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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 SEPTEMBER 30, 2002
------------------
Commission File Number 1-14784
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
-------------------------------
(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 .
--- ---
Common Stock, $.01 par value 1,438,945
- ---------------------------- ---------------------------------
(Class) (Outstanding at November 1, 2002)
1
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
- -----------------------------
The accompanying Consolidated Financial Statements as of and for the three and
nine month periods ended September 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
September 30, December 31,
2002 2001
----------- ---------
(dollars in thousands,
except per share)
Assets
Real estate held for investment .................................................... $ 82,052 $ 95,190
Less - accumulated depreciation .................................................... (7,082) (7,875)
----------- ---------
74,970 87,315
Notes and interest receivable (including $5,372 in 2002
from related parties) ............................................................ 5,372 505
Allowance for loss ................................................................. (767) --
----------- ---------
4,605 505
Investment in real estate partnerships ............................................. 158 142
Cash and cash equivalents .......................................................... 131 66
Other assets (including $7,782 in 2002 from affiliates) ............................ 11,864 3,805
----------- ---------
$ 91,728 $ 91,833
=========== =========
Liabilities and Stockholders' Equity
Liabilities
Notes and interest payable ......................................................... $ 51,482 $ 54,426
Other liabilities (including $252 in 2002 and $593 in
2001 to affiliates) .............................................................. 2,079 2,185
----------- ---------
53,561 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 deficit ................................................................ (25,306) (28,251)
----------- ---------
38,167 35,222
----------- ---------
$ 91,728 $ 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 Nine Months
Ended September 30, Ended September 30,
--------------------------- --------------------------
2002 2001 2002 2001
---------- --------- ---------- ---------
(dollars in thousands, except per share)
Property revenue
Rents ..................................................... $ 2,562 $ 2,488 $ 7,473 $ 7,679
Property expense
Property operations ....................................... 1,610 1,993 4,152 4,470
---------- --------- ---------- ---------
Operating income .......................................... 952 495 3,321 3,209
Other income
Interest .................................................. 185 8 533 142
Equity in income (loss) of equity
partnerships ............................................ 60 (30) 91 (27)
---------- --------- ---------- ---------
245 (22) 624 115
Other expense
Interest .................................................. 1,101 1,297 3,355 3,868
Depreciation .............................................. 431 466 1,339 1,382
Advisory fee to affiliate ................................. 197 179 544 570
Net income fee to affiliate ............................... -- -- 411 --
Provision for asset impairment ............................ 336 -- 336 --
Provision for loss on note receivable ..................... -- -- 767 --
General and administrative ................................ 291 377 929 849
---------- --------- ---------- ---------
2,356 2,319 7,681 6,669
---------- --------- ---------- ---------
Net loss from continuing operations ......................... (1,159) (1,846) (3,736) (3,345)
Discontinued operations:
Income (loss) from operations ............................. (82) 97 (424) 147
Gain on sale of operations ................................ -- -- 7,105 --
---------- --------- ---------- ---------
(82) 97 6,681 147
---------- --------- ---------- ---------
Net income (loss) ........................................... $ (1,241) $ (1,749) $ 2,945 $ (3,198)
========== ========= ========== =========
Earnings (loss) per share
Net loss from continuing operations ....................... $ (.80) $ (1.22) $ (2.60) $ (2.21)
Discontinued operations ................................... (.06) .06 4.64 .10
---------- --------- ---------- ---------
Net income (loss) ....................................... $ (.86) $ (1.16) $ 2.04 $ (2.11)
========== ========= ========== =========
Weighted average Common shares used
in computing earnings per share ........................... 1,438,945 1,508,331 1,438,945 1,512,119
========== ========= ========== =========
The accompanying notes are an integral part of these Consolidated Financial
Statements.
