COMMITMENTS AND CONTINGENCIES
Liquidity. Although management anticipates that IORI will generate excess cash
from commercial operations in 2002 due to increased rental
12
INCOME OPPORTUNITY REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 7. COMMITMENTS AND CONTINGENCIES (Continued)
- -------------------------------------
rates and occupancy at its properties, such excess, however, will not be
sufficient to discharge all of IORI's debt obligations as they mature.
Management intends to refinance real estate and incur additional borrowings
against real estate to meet IORI's cash requirements.
Litigation. IORI is involved in various lawsuits arising in the ordinary course
of business. Except for the Olive litigation, management is of the opinion that
the outcome of these lawsuits will have no material impact on IORI's financial
condition, results of operations or liquidity. See PART II. OTHER INFORMATION,
ITEM 1. "LEGAL PROCEEDINGS."
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Introduction
IORI invests in equity interests in real estate through acquisitions, leases and
partnerships and also invests in mortgage loans. IORI is the successor to a
California business trust organized on December 14, 1984, which commenced
operations on April 10, 1985.
Critical Accounting Policies
Critical accounting policies are those that are both important to the
presentation of IORI's financial condition and results of operations and require
management's most difficult, complex or subjective judgements. IORI's critical
accounting policies relate to the evaluation of impairment of long-lived assets
and the evaluation of the collectibility of accounts and notes receivable.
If events or changes in circumstances indicate that the carrying value of a
rental property to be held and used or land held for development may be
impaired, management performs a recoverability analysis based on estimated
undiscounted cash flows to be generated from the property in the future. If the
analysis indicates that the carrying value is not recoverable from future cash
flows, the property is written down to estimated fair value and an impairment
loss is recognized. If management decides to sell rental properties or land held
for development, management evaluates the recoverability of the carrying amounts
of the assets. If the evaluation indicates that the carrying value is not
recoverable from estimated net sales proceeds, the property
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
Critical Accounting Policies (Continued)
is written down to estimated fair value less costs to sell and an impairment
loss is recognized within income from continuing operations. IORI's estimates of
cash flow and fair values of the properties are based on current market
conditions and consider matters such as rental rates and occupancies for
comparable properties, recent sales data for comparable properties and, where
applicable, contracts or the results of negotiations with purchasers or
prospective purchasers. IORI's estimates are subject to revision as market
conditions and IORI's assessments of them change.
IORI's allowance for doubtful accounts receivable and notes receivable is
established based on analysis of the risk of loss on specific accounts. The
analysis places particular emphasis on past due accounts. Management considers
such information as the nature and age of the receivable, the payment history of
the tenant or other debtor, the financial condition of the tenant or other
debtor and IORI's assessment of its ability to meet its lease or interest
obligations. IORI's estimate of the required allowance, which is reviewed on a
quarterly basis, is subject to revision as these factors change and is sensitive
to the effects of economic and market conditions.
Liquidity and Capital Resources
Cash and cash equivalents at June 30, 2002, were $69,000, compared with $66,000
at December 31, 2001. IORI's principal sources of cash have been, and will
continue to be property operations, proceeds from property sales, financings and
refinancings and partnership distributions. Management anticipates that IORI
will generate excess cash from operations in 2002 due to increased rental
receipts at its properties, however, such excess will not be sufficient to
discharge all of IORI's debt obligations as they mature. Management intends to
selectively sell income producing real estate, refinance real estate and incur
additional borrowings against real estate to meet its cash requirements.
IORI's cash from property operations (rents collected less payments for expenses
applicable to rental income) decreased to $1.5 million in the six months ended
June 30, 2002, from $2.9 million in 2001. Of this decrease, $1.1 million was due
to payment of escrows and taxes and $300,000 was due to decreased occupancies at
IORI's commercial properties.
Interest paid decreased to $1.9 million for the six months ended June 30, 2002,
from $2.7 million paid in 2001. Of this decrease, $269,000
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
was due to the Traveler's land refinancing in 2001, $279,000 was due to the
Daley sale; $147,000 was due to the refinancing of all IORI's apartments and the
remaining amount was due to lower variable interest rates.
