10-Q 1 d08446e10vq.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 JUNE 30, 2003 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 is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [ ] No [X] 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 July 31, 2003) 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
June 30, December 31, 2003 2002 -------- ------------ (dollars in thousands, except per share) ASSETS Real estate held for investment .............................................. $ 75,722 $ 82,252 Less - accumulated depreciation .............................................. (7,191) (7,502) -------- ------------ 68,531 74,750 Real estate held for sale .................................................... 5,000 - Investment in real estate partnerships ....................................... 599 609 Cash and cash equivalents .................................................... 274 10 Other assets (including $10,511 in 2003 and $10,497 in 2002 from affiliates).. 14,986 14,816 -------- ------------ $ 89,390 $ 90,185 ======== ============
The accompanying notes are an integral part of these Consolidated Financial Statements. 2 INCOME OPPORTUNITY REALTY INVESTORS, INC. CONSOLIDATED BALANCE SHEETS - CONTINUED
June 30, December 31, 2003 2002 -------- ----------- (dollars in thousands, except per share) LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Notes and interest payable........................................................... $ 46,649 $ 47,351 Liabilities related to assets held for sale ......................................... 4,056 4,081 Other liabilities (including $32 in 2003 and $33 in 2002 to affiliates).............. 1,744 1,446 -------- ----------- 52,449 52,878 Commitments and contingencies ....................................................... - - Stockholders' equity Common Stock, $.01 par value; authorized 10,000,000 shares; issued and outstanding 1,438,945 shares in 2003 and 2002..................................................... 14 14 Paid-in capital ...................................................................... 62,774 62,774 Accumulated deficit .................................................................. (25,847) (25,481) -------- ----------- 36,941 37,307 -------- ----------- $ 89,390 $ 90,185 ======== ===========
The accompanying notes are an integral part of these Consolidated Financial Statements. 3 INCOME OPPORTUNITY REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months For the Six Months Ended June 30, Ended June 30, -------------------- ------------------ 2003 2002 2003 2002 ------- ------- ------- ------ (dollars in thousands, except per share) Property revenue Rents .......................... $ 2,445 $ 2,302 $ 4,712 $ 4,644 Property expense Property operations(including $-0- in 2003 and $96 in 2002 to affiliates and related parties) ..................... 1,355 1,299 2,612 2,460 ------- ------- ------- ------ Operating income ............... 1,090 1,003 2,100 2,184 Other income Interest ....................... 614 310 614 348 Equity in income (loss) of equity partnerships ......... - 48 (15) 30 Recovery of loss provision on receivable from related party 1,569 - 1,569 - ------- ------- ------- ------ 2,183 358 2,168 378 Other expense Interest ....................... 1,185 1,252 2,341 2,146 Depreciation ................... 490 425 849 860 Advisory fee to affiliate ...... 167 163 334 348 Net income fee to affiliate .... - - - 411 Provision for loss ............. - - - 767 Impairment loss on real estate held for sale 653 - 653 - General and administrative (including $-0- in 2003 and $157 in 2002 to affiliates and related parties) ......... 114 352 369 637 ------- ------- ------- ------ 2,609 2,192 4,546 5,169 ------- ------- ------- ------ Net income (loss) from continuing operations ........................ 664 (831) (278) (2,607)
The accompanying notes are an integral part of these Consolidated Financial Statements. 4 INCOME OPPORTUNITY REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months For the Six Months Ended June 30, Ended June 30, ------------------------ ----------------------- 2003 2002 2003 2002 --------- --------- ---------- --------- (dollars in thousands, except per share) Discontinued operations: Income (loss) from operations .......................... (32) (58) (88) (314) Gain on sale of operations ............................. - - - 7,105 ---------- ---------- ---------- ---------- (32) (58) (88) 6,791 ---------- ---------- ---------- ---------- Net income (loss).......................................... $ 632 $ (889) $ (366) $ 4,184 ========== ========== ========== ========== Earnings (loss) per share Net income (loss) from continuing operations............ $ .46 $ (.58) $ (.19) $ (1.81) Discontinued operations ................................ (.02) (.04) (.06) 4.73 ---------- ---------- ---------- ---------- Net income (loss).................................... $ .44 $ (.62) $ (.25) $ 2.92 ========== ========== ========== ========== Weighted average Common shares used in computing earnings per share.................................................. 1,438,945 1,438,945 1,438,945 1,438,945 ========== ========== ========== ==========
