10-Q 1 d10q.txt FORM 10-Q 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 MARCH 31, 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 April 26, 2002) 1 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS ----------------------------- The accompanying Consolidated Financial Statements have not been audited by independent certified public accountants, but in the opinion of the management of 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
March 31, December 31, 2002 2001 ---------- ------------ (dollars in thousands, Assets except per share) Real estate held for investment................................................. $ 86,319 $ 95,190 Less - accumulated depreciation................................................. (6,745) (7,875) ---------- ------------ 79,574 87,315 Notes and interest receivable (including $5,109 in 2002 from related parties)............................................................. 7,614 505 Allowance for loss.............................................................. (767) -- ---------- ------------ 6,847 505 Investment in real estate partnerships.......................................... 103 142 Cash and cash equivalents....................................................... 59 66 Other assets (including $108 in 2002 from affiliates)........................... 3,173 3,805 ---------- ------------ $ 89,756 $ 91,833 ========== ============ Liabilities and Stockholders' Equity Liabilities Notes and interest payable...................................................... $ 47,552 $ 54,426 Other liabilities (including $447 in 2002 and $593 in 2001 to affiliates)............................................................... 1,909 2,185 ---------- ------------ 49,461 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..................... (23,178) (28,251) ---------- ------------ 40,295 35,222 ---------- ------------ $ 89,756 $ 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 Ended March 31, -------------------------- 2002 2001 -------------------------- (dollars in thousands, except per share) Property revenue Rents........................................................................ $ 2,800 $ 3,251 Property expense Property operations (including $51 in 2002 and $74 in 2001 to affiliates and related parties)................................... 1,641 1,479 ---------- ---------- Operating income........................................................ 1,159 1,772 Other income Interest..................................................................... 37 72 Equity in income/(loss) of equity partnerships............................... (17) 9 Gain on sale of real estate.................................................. 7,105 -- ---------- ---------- 7,125 81 Other expense Interest..................................................................... 1,062 1,517 Depreciation................................................................. 500 585 Advisory fee to affiliate.................................................... 186 157 Net income fee to affiliate.................................................. 411 -- Provision for loss........................................................... 767 -- General and administrative (including $81 in 2002 and $93 in 2001 to affiliates and related parties)................................ 285 311 ---------- ---------- 3,211 2,570 ---------- ---------- Net income (loss)............................................................... $ 5,073 $ (717) ========== ========== Earnings (loss) per share Net income (loss)............................................................ $ 3.53 $ (.47) ========== ========== Weighted average Common shares used in computing earnings per share.................................................................... 1,438,945 1,514,045 ========== ==========
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 Three Months Ended March 31, 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.................... -- -- -- 5,073 5,073 ------------ --------- ---------- -------------- ------------- Balance, March 31, 2002....... 1,438,945 $ 14 $ 63,459 $ (23,178) $ 40,295 ============ ========= =========== ============== ===========
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 Three Months Ended March 31, ------------------------------- 2002 2001 ----------- ---------- (dollars in thousands) Cash flows from Operating Activities Rents collected................................................................. $ 2,842 $ 3,119 Payments for property operations (including $51 in 2002 and $74 in 2001 to affiliates and related parties)..................................................................... (1,682) (2,633) Interest collected.............................................................. 8 72 Interest paid................................................................... (974) (1,124) Advisory and net income fee to affiliate........................................ (186) (157) General and administrative expenses paid (including $81 in 2002 and $93 in 2001 to affiliates)................................... (361) (317) Distributions from equity partnerships' operating cash flow.................................................................... 25 -- Other........................................................................... 30 -- ----------- ---------- Net cash used in operating activities..................................... (298) (1,040) Cash Flows from Investing Activities Funding of notes receivable (including $7,109 in 2002 to related parties).......................................................... (7,109) -- Funding of equity partnerships.................................................. (4) (1) Real estate improvements........................................................ (229) (364) Proceeds from sale of real estate............................................... 14,575 -- ------------ ---------- Net cash provided by (used in) investing activities............................................................. 7,233 (365) Cash Flows from Financing Activities Payments on notes payable....................................................... (6,834) (216) Proceeds from notes payable..................................................... -- 2,974 Deferred financing costs........................................................ -- (76) Advances from/payments (to) advisor............................................. (108) 1,953 ----------- ---------- Net cash (used in) provided by financing activities............................................................. (6,942) 4,635 Net increase in cash and cash equivalents.......................................... (7) 3,230 Cash and cash equivalents, beginning of period..................................... 66 2,087 ----------- ---------- Cash and cash equivalents, end of period........................................... $ 59 $ 5,317 =========== ==========