During the six months ended June 30, 2002, IORI paid $503,000 to its advisor
compared to $432,000 in the six months ended June 30, 2001. Fees paid to the
advisor are based on gross assets and 7.5% of net income. The increase in
advisory and net income fees was due to IORI's net income during the first
quarter of 2002.
General and administrative expenses paid increased to $613,000 in the six months
ended June 30, 2002, from $436,000 paid in 2001. The increase was due to
increases in insurance and investor relations.
In the first quarter of 2002, IORI sold one office building for $15.5 million,
receiving net cash of $8.1 million after the payoff of existing debt and the
payment of various closing costs. IORI also funded two loans in the first
quarter for $7.1 million.
In the second quarter of 2002, IORI received $500,000 cash on one mortgage note
and $5.4 million cash on its residential property refinancing.
Management reviews the carrying values of IORI's 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. If impairment is found to exist, a
provision for loss is recorded by a charge against earnings. The property review
generally includes selective property inspections, discussions with the manager
of the property, visits to selected properties in the area and a review of the
following: (1) the property's current rents compared to market rents, (2) the
property's expenses, (3) the property's maintenance requirements, and (4) the
property's cash flows.
Results of Operations
IORI had a loss of $889,000 for the three months ended June 30, 2002, and net
income of $4.2 million for the six months ended June 30, 2002, which included
gains on sale of real estate totaling $7.1 million, as compared to net losses of
$732,000 and $1.4 million for the corresponding periods in 2001. Fluctuations in
components of revenue and expense between the 2002 and 2001 periods are
discussed below.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
Results of Operations (Continued)
Rents in the three and six months ended June 30, 2002, were $2.5 million and
$5.2 million as compared to $2.8 million and $5.4 million in the corresponding
periods in 2001. These decreases were due to decreased occupancies at IORI's
commercial properties. IORI's commercial properties in California were the
largest contributors to the decrease where occupancies decreased by 24%, falling
to 63% in 2002 from 87% in 2001. Rents for the remainder of 2002 are expected to
remain constant or decline as market forces in California continue to drive
rents lower.
Property operations expense in the three and six months ended June 30, 2002, was
$1.4 million and $2.7 million, as compared to $1.3 million and $2.6 million in
the corresponding periods in 2001. This increase was due to taxes on IORI's land
and operations expenses remaining constant throughout the commercial and
residential properties. Property operations expense for the remainder of 2002 is
expected to remain constant.
Interest income in the three and six months ended June 30, 2002, was $310,000
and $348,000, as compared to $62,000 and $134,000 in the corresponding periods
in 2001. Interest income for the remainder of 2002 is expected to decrease due
to the payment of one loan in April and another loan maturing in September 2002.
Equity in income of partnerships in the three and six months ended June 30,
2002, was $48,000 and $30,000, as compared to a loss of $6,000 and income of
$3,000 in the corresponding periods in 2001. The increase was primarily due to a
$950,000 lease buy out from a tenant of which $95,000 was IORI's equity portion
at Eton Square Office Building.
Interest expense in the three and six months ended June 30, 2002, was $1.3
million and $2.3 million, as compared to the $1.4 million and $2.7 million in
the corresponding periods in 2001. Of these decreases $108,000 and $299,000 was
due to the Traveler's land loan refinancing in 2001, $234,000 and $399,000 was
due to the apartment loan refinancing and the remaining amount was due to lower
interest rates. Interest expense for the remaining quarters of 2002 is expected
to approximate the second quarter of 2002.
Advisory fee expense in the three and six months ended June 30, 2002, was
$163,000 and $348,000, as compared to $234,000 and $391,000 in the corresponding
periods in 2001. The advisory fee is based on IORI's gross assets. Advisory fees
for the remaining quarters of 2002 are expected to approximate the second
quarter of 2002.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
Results of Operations (Continued)
Net income fee was $411,000 in the six months ended June 30, 2002. The net
income fee is payable to IORI's advisor based on 7.5% of IORI's net income.