3
INCOME OPPORTUNITY REALTY INVESTORS, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
For the Nine Months Ended September 30, 2002
Common Stock
----------------------- Paid-in Accumulated Stockholders'
Shares Amount Capital Deficit Equity
---------- -------- --------- ----------- -------------
(dollars in thousands)
Balance, January 1, 2002 ............................. 1,438,945 $ 14 $ 63,459 $ (28,251) $ 35,222
Net income ........................................... -- -- -- 2,945 2,945
---------- -------- --------- ----------- -------------
Balance, September 30, 2002 .......................... 1,438,945 $ 14 $ 63,459 $ (25,306) $ 38,167
========== ======== ========= =========== =============
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 Nine Months
Ended September 30,
----------------------------
2002 2001
-------- --------
(dollars in thousands)
Cash flows from Operating Activities
Rents collected .............................................................. $ 8,218 $ 9,578
Payments for property operations ............................................. (5,231) (4,969)
Interest collected ........................................................... 291 126
Interest paid ................................................................ (3,117) (4,112)
Advisory and net income fee to affiliate ..................................... (699) (520)
General and administrative expenses paid ..................................... (910) (1,479)
Distributions from equity partnerships' operating cash flow .................. 79 18
Other ........................................................................ -- 17
-------- --------
Net cash used in operating activities ...................................... (1,369) (1,341)
Cash Flows from Investing Activities
Collections on notes receivable .............................................. 2,500 1,000
Funding of notes receivable (including $5,109 in 2002
to related parties) ....................................................... (7,109) --
Funding of equity partnerships ............................................... (5) (25)
Real estate improvements ..................................................... (476) (1,316)
Proceeds from sale of real estate ............................................ 18,141 --
Advance to affiliate ......................................................... (5,293) --
Advances from/(payments to) advisor .......................................... (2,488) 4,957
-------- --------
Net cash provided by investing activities .................................. 5,270 4,616
Cash Flows from Financing Activities
Payments on notes payable .................................................... (26,083) (5,010)
Proceeds from notes payable .................................................. 23,152 5,000
Deferred financing costs ..................................................... (905) (124)
Repurchase of Common Stock ................................................... -- (1,314)
-------- --------
Net cash used in financing activities ...................................... (3,836) (1,448)
Net increase in cash and cash equivalents ...................................... 65 1,827
Cash and cash equivalents, beginning of period ................................. 66 2,087
-------- --------
Cash and cash equivalents, end of period ....................................... $ 131 $ 3,914
======== ========
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 Nine Months
Ended September 30,
----------------------
2002 2001
-------- --------
(dollars in thousands)
Reconciliation of net income (loss) to net cash
used in operating activities
Net income (loss) .......................................................... $ 2,945 $ (3,198)
Adjustments to reconcile net income (loss) to net cash
used in operating activities
Depreciation and amortization ............................................ 1,446 1,792
Gain on sale of real estate .............................................. (7,105) --
Equity (income) loss of equity partnerships .............................. (91) 27
Distributions from equity partnerships' operating cash flow .............. 79 18
Provision for asset impairment ........................................... 336 --
Provision for loss on note receivable .................................... 767 --
Increase in interest receivable .......................................... (259) --
(Increase) decrease in other assets ...................................... 606 (856)
Increase in interest payable ............................................. 13 132
(Decrease) increase in other liabilities ................................. (106) 744
-------- --------
Net cash used in operating activities ................................. $ (1,369) $ (1,341)
======== ========
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 nine month period ended September 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"). Dollar amounts in
tables are in thousands, except per share amounts.
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 related 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.
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.
7
INCOME OPPORTUNITY REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 1. BASIS OF PRESENTATION (Continued)
- -----------------------------
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.
In October 2002, the FASB issued Financial Accounting Standards No. 147,
"Acquisition of Certain Financial Institutions" ("SFAS No. 147") which clarifies
the accounting treatment for acquisitions of financial institutions. In
addition, the Statement amends SFAS Statement No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," to include in its scope long-term
customer-relationship intangible assets of financial institutions such as
depositor- and borrower-relationship intangible assets and credit cardholder
intangible assets. SFAS No. 147 is effective October 1, 2002. IORI's adoption of
SFAS No. 147 is not expected to have a material impact on IORI's financial
statements.