The accompanying notes are an integral part of these Consolidated Financial Statements. 5 INCOME OPPORTUNITY REALTY INVESTORS, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY For the Six Months Ended June 30, 2003
COMMON STOCK PAID-IN ACCUMULATED STOCKHOLDERS' SHARES AMOUNT CAPITAL DEFICIT EQUITY --------- --------- ---------- ----------- ------------- (DOLLARS IN THOUSANDS) BALANCE, JANUARY 1, 2003...... 1,438,945 $ 14 $ 62,774 $ (25,481) $ 37,307 Net loss ..................... - - - (366) (366) --------- --------- ---------- ----------- ---------- BALANCE, JUNE 30, 2003........ 1,438,945 $ 14 $ 62,774 $ (25,847) $ 36,941 ========= ========= ========== =========== ==========
The accompanying notes are an integral part of these Consolidated Financial Statements. 6 INCOME OPPORTUNITY REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months Ended June 30, -------------------- 2003 2002 -------- -------- (dollars in thousands) Net income (loss) .......................................................... $ (366) $ 4,184 Reconciliation of net income (loss) to net cash used in operating activities Adjustments to reconcile net income (loss) to net cash used in operating activities Depreciation ...................................................... 1,187 1,290 (Income) loss on impairment of fixed asset ........................ 653 (7,105) (Income) loss of equity partnerships .............................. 15 (30) Distributions from equity partnerships' operating cash flow ....... -- 42 Provision for loss ................................................ -- (767) Change in interest receivable ..................................... (85) (183) Change in other assets ............................................ (215) 884 Change in interest payable ........................................ (369) (4) Change in other liabilities ....................................... 298 346 -------- -------- Net cash provided by (used in) operating activities ............... 1,118 (1,343) Cash Flows from Investing Activities Collections on notes receivable ......................................... -- 500 Funding of notes receivable (including $5,109 in 2002 to related parties) (7,109) Funding of equity partnerships .......................................... -- (5) Real estate improvements ................................................ (362) (317) Proceeds from sale of real estate ....................................... -- 14,575 -------- -------- Net cash provided by (used in) investing activities ..................................................... (362) 7,644
The accompanying notes are an integral part of these Consolidated Financial Statements. 7 INCOME OPPORTUNITY REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
For the Six Months Ended June 30, --------------------- 2003 2002 -------- --------- (dollars in thousands) Cash Flows from Financing Activities Payments on notes payable ....................................................... $ (358) $ (23,134) Proceeds from notes payable ..................................................... - 23,152 Payments to affiliate ........................................................... - (3,920) Payments to advisor ............................................................. (14) (1,507) Deferred financing costs ........................................................ (120) (889) -------- --------- Net cash used in financing activities ..................................... (492) (6,298) Net increase in cash and cash equivalents .......................................... 264 3 Cash and cash equivalents, beginning of period ..................................... 10 66 -------- --------- Cash and cash equivalents, end of period............................................ $ 274 $ 69 ======== ========= Supplemental Disclosures of Cash Flow Information Cash paid for interest.......................................................... $ 2,496 $ 974
The accompanying notes are an integral part of these Consolidated Financial Statements. 8 INCOME OPPORTUNITY REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. BASIS OF PRESENTATION The accompanying Consolidated Financial Statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for complete financial statements. Operating results for the six month period ended June 30, 2003, are not necessarily indicative of the results that may be expected for the year ending December 31, 2003. 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, 2002 (the "2002 Form 10-K"). Dollar amounts in tables are in thousands, except per share amounts. Certain balances for 2002 have been reclassified to conform to the 2003 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 became 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. 