General and administrative expense was $352,000 and $637,000 for the three and
six months ended June 30, 2002, as compared to $161,000 and $472,000 in the
corresponding periods in 2001. The three and six month increase was primarily
due to an increase in insurance and investor relations. General and
administrative expense for the remaining quarters of 2002 is expected to
approximate that of the second quarter of 2002.
Tax Matters
As more fully discussed in IORI's 2001 Form 10-K, IORI has elected and, in
management's opinion, qualified, to be taxed as a real estate investment trust
("REIT"), as defined under 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, IORI is required to hold at least 75% of the value of
its total assets in real estate assets, government securities, 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, all as defined in Section 857 of
the Code, on an annual basis to shareholders.
Inflation
The effects of inflation on IORI's operations are not quantifiable. Revenues
from apartment operations tend to fluctuate proportionately with inflationary
increases and decreases in housing costs. Fluctuations in the rate of inflation
also affect the sales value of properties and the ultimate gain to be realized
from property sales. To the extent that inflation affects interest rates,
earnings from short-term investments and the cost of new financings, as well as
the cost of variable interest rate debt, will be affected.
Environmental Matters
Under various federal, state and local environmental laws, ordinances and
regulations, IORI 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
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
Environmental Matters (Continued)
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 for personal injury
associated with such materials.
Management is not aware of any environmental liability relating to the above
matters that would have a material adverse effect on IORI's business, assets or
results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES REGARDING MARKET RISK
At June 30, 2002, IORI's exposure to a change in interest rates on its debt is
as follows:
Weighted Effect of 1%
Average Increase In
Balance Interest Rate Base Rates
------- ------------- ----------
Wholly-owned debt:
Variable rate................ $ 15,487 8.60% $ 155
======== =======
Total decrease in IORI's annual
net income.......................... $ 155
=======
Per share............................ $ .11
=======
___________________________________
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Olive Litigation. In February 1990, IORI, together with National Income Realty
Trust, Continental Mortgage and Equity Trust ("CMET") and Transcontinental
Realty Investors, Inc. ("TCI"), three real estate entities with, at the time,
the same officers, directors or trustees and advisor as IORI, entered into a
settlement (the "Settlement") of a class and derivative action entitled Olive et
al. v. National Income Realty Trust et al., relating to the operation and
management of each of the entities. On April 23, 1990, the Court granted final
approval of the terms of the Settlement. The Settlement was modified in 1994
(the "Modification").
18
ITEM 1. LEGAL PROCEEDINGS (Continued)
On January 27, 1997, the parties entered into an Amendment to the Modification
effective January 9, 1997 (the "Olive Amendment"). The Olive Amendment provided
for the settlement of additional matters raised by plaintiffs' counsel in 1996.
The Court issued an order approving the Olive Amendment on July 3, 1997.
The Olive Amendment provided that IORI's Board retain a management/compensation
consultant or consultants to evaluate the fairness of the BCM advisory contract
and any contract of its affiliates with IORI, CMET and TCI, including, but not
limited to, the fairness to IORI, CMET and TCI of such contracts relative to
other means of administration. In 1998, the Board engaged a
management/compensation consultant to perform the evaluation which was completed
in September 1998.
In 1999, plaintiffs' counsel asserted that the Board did not comply with the
provision requiring such engagement and requested that the Court exercise its
retained jurisdiction to determine whether there was a breach of this provision
of the Olive Amendment. In January 2000, the Board engaged another
management/compensation consultant to perform the required evaluation again.
This evaluation was completed in April 2000 and was provided to plaintiffs'
counsel. The Board believes that any alleged breach of the Olive Amendment has
been fully remedied by the Board's engagement of the second consultant. Although
several status conferences have been held on this matter, there has been no
Court order resolving whether there was any breach of the Olive Amendment.