NOTE 2. REAL ESTATE
- -------------------
In 2002, IORI sold the following properties:
Sales Net Cash Debt Gain
Property Location Sq.Ft. Price Received Discharged on Sale
- ---------------------- -------------- -------------- --------- -------- ---------- --------
First Quarter
Office Building
Daley Corporate Center San Diego, CA 124,059 Sq.Ft. $ 15,500 $ 7,820 $ 6,618 $ 7,105
Third Quarter
Office Building
Westlake Village Westlake, CA 45,500 Sq.Ft. 3,730 767 2,728 --
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.
8
INCOME OPPORTUNITY REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 3. NOTES AND INTEREST RECEIVABLE (Continued)
- -------------------------------------
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 was secured by a second lien on a retail center in Montgomery County,
Texas. The note receivable bore interest at 16.0% per annum, required 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, with IORI receiving $8,500 as an
extension fee. Also in July 2002, IORI received a $500,000 principal paydown on
the note. In August 2002, the note was paid off including accrued but unpaid
interest.
In April 2002, a mortgage loan with a principal balance of $500,000 was paid
off, including accrued but unpaid interest.
NOTE 4. OTHER ASSETS
- --------------------
Related Party. From time-to-time, IORI and its affiliates and related parties
have made advances to each other to fund their respective operations, which
generally have not had specific repayment terms and have been reflected in
IORI's financial statements as other assets. At September 30, 2002, IORI had
receivables of $2.5 million and $5.3 million from Basic Capital Management, Inc.
("BCM") and TCI, respectively, and payables of $252,000 to GS Realty Services,
Inc.
NOTE 5. 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.
9
INCOME OPPORTUNITY REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 5. NOTES AND INTEREST PAYABLE (Continued)
- ----------------------------------
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.
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 6. 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 $245,000 and $624,000 for the three
and nine months ended September 30, 2002 and a loss of $22,000 and income of
$115,000 in the three and nine months ended September 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 $906,000 and $3.4 million for the three and nine months ended
September 30, 2002, and $459,000 and $1.3 million for the three and nine months
ended September 30, 2001. Excluded from operating segment assets are assets of
$16.8 million at September 30, 2002, and $7.1 million at September 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 nine months ended September 30, 2002 and 2001, and each segment's assets at
September 30.
Three Months Ended Commercial
September 30, 2002 Properties Apartments Land Total
- ----------------------------------------------- ---------- ---------- --------- ----------
Rents ......................................... $ 1,187 $ 1,375 $ -- $ 2,562
Property operating expenses ................... 656 872 82 1,610
---------- ---------- --------- ----------
Operating income (loss) ....................... $ 531 $ 503 $ (82) $ 952
========== ========== ========= ==========
Interest ...................................... $ 389 $ 338 $ 374 $ 1,101
Depreciation .................................. 313 118 -- 431
Real estate improvements ...................... 6 -- 153 159
Assets ........................................ 28,808 21,241 24,921 74,970
10
INCOME OPPORTUNITY REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 6. OPERATING SEGMENTS (Continued)
- --------------------------
Commercial
Property Sales: Properties Total
---------- ----------
Sales price...................................... $ 3,730 $ 3,730
Cost of sale..................................... 3,730 3,730
---------- ----------
Gain on sale..................................... $ -- $ --
========== ==========
Nine Months Ended Commercial
September 30, 2002 Properties Apartments Land Total
------------------- ---------- ---------- -------- ----------
Rents............................................ $ 3,450 $ 4,023 $ -- $ 7,473
Property operating expenses...................... 1,827 2,102 223 4,152
---------- ---------- -------- ----------
Operating income (loss).......................... $ 1,623 $ 1,921 $ (223) $ 3,321
========== ========== ======== ==========