9 INCOME OPPORTUNITY REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE 1. BASIS OF PRESENTATION (CONTINUED) In June 2002, the FASB issued SFAS No. 146, "Accounting for costs Associated with Exit or Disposal Activities," which addresses accounting for restructuring and similar costs. SFAS No. 146 supersedes previous accounting guidance, principally Emerging Issues Task Force ("EITF") Issue No. 94-3. IORI has adopted the provisions of SFAS No. 146 for restructuring activities initiated after December 31, 2002. SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF No. 94-3, a liability for an exit cost was recognized at the date of a company's commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing future restructuring costs as well as the amount recognized. Effective June 30, 2003 IORI terminated its Advisory Agreement with Basic Capital Management, Inc. Basic Capital Management, Inc. had served as IORI's advisor since 1989. On July 1, 2003 IORI entered into an Advisory Agreement with Syntek West, Inc., the owner and holder of approximately 54.3% of IORI's common stock. All of the issued and outstanding stock of Syntek West, Inc. is owned by Gene Phillips. The new advisory agreement with Syntek West, Inc. contains the same terms as the old one with Basic Capital Management, Inc. NOTE 2. REAL ESTATE In 2003, IORI sold the following property:
SALES NET CASH DEBT GAIN PROPERTY LOCATION SQ.FT. PRICE RECEIVED DISCHARGED ON SALE --------------- ---------- ------- ----- -------- ---------- ------- THIRD QUARTER OFFICE BUILDING 5600 MOWRY NEWARK, CA 56,120 $5,000 $ 1,113 $ 4,056 $ 653 SQ.FT.
In 2002, IORI sold the following property:
SALES NET CASH DEBT GAIN PROPERTY LOCATION SQ.FT. PRICE RECEIVED DISCHARGED ON SALE --------------- -------- ------ ----- -------- ---------- ------- FIRST QUARTER OFFICE BUILDING DALEY CORPORATE SAN DIEGO, CA 124,059 $15,500 $ 7,820 $ 6,618 $ 7,105 CENTER SQ.FT.
10 INCOME OPPORTUNITY REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE 3. NOTES AND INTEREST RECEIVABLE There were no new notes funded in 2003. 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 guaranteed that the asset would produce at least a 12% return annually of the purchase price for a period of three years from the purchase date. If the asset failed to produce the 12% return, ARI would pay IORI any shortfall. In addition, if the asset failed to produce the 12% return for a calendar year, IORI could require ARI to repurchase the shares of Rosedale for the purchase price. Management 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 had guaranteed the 12% return, IORI recognized a provision for loss on the note receivable of $767,000. In December 2002, the Rosedale Towers Office Building was sold for $7.2 million. ARI received $3.5 million in proceeds after the payment of the first lien debt and various closing costs and IORI recognized an additional loss of $801,000 on its note. The $3.5 million received by ARI is included within other assets in the accompanying December 31, 2002 Consolidated Balance Sheet. The remaining $1.5 million is included within other assets in the accompanying June 30, 2003 Consolidated Balance Sheet. In April 2003, IORI received a $2.0 million paydown from ARI on the receivable. 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. Of the $2.0 million in principal payments, $1.5 million was received by TCI and $500,000 was received by Basic Capital Management, Inc. ("BCM"), an affiliate and the advisor to IORI. These amounts are included within receivable from affiliates in the accompanying Consolidated Balance Sheets. 11 INCOME OPPORTUNITY REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED 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 June 30, 2003, IORI had receivables of $1,797,000, $3,454,000 and $5,260,000 from BCM, ARI and TCI, respectively. 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 until July 2003 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 $21.3 million, bears interest at 7.57% per annum, requires monthly interest only payments of $135,000 and matures in May 2012. IORI also received $5.2 million of 8% non-recourse, non-convertible Series A Preferred Stock ("Preferred Shares") of Innovo. The dividend on the Preferred Shares will be funded entirely and solely through member distributions from cash flows generated by the operation and subsequent sale of the sold properties. In the event the cash flows for the properties are insufficient to cover the 8% annual dividend, Innovo will have no obligation to cover any shortfall. 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. 12 INCOME OPPORTUNITY REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE 6. RELATED PARTY TRANSACTIONS On September 19, 2002, IORI's Board of Directors authorized the Chief Financial Officer of the Company to advance funds either to or from the Company, through BCM, in an amount up to $5.0 million on the condition that such advances shall be repaid in cash or transfers of assets within 90 days. The following table reconciles the beginning and ending balances of Accounts Receivable from Affiliates as of June 30, 2003.