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 Three Months Ended March 31, ------------------------------ 2002 2001 ----------- ---------- (dollars in thousands) Reconciliation of net income (loss) to net cash used in operating activities Net income (loss).................................................. $ 5,073 $ (717) Adjustments to reconcile net income (loss) to net cash used in operating activities Depreciation and amortization................................... 500 585 Gain on sale of real estate..................................... (7,105) -- Loss of equity partnerships..................................... 17 (9) Distributions from equity partnerships' operating cash flow.................................................... 25 -- Provision for loss.............................................. (767) -- (Increase) decrease in other assets............................. 1,644 (1,406) Increase in interest payable.................................... 40 309 Increase in other liabilities................................... 275 198 ----------- ---------- Net cash used in operating activities........................ $ (298) $ (1,040) ============ ==========
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 three month period ended March 31, 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. 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 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. 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 7 INCOME OPPORTUNITY REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 3. NOTES 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. 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 the second quarter of 2002, IORI sold all of its residential properties to 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, the 114 unit Sinclair, located in Midland, Texas, and the 106 unit Treehouse, located in San Antonio, Texas. Two of the members of Metra are Third Millennium Partners, LLC and Innovo Realty, Inc., a subsidiary of Innovo Group, Inc. ("Innovo"). Joseph Mizrachi, a director for ARI, a related party, has a beneficial interest in Third Millennium Partners, LLC and owns 15.5% 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 including $262,000 in brokerage commissions to Third Millenium. Due to IORI's relationship with ARI and Mr. Mizrachi, management has determined to treat this sale as a refinancing transaction. 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 $4.0 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. The Preferred Shares have a mandatory redemption feature, and are redeemable from the cash proceeds received by Innovo from the operation 8 INCOME OPPORTUNITY REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 4. NOTES AND INTEREST PAYABLE (Continued) ----------------------------------------- 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. 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 $20,000 for the first quarter of 2002, and $81,000 in the first quarter of 2001. Expenses that are not reflected in the segments are general and administrative expenses, advisory fees, provision for losses and net income fees which totaled $1.6 million for the first quarter 2002, and $468,000 for the first quarter of 2001. Excluded from operating segment assets are assets of $10.2 million at March 31, 2002, and $12.2 million at March 31, 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 months ended March 31, and each segment's assets at March 31.
Three Months Ended Commercial March 31, 2002 Properties Apartments Land Total ------------------------------- ---------- ---------- ------- --------- Rents.......................................... $ 1,491 $ 1,309 $ -- $ 2,800 Property operating expenses.................... 1,027 550 64 1,641 --------- ---------- ------- --------- Operating income............................... 464 759 (64) 1,159 Depreciation................................... 373 127 -- 500 Interest....................................... 520 260 282 1,062 Real estate improvements....................... 41 -- 188 229 Assets......................................... 33,411 21,483 24,680 79,574 Commercial Property Sale: Properties Total ---------- --------- Sale price..................................... $ 15,500 $ 15,500 Cost of sale................................... 8,395 8,395 --------- --------- Gain on sale................................... $ 7,105 $ 7,105 ========= =========
9 INCOME OPPORTUNITY REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued NOTE 5. OPERATING SEGMENTS (Continued) ---------------------------------
Three Months Ended Commercial March 31, 2001 Properties Apartments Land Total ---------------------------------------------- ---------- ---------- ---------- --------- Rents......................................... $ 1,892 $ 1,216 $ 143 $ 3,251 Property operating expenses................... 839 639 1 1,479 --------- --------- ---------- --------- Operating income.............................. $ 1,053 $ 577 $ 142 $ 1,772 ========= ========= ========== ========= Depreciation.................................. $ 457 $ 128 $ -- $ 585 Interest...................................... 675 369 473 1,517 Real estate improvements...................... 364 -- -- 364 Assets........................................ 39,170 21,994 24,892 86,056
NOTE 6. 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 sold all of its residential properties and 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. Liquidity and Capital Resources ------------------------------- Cash and cash equivalents at March 31, 2002, were $59,000 compared with $66,000 at December 31, 2001. IORI's principal sources of cash have been, and will continue to be, from property operations, proceeds from 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND ------------------------------------------------------------------------- RESULTS OF OPERATIONS (Continued) --------------------- Liquidity and Capital Resources (Continued) ------------------------------- property sales, financings and refinancings and partnership distributions. Although management anticipates that IORI will generate excess cash from 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. 