Interest......................................... $ 1,177 $ 1,148 $ 1,030 $ 3,355
Depreciation..................................... 969 370 -- 1,339
Real estate improvements......................... 47 -- 429 476
Assets........................................... 28,808 21,241 24,921 74,970
Commercial
Property Sales: Properties Total
---------- ----------
Sales prices..................................... $ 19,230 $ 19,230
Cost of sales.................................... 12,125 12,125
---------- ----------
Gain on sale..................................... $ 7,105 $ 7,105
========== ==========
Three Months Ended Commercial
September 30, 2001 Properties Apartments Land Total
------------------- ---------- ---------- -------- ----------
Rents............................................ $ 1,282 $ 1,206 $ -- $ 2,488
Property operating expenses...................... 718 718 557 1,993
---------- ---------- -------- ----------
Operating income (loss).......................... $ 564 $ 488 $ (557) $ 495
========== ========== ======== ==========
Interest......................................... $ 451 $ 321 $ 525 $ 1,297
Depreciation..................................... 337 129 -- 466
Real estate improvements......................... 168 -- 329 497
Assets........................................... 41,626 21,738 22,417 85,781
Nine Months Ended Commercial
September 30, 2001 Properties Apartments Land Total
------------------- ---------- ---------- -------- ----------
Rents............................................ $ 3,815 $ 3,721 $ 143 $ 7,679
Property operating expenses...................... 1,907 1,994 569 4,470
---------- ---------- -------- ----------
Operating income (loss).......................... $ 1,908 $ 1,727 $ (426) $ 3,209
========== ========== ======== ==========
Interest......................................... $ 1,322 $ 1,066 $ 1,480 $ 3,868
Depreciation..................................... 997 385 -- 1,382
Real estate improvements......................... 987 -- 329 1,316
Assets........................................... 41,626 21,738 22,417 85,781
NOTE 7. PROVISION FOR ASSET IMPAIRMENT
- --------------------------------------
For the three and nine months ended September 30, 2002, IORI recorded an asset
impairment of $336,000, representing the write down of the Westlake Village
Office Building in Westlake, California to its
11
INCOME OPPORTUNITY REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 7. PROVISION FOR ASSET IMPAIRMENT (Continued)
- --------------------------------------
estimated fair value. The property was sold in September 2002 for $3.8 million.
IORI's basis in the Westlake Village Office Building was $3.7 million and
estimated costs to sell the property were $85,000.
NOTE 8. ADVISORY FEES, PROPERTY MANAGEMENT, ETC.
- ------------------------------------------------
Revenue, fees and cost reimbursements to BCM and its affiliates for the three
and nine months ended:
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
--------------------- -----------------------
2002 2001 2002 2001
-------- -------- --------- ---------
Fees
Advisory...................................................... $ 197 $ 179 $ 544 $ 570
Net income.................................................... -- -- 411 --
Real estate brokerage......................................... 122 -- 397 3,043
Property and construction management and leasing
commissions*................................................. 75 89 171 243
-------- -------- --------- ---------
$ 394 $ 268 $ 1,523 $ 3,856
======== ======== ========= =========
Cost reimbursements.............................................. $ 32 $ 62 $ 189 $ 234
======== ======== ========= =========
- ---------------------
* Net of property management fees paid to subcontractors, other than GS Realty,
Inc., which is owned by an affiliate of BCM.
NOTE 9. DISCONTINUED OPERATIONS
- -------------------------------
Effective January 1, 2002, IORI adopted Financial Accounting Standards No. 144,
"Accounting for the Impairment or Disposal of Long-Lived 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 nine months ended September 30, 2002 and 2001, income from
discontinued operations relates to two properties that IORI sold
12
INCOME OPPORTUNITY REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 9. COMMITMENTS AND CONTINGENCIES (Continued)
- -------------------------------------
during 2002. The following table summarizes revenue and expense information for
the properties sold and held for sale.