BCM ARI TCI ------- ------- ------- Balance, December 31, 2002........................................ $ 1,696 $ 3,541 $ 5,260 Cash transfers ................................................. 3,616 -- -- Cash repayments ................................................ (3,277) (2,000) -- Other additions ................................................ 784 1,913 -- Other repayments ............................................... (1,022) -- -- ------- ------- ------- Balance, June 30, 2003............................................ $ 1,797 $ 3,454 $ 5,260 ======= ======= =======
Returns on Metra Properties. As described more fully in Note 5, IORI sold all of its residential properties during 2002 to partnerships controlled by Metra. The partnership agreement for each of these partnerships states that the Metra Partners, as defined, receive cash flow distributions at least quarterly in an amount sufficient to provide them with a fifteen percent cumulative compounded annual rate of return on their invested capital, as well as a cumulative annual amount of 0.50% of the average outstanding balance of the mortgage indebtedness secured by any of these residential properties. These distributions to the Metra Partners have priority over distributions to any of the other partners. 13 INCOME OPPORTUNITY REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE 7. 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, income or (loss) of equity partnerships, and recovery of loss provision on receivable from related party which totaled $2.2 million and $2.2 million for the three and six months ended June 30, 2003, and income of $358,000 and $378,000 for the three and six months ended June 30, 2002. Expenses that are not reflected in the segments are general and administrative expenses, advisory and net income fees, provision for losses, impairment loss on real estate held for sale, and discontinued operations which totaled $966,000 and $1.4 million for the three and six months ended June 30, 2003, and $573,000 and $2.5 million for the three and six months ended June 30, 2002. Excluded from operating segment assets are assets of $15.9 million at June 30, 2003, and $16.5 million at June 30, 2002, which are not identifiable with an operating segment. There are no intersegment revenues and expenses and all business is conducted in the United States. Presented below is the operating income of each operating segment for the three and six months ended June 30, 2003 and 2002, and each segment's assets at June 30.
Three Months Ended Commercial June 30, 2003 Properties Apartments Land Total ------------------ ---------- ---------- ------- ------- Rents............................................... $ 1,115 $ 1,330 $ -- $ 2,445 Property operating expenses ........................ 522 753 80 1,355 ---------- ---------- ------- ------- Operating income (loss)............................. $ 593 $ 577 $ (80) $ 1,090 ========== ========== ======= ======= Interest............................................ $ 307 $ 500 $ 378 $ 1,185 Depreciation ....................................... 414 76 - 490 Real estate improvements ........................... 155 -- -- 155 Assets ............................................. 27,661 20,941 24,929 73,531
14 INCOME OPPORTUNITY REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE 7. OPERATING SEGMENTS (CONTINUED)
Six Months Ended Commercial June 30, 2003 Properties Apartments Land Total ------------------------ ---------- ---------- -------- --------- Rents............................................... $ 2,047 $ 2,665 $ - $ 4,712 Property operating expenses ........................ 996 1,454 162 2,612 ---------- ---------- -------- -------- Operating income (loss)............................. $ 1,051 $ 1,211 $ (162) $ 2,100 ========== ========== ======== ======== Interest............................................ $ 577 $ 1,019 $ 745 $ 2,341 Depreciation ....................................... 657 192 - 849 Real estate improvements ........................... 365 - - 365 Assets ............................................. 27,661 20,941 24,929 73,531
Three Months Ended Commercial June 30, 2002 Properties Apartments Land Total ------------------------ ---------- ---------- -------- --------- Rents............................................... $ 962 $ 1,340 $ - $ 2,302 Property operating expenses......................... 547 681 71 1,299 ---------- ---------- -------- --------- Operating income (loss)............................. $ 415 $ 659 $ (71) $ 1,003 ========== ========== ======== ========= Interest............................................ $ 328 $ 550 $ 374 $ 1,252 Depreciation........................................ 301 124 425 Real estate improvements............................ - - 88 88 Assets.............................................. 33,051 21,359 24,769 79,179
15 INCOME OPPORTUNITY REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE 7. OPERATING SEGMENTS (CONTINUED)