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 flow from property operations (rents collected less payments for expenses applicable to rental income) increased to $1.2 million in the first quarter of 2002, from $486,000 in 2001. Of this increase, $1.2 million was due to the payment of property taxes in the first quarter of 2001 and an increase of $180,000 was due to increased occupancy at IORI's apartments. This increase was offset by a decrease of $570,000 from the sale of one commercial property in 2002 and a decrease of $20,000 and $62,000 due to decreased occupancies at IORI's commercial properties and an increase in real estate taxes on IORI's land. Interest paid decreased to $1.0 million for the first quarter of 2002 from $1.1 million in 2001. The decrease was due to the sale of one commercial property in 2002. During the first quarter of 2002, IORI paid $186,000 to its advisor compared to $157,000 in the first quarter of 2001. Fees paid to the advisor are based on gross assets. The increase in advisory fees was due to IORI's increase in gross assets. General and administrative expenses paid increased to $361,000 in the first quarter of 2002, from $317,000 paid in 2001. The increase was due to increases in insurance. 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 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND -------------------------------------------------------------------------- RESULTS OF OPERATIONS (Continued) --------------------- Liquidity and Capital Resources (Continued) ------------------------------- 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 --------------------- For the first quarter of 2002, IORI had net income of $5.1 million, as compared to a net loss of $717,000 for the corresponding period in 2001, which included gains on sale of on real estate totaling $7.1 million in 2002. Fluctuations in components of revenue and expense between the 2002 and 2001 periods are discussed below. Rents for the first quarter of 2002, decreased to $2.8 million, as compared to $3.3 million in the corresponding period in 2001. Of this decrease, $390,000 was due to the sale of one commercial property, $14,000 was due to a decrease in occupancy at IORI's commercial properties, and $136,000 was due to an earnest money deposit refund on IORI's land property in 2001. These decreases were offset by an increase of $90,000 due to increased occupancies at IORI's apartments. Rental income for the remaining quarters of 2002, are expected to decline as IORI selectively sells properties. Property operations expense increased in the first quarter of 2002, to $1.6 million, as compared to $1.5 million in the corresponding period in 2001. Of this increase, $183,000 was due to increased leasing costs associated with IORI's commercial properties and was offset by a decrease of $89,000 in repairs at IORI's apartment properties. Operating expense for the remaining quarters of 2002, are expected to decline as IORI selectively sells properties. Interest income in the first quarter of 2002, was $37,000, as compared to $72,000 in the corresponding period in 2001. The decrease was due to a $1.0 million paydown received in May 2001 on one of IORI's note receivables. Interest income for the remainder of 2002 is expected to decrease from one note maturing in April 2002, and one note maturing in July 2002. Interest expense for the first quarter of 2002, decreased to $1.1 million from $1.5 million in the corresponding period in 2001. Of this 12 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND ------------------------------------------------------------------------- RESULTS OF OPERATIONS (Continued) --------------------- Results of Operations (Continued) --------------------- decrease, $191,000 was due to the loan refinancing in 2001 for one parcel of unimproved land, $114,000 was due to the sale of one commercial property in 2002, and the remaining $95,000 was due to lower variable interest rates at IORI's apartments and commercial properties. Interest expense for the remaining quarters of 2002, is expected to increase due to the refinancing of IORI's residential properties. Depreciation expense for the first quarter of 2002, decreased to $500,000 from $585,000 in the corresponding period in 2001. The decrease was due to a decrease of $100,000 from the sale of one commercial property in 2002 and was offset by an increase of $16,000 from increased tenant improvements at IORI's commercial properties. Depreciation for the remaining quarters of 2002, is expected to approximate the first quarter of 2002. Advisory fee expense in the first quarter of 2002, was $186,000, as compared to $157,000 in the corresponding period in 2001. The advisory fee is based on IORI's gross assets. Advisory fees for the remainder of 2002 are expected to decrease as IORI selectively sells properties. Net income fee was $411,000 in the first quarter of 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 $285,000 for the first quarter of 2002, as compared to $311,000 in the corresponding period in 2001. The decrease was primarily due to a decrease in professional fees. General and administrative expense for the remaining quarters of 2002 is expected to approximate that of the first quarter. 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. 13 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND -------------------------------------------------------------------------- RESULTS OF OPERATIONS (Continued) --------------------- 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 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 March 31, 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................ $ 18,201 8.48% $ 182 ======== ======= Total increase in IORI's annual net loss................... $ 182 ======= Per share...................... $ .13 ======= 14 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"). 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. 15 ITEM 1. LEGAL PROCEEDINGS (Continued) ---------------------------- 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 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. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ------------------------------------------- (a) Exhibits: None. (b) Reports on Form 8-K as follows: A Current Report on Form 8-K, dated April 10, 2002, was filed with respect to Item 5. "Other Events and Regulation FD Disclosures," which reports the Amendment to the Second Amendment to the Modification of Stipulation of Settlement in Olive, et al. v. National Income Realty Trust et al. A Current Report on Form 8-K, dated April 19, 2002, was filed with respect to Item 2. "Acquisition or Disposition of Assets," which reports the sale of Daley Plaza in San Diego, California and the sale of all of IORI's residential properties. 16 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: May 15, 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) 17