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
Revenue 2002 2001 2002 2001
--------- --------- --------- --------
Rental........................................................... $ 97 $ 732 $ 515 $ 2,080
Property Operations.............................................. 107 280 638 822
--------- --------- --------- --------
Operating income (loss)........................................ (10) 452 (123) 1,258
Expenses
Interest......................................................... 38 208 194 701
Depreciation..................................................... 34 147 107 410
--------- --------- --------- --------
Total expenses................................................. 72 355 301 1,111
Net income (loss) from discontinued operations before
gains on sale of real estate..................................... (82) 97 (424) 147
Gain on sale of operations......................................... -- -- 7,105 --
--------- --------- --------- --------
Net income (loss) from discontinued operations..................... $ (82) $ 97 $ 6,681 $ 147
========= ========= ========= ========
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 10. COMMITMENTS AND CONTINGENCIES
- ----------------------------------------
Liquidity. Although management anticipates that IORI will generate excess cash
from commercial operations in 2002 due to increased rental rates and occupancy
at its properties, such excess, however, will not be sufficient to discharge all
of IORI's debt obligations as they mature. IORI has $19.1 million in debt due
within one year. Management will need to refinance or sell 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.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
---------------------------------------------------------------
RESULTS OF OPERATIONS (Continued)
---------------------
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 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. In the third quarter of 2002, IORI recognized asset impairments of
$336,000.
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 September 30, 2002, were $131,000, 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
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- -----------------------------------------------------------------------
RESULTS OF OPERATIONS (Continued)
---------------------
Liquidity and Capital Resources (Continued)
- -------------------------------
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 $3.0 million in the nine months ended
September 30, 2002, from $4.6 million in 2001. Of this decrease, $1.4 million
was due to the sale of two commercial properties in 2002 and $364,000 was due to
decreased occupancies at IORI's commercial properties. This decrease was offset
by increases of $153,000 due to increases in occupancies at IORI's apartment
properties.
Interest collected increased to $291,000 for the nine months ended September 30,
2002, from $126,000 in 2001. The increase was due to IORI funding two notes in
2002.
Interest paid decreased to $3.1 million for the nine months ended September 30,
2002, from $4.1 million paid in 2001. Of this decrease, $410,000 was due to the
Traveler's land refinancing in 2001, $442,000 was due to the sale of two
commercial properties in 2002 and the remaining amount was due to lower variable
interest rates.
During the nine months ended September 30, 2002, IORI paid $699,000 to its
advisor compared to $520,000 paid in 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 decreased to $910,000 in the nine
months ended September 30, 2002, from $1.5 million paid in 2001. The decrease
was due to decreases in state and federal taxes.
Collections on notes receivable increased to $2.5 million for the nine months
ended September 30, 2002, from $1.0 million collected in 2001. IORI received
$2.5 million cash from the payments in full of two mortgage notes in 2002
compared to a principal paydown of $1.0 million in 2001. IORI also funded notes
receivable of $7.1 million for the nine months ended September 30, 2002. IORI
does not expect to receive any collections from its remaining note receivable of
$5.1 million from the Rosedale note receivable in the remaining quarter of
2002.
In the nine months ended September 30, 2002, IORI sold two office buildings for
$19.2 million, receiving net cash of $8.6 million after the pay off of existing
debt and the payment of various closing costs.
Payments of notes payable increased to $26.0 million for the nine months ended
September 30, 2002, from $5.0 million paid in 2001. Of this increase, $16.1
million was due to the Metra transaction, $9.3 million was due to the sale of
two commercial properties, and $655,000 was due to normal principal payments in
2002. This increase was offset by a decrease of $5.0 million on a refinancing of
an office building in 2001.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- -----------------------------------------------------------------------
RESULTS OF OPERATIONS (Continued)
---------------------
Liquidity and Capital Resources (Continued)
- -------------------------------
Proceeds from notes payables increased to $23.2 million for the nine months
ended September 30, 2002, from $5.0 million received in 2001. This increase was
due to $23.2 million from the Metra transaction in 2002. This increase was
offset by decreases of $5.0 million from the refinancing of an office building
in 2001.
Advances to affiliates and advisor increased to $7.8 million for the nine months
ended September 30, 2002, from $5.0 million received in 2001. Of this increase,
$5.3 million and $12.8 million was to fund operations for TCI and BCM,
respectively.
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 $1.2 million for the three months ended September 30, 2002,
and net income of $2.9 million for the nine months ended September 30, 2002,
which included gains on sale of real estate totaling $7.1 million, as compared
to net losses of $1.7 million and $3.2 million for the corresponding periods in
2001. Fluctuations in components of revenue and expense between the 2002 and
2001 periods are discussed below.