Six Months Ended Commercial June 30, 2002 Properties Apartments Land Total ---------------------------- ---------- ---------- ------- -------- Rents............................................... $ 1,995 $ 2,649 $ -- $ 4,644 Property operating expenses ........................ 1,095 1,230 135 2,460 ---------- ---------- ------- -------- Operating income (loss)............................. $ 900 $ 1,419 $ (135) $ 2,184 ========== ========== ======= ======== Interest............................................ $ 681 $ 809 $ 656 $ 2,146 Depreciation ........................................ 608 252 -- 860 Real estate improvements ............................ 41 -- 276 317 Assets .............................................. 33,051 21,359 24,769 79,179
Commercial Property Sales: Properties Total ----------- ------- Sales prices........................................ $ 15,500 $15,500 Cost of sales ...................................... 8,395 8,395 ----------- ------- Gain on sale........................................ $ 7,105 $ 7,105 =========== =======
NOTE 8. ADVISORY FEES, PROPERTY MANAGEMENT, ETC. Revenue, fees and cost reimbursements to BCM and its affiliates for the six months ended:
For the Six Months Ended June 30, ------------------ 2003 2002 ----- ----- Fees Advisory............................................................................. $ 334 $186 Net income .......................................................................... -- 411 Property and construction management and leasing commissions* .............................................................. 194 51 ----- ---- $ 528 $648 ===== ==== Cost reimbursements..................................................................... $ 132 $ 81 ===== ====
* Net of property management fees paid to subcontractors, other than GS Realty, Inc., which is owned by an affiliate of BCM. 16 INCOME OPPORTUNITY REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED 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. In the event of a future asset sale, IORI is required to reclassify portions of previously reported operations to discontinued operations within the Statements of Operations. For the three months and six months ended June 30, 2003 income from discontinued operations relates to a property that IORI sold in 2003. For the three months and six months ended June 30, 2002, income from discontinued operations relates to two properties that IORI sold during 2002 and a property that IORI sold in 2003. The following table summarizes revenue and expense information for the properties sold.
FOR THE THREE FOR THE SIX MONTHS MONTHS ENDED JUNE 30, ENDED JUNE 30, --------------------------- ------------------------- 2003 2002 2003 2002 ------------- ----------- ----------- ----------- REVENUE RENTAL............................................................... $ 143 $ 229 $ 352 $ 687 PROPERTY OPERATIONS.................................................. 80 133 201 613 ------------- ----------- ----------- ----------- OPERATING INCOME (LOSS)............................................ 63 96 151 74 EXPENSES INTEREST............................................................. 63 97 159 265 DEPRECIATION......................................................... 32 57 80 123 ------------- ----------- ----------- ----------- TOTAL EXPENSES..................................................... 95 154 239 388 NET INCOME (LOSS) FROM DISCONTINUED OPERATIONS BEFORE GAINS ON SALE OF REAL ESTATE................................... (32) (58) (88) (314) GAIN ON SALE OF OPERATIONS............................................ -- -- -- 7,105 ------------- ----------- ----------- ----------- NET INCOME (LOSS) FROM DISCONTINUED OPERATIONS........................ $ (32) $ (58) $ (88) $ 6,791 ============= =========== =========== ===========
17 INCOME OPPORTUNITY REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE 9. DISCONTINUED OPERATIONS - CONTINUED 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 2003 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 $6.5 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. 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. 18 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INTRODUCTION IORI invests in equity interests in real estate through acquisitions, leases and partnerships and also invests in mortgage loans. IORI is the successor to a California business trust organized on December 14, 1984, which commenced operations on April 10, 1985. CRITICAL ACCOUNTING POLICIES Critical accounting policies are those that are both important to the presentation of IORI's financial condition and results of operations and require management's most difficult, complex or subjective judgments. 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. 19 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) 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. Typically, IORI's notes receivable are collateralized by income producing real estate. IORI had notes receivable of $97,000 and $-0- at June 30, 2003 and December 31, 2002, respectively. LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents at June 30, 2003, were $274,000, compared with $10,000 at December 31, 2002. 