In October 2000, plaintiffs' counsel asserted that the stock option agreement to
purchase TCI shares, which was entered into by IORI and an affiliate of IORI,
American Realty Investors, Inc. ("ARI"), in October 2000 with Gotham Partners,
breached a provision of the Modification. As a result of this assertion, IORI
assigned all of its rights to purchase the TCI shares under this stock option
agreement to ARI.
The Board believes that all provisions of the Settlement, the Modification and
Olive Amendment terminated on April 28, 1999. However, in September 2000, the
Court ruled that certain provisions of the Modification continue to be effective
after the termination date. This ruling was appealed to the United States Court
of Appeals for the Ninth Circuit by IORI and TCI.
On October 23, 2001, IORI, TCI and ARI jointly announced a preliminary agreement
with the plaintiff's legal counsel for complete settlement of all disputes in
the lawsuit. In February 2002, the court granted final approval of the proposed
settlement. Under the proposal, the pending appeal has been dismissed and ARI
will acquire all of the outstanding
19
ITEM 1. LEGAL PROCEEDINGS (Continued)
shares of IORI and TCI not currently owned by ARI for a cash payment or shares
of ARI preferred stock. ARI will pay $19.00 cash per IORI share and $17.50 cash
per TCI share for the stock held by non-affiliated stockholders. ARI would issue
one share of Series H Preferred Stock with a liquidation value of $21.50 per
share for each share of IORI Common Stock for stockholders who elect to receive
ARI preferred stock in lieu of cash. ARI would issue one share of Series G
Preferred Stock with a liquidation value of $20.00 per share for each share of
TCI Common Stock for stockholders who elect to receive ARI preferred stock in
lieu of cash. Each share of Series H Preferred Stock will be convertible into
2.25 shares of ARI Common Stock during a 75-day period that commences fifteen
days after the date of the first ARI Form 10-Q filing that occurs after the
closing of the merger transaction. Upon the acquisition of the IORI and TCI
shares, IORI and TCI would become wholly-owned subsidiaries of ARI. The
transaction is subject to the negotiation of a definitive merger agreement, and
a vote of the shareholders of all three entities. IORI has the same board as TCI
and the same advisor as TCI and ARI. Earl D. Cecil, a Director of IORI and TCI,
is also a Director for ARI.
ITEM 4. SUBMISSION OF MATTERS TO SECURITY HOLDERS
The annual meeting was held on July 2, 2002, at which meeting stockholders were
asked to consider and vote upon the election of Directors. At the meeting,
stockholders elected the following individuals as Directors:
Shares Voting
--------------------------
Withheld
Director For Authority
-------------------------------------------------------- --------- --------
Henry A. Butler......................................... 1,225,458 9,910
Earl D. Cecil........................................... 1,225,394 9,973
Ted P. Stokely.......................................... 1,225,458 9,910
Martin L. White......................................... 1,225,458 9,910
There were no abstentions or broker non-votes on the election of the Directors.
20
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit
Number Description
------- -----------------------------------------------------------------
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K as follows:
A Current Report on form 8-K/A, dated June 25, 2002, was filed with
respect to Item 5. "Other Events and Regulation FD Disclosures," which
reports the sale of Daley Corporate Center in San Diego, California and
the sale of all of IORI's residential properties.
21
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.
INCOME OPPORTUNITY REALTY INVESTORS,
INC.
Date: August 14, 2002 By: /s/ Ronald E. Kimbrough
---------------------- -----------------------------------
Ronald E. Kimbrough
Executive Vice President and Chief
Financial Officer (Principal
Financial and Accounting Officer
and Acting Principal Executive
Officer)
22
INCOME OPPORTUNITY REALTY INVESTORS, INC.
EXHIBITS TO
QUARTERLY REPORT ON FORM 10-Q
For the Quarter ended June 30, 2002
Exhibit Page
Number Description Number
- -------- ------------------------------------------------- ------
99.1 Certification Pursuant to 18 U.S.C. Section 1350, 24
as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
23