Rents in the three and nine months ended September 30, 2002, were $2.6 million
and $7.5 million as compared to $2.5 million and $7.7 million in the
corresponding periods in 2001. The increase for the quarter was due to increases
in rents and occupancies from IORI's apartments of $169,000, offset by a
decrease of $95,000 from the commercial properties due to a decrease in
occupancies at the commercial properties. The nine month decrease was due to
decreased occupancies at the commercial properties, offset by increases in
occupancies for the apartments. Commercial property net rents decreased by
$365,000 as occupancies fell to 71% in 2002 from 82% in 2001. Rents for the
remainder of 2002 are expected to remain constant or decline as market forces
continue to drive rents lower.
Property operations expense in the three and nine months ended September 30,
2002, was $1.6 million and $4.2 million, as compared to $2.0 million and $4.5
million in the corresponding periods in 2001. This decrease was due to decreased
taxes on IORI's land and operations expenses
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- -----------------------------------------------------------------------
RESULTS OF OPERATIONS (Continued)
---------------------
Results of Operations (Continued)
- ---------------------
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 nine months ended September 30, 2002, was
$185,000 and $533,000, as compared to $8,000 and $142,000 in the corresponding
periods in 2001. This increase was due to the funding of two loans in 2002.
Interest income for the remainder of 2002 is expected to decrease due to the
payment of two loans in 2002.
Equity in income of partnerships in the three and nine months ended September
30, 2002, was $60,000 and $91,000, as compared to losses of $30,000 and $27,000
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 nine months ended September 30, 2002, was $1.1
million and $3.4 million, as compared to the $1.3 million and $3.9 million in
the corresponding periods in 2001. Of these decreases $152,000 and $451,000 was
due to the Traveler's land loan refinancing in 2001, and the remaining amount
was due to lower interest rates. Interest expense for the remaining quarter of
2002 is expected to approximate the third quarter of 2002.
Advisory fee expense in the three and nine months ended September 30, 2002, was
$197,000 and $544,000, as compared to $179,000 and $570,000 in the corresponding
periods in 2001. The advisory fee is based on IORI's gross assets. Advisory fees
for the remaining quarter of 2002 is expected to approximate the third quarter
of 2002.
Net income fee was $411,000 in the nine months ended September 30, 2002. The net
income fee is payable to IORI's advisor based on 7.5% of IORI's net income.
For the three and nine months ended September 30, 2002, IORI recorded an asset
impairment of $336,000, representing the write down of the Westlake Village
Office Building in Westlake, California to its estimated fair value. The
property was sold in September 2002 for $3.8 million. IORI's basis in the
Westlake Village Office Building was $3.7 million and estimated costs to sell
the property were $85,000.
General and administrative expense was $291,000 and $928,000 for the three and
nine months ended September 30, 2002, as compared to $377,000 and $849,000 in
the corresponding periods in 2001. The three month decrease was primarily due to
a decrease in consultant fees. The nine month increase was primarily due to an
increase in insurance and investor relations offset by a decrease in
consultants. General and administrative expense for the remaining quarter of
2002 is expected to approximate that of the third quarter of 2002.
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- -----------------------------------------------------------------------
RESULTS OF OPERATIONS (Continued)
---------------------
Related Party Transactions
- --------------------------
Historically, IORI, ARI, BCM and TCI have each engaged in and may continue to
engage in business transactions, including real estate partnerships with related
parties. Management believes that all of the related party transactions
represented the best investments available at the time and were at least as
advantageous to IORI, ARI, BCM and TCI as could have been obtained from
unrelated third parties.
Property Transactions
- ---------------------
In January 2002, IORI purchased 100% of the outstanding common shares of
Rosedale Corporation from ARI, for $5.1 million. See NOTE 3. "NOTES AND INTEREST
RECEIVABLE." The purchase price was determined based upon the market value of
the property exchanged, using a market rate multiple of net operating income
("cap rate") of 7.0%. The business purpose of the transaction was for IORI to
make an equity investment in Rosedale anticipating a profitable return.