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 2003 due to increased rental receipts at its properties, however, such excess will not be sufficient to discharge all of IORI's debt obligations as they mature. Management intends to selectively sell income producing real estate, refinance real estate and incur additional borrowings against real estate to meet its cash requirements. The Company reported a net loss of $366,000 for the six months ended June 30, 2003, which included the following non-cash charges: depreciation of $1.2 million, loss of equity partnerships of $15,000, impairment loss of $653,000 and decrease in other assets of $300,000 and increase in other liabilities of $71,000. Net cash provided by operating activities amounted to $1.1 million for the six months ended June 30, 2003. During the six months ended June 30, 2003 the increase in other assets was due to an increase in accounts receivable from affiliates and the increase in other liabilities was due to an increase in accrued property taxes. Net cash used in investing activities of $362,000 was comprised of real estate improvements of $362,000. Net cash used in financing activities of $492,000 was comprised of payments on notes payable of $358,000 and deferred financing costs and other costs of $134,000. 20 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) 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 net income of $632,000 for the three months ended June 30, 2003, and a net loss of $366,000 for the six months ended June 30, 2003, which included an impairment on real estate held for sale of $653,000 and a recovery of a previous impairment of an asset of $1.6 million, as compared to net loss of $889,000 and net income of $4.2 million for the corresponding periods in 2002. Fluctuation in components of revenue and expense between the 2003 and 2002 periods are discussed below. Rents in the three and six months ended June 30, 2003, were $2.4 million and $4.7 million as compared to $2.3 million and $4.6 million in the corresponding period in 2002. This slight overall increase was due to an overall increase in occupancy in IORI's commercial and residential properties. Rental income for the remaining quarters of 2003 are expected to decline when IORI selectively sells properties. Property operations expense in the three and six months ended June 30, 2003 were $1.4 million and $2.6 million, as compared to $1.3 million and $2.5 million in the corresponding periods in 2002. This slight increase was due to increased repairs and personnel costs. Property operations expense for the remainder of 2003 is expected decline when IORI selectively sells properties. Interest income in the three and six months ended June 30, 2003 were $614,000 and $614,000 as compared to $310,000 and $348,000 in the corresponding periods in 2002. The increase reflects additional interest income earned on the reinstated note receivable previously written off in 2002, but collected in 2003. 21 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) RESULTS OF OPERATIONS (CONTINUED) For the three and six months ended June 30, 2003, IORI recorded a Recovery of loss provision on receivable from related party in the amount of $1.5 million. This represents the amounts received or to be received from a related party of an amount that was written off in late 2002. Interest expense in the three and six months ended June 30, 2003 were $1.2 million and $2.3 million, as compared to $1.3 million and $2.1 million in the corresponding periods in 2002. The increase was due to refinancing IORI's residential properties and a parcel of unimproved land, partially offset by a decrease in variable interest rates at IORI's commercial properties. Interest expense for the remaining quarters of 2003 may decrease due to lower variable interest rates and the paydown of debt. Depreciation expense in the three and six months ended June 30, 2003 were $490,000 and $849,000, as compared to $425,000 and $860,000 in the corresponding periods in 2002. Advisory fee expense in the three and six months ended June 30,2003 were $167,000, and $334,000 as compared to $163,000 and $348,000 in the corresponding period in 2002. The advisory fee is based on IORI's gross assets. Advisory fees for the remainder of 2003 are expected to decrease when 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. For the three and six months ended June 30, 2003, IORI recorded an asset impairment of $653,000 representing the writedown of the 5600 Mowry Building in Newark, California to its estimated fair value. The property was sold in July 2003 for $5.0 million. General and administrative expense in the three and six months ended June 30, 2003 were $114,000 and $369,000, as compared to $352,000 and $637,000 in the corresponding periods in 2002. The decrease was primarily due to a decrease in insurance premiums and investor relations expenses in 2003. 