INCOME OPPORTUNITY REALTY INVESTORS INC quarterly report, Q3 FY2012

Business context and reporting period

Income Opportunity Realty Investors, Inc. (IOT) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2012. IOT holds 178.1 acres of Texas land for future development or sale, but reported no rental or other property revenue. Its principal income source is interest on notes receivable from related parties. TCI owned approximately 81.1% of IOT.

Financial results and position

Amounts below are in thousands of dollars unless stated otherwise.

• Cash flow: Nine-month operating cash flow was $4,256, versus $982 in 2011; investing used $4,057, versus $954 provided; financing used $189, versus $1,954. Cash ended at just $11, compared with $1 at year-end 2011.
• Balance sheet: September 30 assets were $109,704, liabilities $33,641, and shareholders’ equity $76,063. Land was carried at cost of $24,511. Related-party notes and interest receivable were $26,295 gross, less a $1,826 allowance, or $24,469 net; a separate related-party receivable and accrued-interest balance was $59,207.
• Debt: Notes and interest payable totaled $28,399, including $25,522 principal allocated to the Mercer Crossing/Travelers loan and $2,872 accrued interest. The filing says IOT is jointly and severally liable for the entire underlying loan, reported at $33.1 million plus accrued interest across IOT and parent TCI.
• Margins and liquidity: Property revenue was zero, so property operating margins are not meaningful. The filing reports no current ratio or other standard liquidity ratio; cash was minimal relative to liabilities.

Material changes versus prior comparable periods

• Net income improved to $356 in Q3 and $1,862 for the nine months, from losses of $515 and $2,347, respectively. The main driver was higher interest income on related-party notes, not property operations.
• Management began accruing interest on surplus-cash notes as earned from January 1, 2012, rather than recognizing unpaid interest only when cash was received. The filing attributes much of the interest-income increase to this change and UHF-related notes.
• Nine-month discontinued-operations losses fell to $34 from $1,247, with no property sales in 2012; 2011 included the Eagle Crest sale, impairment, and loss.
• Total assets rose to $109,704 from $108,041 at December 31, 2011, while debt and interest payable declined modestly from $28,588. Cash increased by only $10.

Outlook, risks, contingencies, and unusual items

• No specific earnings or operating guidance was provided. Management says liquidity needs include debt service, recurring expenses, capital expenditures, and acquisitions; expected sources include note collections, property sales, and refinancing. It may sell or refinance real estate or incur additional secured borrowings if cash and refinancing are insufficient.
• The $25,522 Mercer Crossing/Travelers loan was past maturity, accelerated after borrower default, and subject to a forbearance extension expiring April 12, 2013. The agreement requires monthly payments of $150,000. IOT disclosed joint-and-several exposure to the full loan obligation.
• Related-party concentration is substantial: TCI and other affiliates are counterparties to significant receivables, financing, advisory, and cash-management arrangements. The filing cautions these transactions may not be on arm’s-length terms. The UHF notes bear 5.25%, mature in 2027, and are payable from surplus cash flow or sale/refinancing of underlying properties.
• A 1% increase in base rates was estimated to reduce annual net income by $255, or $0.06 per share, on variable-rate notes payable of $25,522. The filing also identifies real-estate market, financing, development, interest-rate, environmental, and litigation risks.
• IOT reported a $1,460 deferred tax asset fully offset by a valuation allowance. During Q3, a change in ARL ownership caused IOT to join Realty Advisors Management, Inc.’s consolidated federal tax group. Management said ordinary-course lawsuits were not expected to materially affect financial condition, results, or liquidity; no subsequent events were reported.
• Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter. No quarterly dividends were paid in 2012 or 2011.

Important facts for investors to verify

1. Collectability and cash realization of the large related-party receivables, accrued interest, and UHF notes, including the impact of accruing surplus-cash interest before receipt.
2. Status of the defaulted, accelerated Mercer Crossing/Travelers loan, the forbearance terms and expiry, required payments, and IOT’s joint-and-several liability for the full obligation.
3. Current cash needs and refinancing or repayment plans, given $11 of cash and the loan’s default and maturity history.
4. Basis for the related-party balances, transactions, fees, and interest income, including any affiliate exposures or changes in terms.
5. Whether land-sale or development plans, tax-group changes, or other subsequent developments alter the company’s outlook; the filing provides no specific forecast.