In February 2002, IORI purchased a $2.0 million senior participation interest in
a loan from TCI. See NOTE 3. "NOTES AND INTEREST RECEIVABLE." Management
determined that IORI could benefit from the favorable interest rate payments on
the note.
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.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- -----------------------------------------------------------------------
RESULTS OF OPERATIONS (Continued)
---------------------
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 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 September 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 ..................... $ 12,650 9.26% $ 127
======== =======
Total decrease in IORI's annual
net income ........................ $ 127
=======
Per share ........................... $ .09
=======
ITEM 4. CONTROLS AND PROCEDURES
- -------------------------------
(a) Within the 90 days prior to the date of this report, IORI carried out an
evaluation, under the supervision and with the participation of IORI's
management, including IORI's Acting Principal Executive Officer and
principal accounting officer, of the effectiveness of the design and
operation of IORI's disclosure controls and procedures pursuant to Exchange
Act Rule 13a-14. Based upon the evaluation, IORI's Acting Principal
Executive Officer and principal accounting officer concluded that IORI's
disclosure controls and procedures are effective in timely alerting him to
material information relating to IORI (including its consolidated
subsidiaries) required to be included in IORI's periodic SEC filings.
(b) There have been no significant changes in IORI's internal controls or in
other factors that could significantly affect IORI's internal controls
subsequent to the date IORI carried out this evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
19
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
- -------------------------
On October 23, 2001, IORI, TCI and ARI jointly announced a preliminary agreement
with the plaintiff's legal counsel of a class and derivative action entitled
Olive et al. v. National Income Realty Trust et al. for complete settlement of
all disputes in the lawsuit. For further information refer to ITEM 1. "LEGAL
PROCEEDINGS" included in IORI's second quarter Report on Form 10-Q for the six
months ended June 30, 2002.
On November 7, 2002, ARI announced that it intends to commence, through
subsidiaries, a tender offer for shares of common stock of TCI and IORI. The
price per share to be paid will be $17.50 for TCI shares and $19.00 for IORI
shares. ARI expects to commence the tender offer on or before November 15, 2002.
The tender offers are being made to cure a default under the settlement
resulting from ARI's failure to timely complete the SEC review process of the
registration statement for the proposed mergers with TCI and IORI. ARI will
defer further action on the mergers, pending completion of the tender offers.
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:
None.
20
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: November 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)
21
Certification
I, Ronald E. Kimbrough, Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer and Acting Principal Executive
Officer) of Income Opportunity Realty Investors, Inc. ("IORI"), certify that:
1. I have reviewed this quarterly report on Form 10-Q of IORI;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. I am responsible for establishing and maintaining internal controls and
procedures and have:
a. designed such internal controls to insure that material information
relating to IORI and its consolidated subsidiaries is made known to me
by others within those entities, particularly for the periods
presented in this quarterly report;
b. evaluated the effectiveness of IORI's internal controls as of a date
within 90 days prior to the filing date of this quarterly report; and
c. presented in this quarterly report my conclusions about the
effectiveness of the disclosure controls and procedures based on a
date within 90 days prior to the filing date of this quarterly report;
5. I have disclosed to IORI's auditors and Audit Committee of the Board of
Directors (or persons fulfilling the equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect IORI's ability to record,
process, summarize, and report financial data and have identified for
IORI's auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in IORI's internal controls; and
6. I have indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors that could
significantly affect internal controls subsequent to the date of my most
recent evaluation, including corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 14, 2002 /s/ Ronald E. Kimbrough
------------------------ -----------------------------------
Ronald E. Kimbrough
Executive Vice President
and Chief Financial Officer
(Principal Financial and
Accounting Officer and
Acting Principal Executive Officer)
23
INCOME OPPORTUNITY REALTY INVESTORS, INC.
EXHIBITS TO
QUARTERLY REPORT ON FORM 10-Q
For the Quarter ended September 30, 2002
Exhibit Page
Number Description Number
- ------- ----------------------------------------------------------------- ------
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 25
24