22 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 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 2002 Form 10-K, for the year 2002 IORI elected and qualified to be treated as a Real Estate Investment Trust ("REIT"), as defined in Sections 856 and 860 of the Internal Revenue Code of 1986, as amended (the "Code"), and as such was not taxed for federal income tax purposes on that portion of its taxable income which is distributed to stockholders. Due to the completion of the tender offer by ARI, an affiliate, and the resulting concentration of ownership, IORI no longer met the requirements for tax treatment as a REIT under the Code as of January 1, 2003, and is prohibited for re-qualifying for REIT status for at least five years. Financial statement income varies from taxable income principally due to the accounting for income and losses of investees, gains and losses from asset sales, depreciation on owned properties, amortization of discounts on notes receivable and payable and the difference in the allowance for estimated losses. IORI had a loss for federal income tax purposes in the first six months of 2003; therefore, it recorded no provision for income taxes. 23 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) TAX MATTERS - CONTINUED At June 30, 2003, IORI had a net deferred tax asset of approximately $5.2 million due to tax deductions available to it in future years. However, as management cannot determine that it is more likely than not that IORI will realize the benefit of the deferred tax asset, a 100% valuation allowance has been established. 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. 24 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES REGARDING MARKET RISK At June 30, 2003, 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.................... $ 12,332 9.26% $ 123 ======== ============ Total decrease in IORI's annual net income....................... $ 123 ============ 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. 25 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS OLIVE LITIGATION SETTLEMENT On November 15, 2002, ARI commenced tender offers for shares of common stock of IORI and TCI. The price per share to be paid was $19.00 for IORI shares and $17.50 for TCI shares. The tender offers were made as an alternative under settlement resulting from a failure of timely completion of the SEC review process of a registration statement for proposed mergers among ARI subsidiaries and IORI and TCI. The tender offers were completed on March 19, 2003. Pursuant to the tender offers, ARI acquired 265,036 IORI shares and 1,213,226 TCI shares. The completion of the tender offers fulfilled the remaining obligations under the Olive Settlement and the Olive Litigation has been dismissed with prejudice. For further information refer to NOTE 17. "COMMITMENTS AND CONTINGENCIES AND LIQUIDITY," included in IORI's Form 10-K for the year ended December 31, 2002. 26 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits:
Exhibit Number Description ------ ----------- 31.1 Certification Pursuant to Rules 13a-14 and 15d-14 Under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith. 32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.
(b) Reports on Form 8-K as follows: A Current Report on Form 8-K, dated June 2, 2003, was filed with respect to Item 1. "Changes in Control of Registrant", which reports the exchange of IORI stock between Syntek West, Inc. and Basic Capital Management, Inc. resulting in Syntek West, Inc. owning 54.3% of the outstanding stock of IORI and that Syntek West, Inc. is 100% owned by Gene E. Phillips. A Current Report on Form 8-K, dated July 1, 2003, was filed with respect to Item 4. "Changes in Registrant's Certifying Accountant" and Item 5. "Other Events and Regulation FD Disclosure" which reports the change of IORI's certifying accountant from BDO Seidman to Farmer, Fuqua & Huff, P.C. and the termination of IORI's advisory agreement with Basic Capital Management, Inc. and the establishment of IORI's advisory agreement with Syntek West, Inc. A Current Report on Form 8-K/A, dated July 1, 2003, was filed with respect to Item 4. "Changes in Registrant's Certifying Accountant" and Item 5. "Other Events and Regulation FD Disclosure" which reports the change of IORI's certifying accountant from BDO Seidman to Farmer, Fuqua & Huff, P.C. and the termination of IORI's advisory agreement with Basic Capital Management, Inc. and the establishment of IORI's advisory agreement with Syntek West, Inc. The Form 8-K/A was filed to include an additional exhibit related to the change in certifying accountants. 27 SIGNATURE PAGE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. INCOME OPPORTUNITY REALTY INVESTORS, INC. Date: August 14, 2003 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) 28 INCOME OPPORTUNITY REALTY INVESTORS, INC. EXHIBITS TO QUARTERLY REPORT ON FORM 10-Q For the Quarter ended June 30, 2003
Exhibit Number Description ------ ----------- 31.1 Certification Pursuant to Rules 13a-14 and 15d-14 Under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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