ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The
following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this
report.
This
Report on Form 10-Q may contain forward-looking statements within the meaning of the federal securities laws, principally, but
not only, under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.
We caution investors that any forward-looking statements in this report, or which management may make orally or in writing from
time to time, are based on management’s beliefs and on assumptions made by, and information currently available to, management.
When used, the words “anticipate”, “believe”, “expect”, “intend”, “may”,
“might”, “plan”, “estimate”, “project”, “should”, “will”,
“result” and similar expressions which do not relate solely to historical matters are intended to identify forward-looking
statements. These statements are subject to risks, uncertainties and assumptions and are not guarantees of future performance,
which may be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control. Should one or
more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially
from those anticipated, estimated, or projected. We caution you that, while forward-looking statements reflect our good faith
beliefs when we make them, they are not guarantees of future performance and are impacted by actual events when they occur after
we make such statements. We expressly disclaim any responsibility to update our forward-looking statements, whether as a result
of new information, future events or otherwise. Accordingly, investors should use caution in relying on past forward-looking statements,
which are based on results and trends at the time they are made, to anticipate future results or trends.
Some
of the risks and uncertainties that may cause our actual results, performance, or achievements to differ materially from those
expressed or implied by forward-looking statements include, among others, the following:
|
|
●
|
risks
associated with the availability and terms of financing and the use of debt to fund acquisitions and developments;
|
|
|
●
|
failure
to manage effectively our growth and expansion into new markets or to integrate acquisitions successfully;
|
|
|
●
|
risks
associated with downturns in the national and local economies, increases in interest rates and volatility in the securities
markets;
|
|
|
●
|
potential
liability for uninsured losses and environmental contamination; and
|
|
|
●
|
risks
associated with our dependence on key personnel whose continued service is not guaranteed.
|
The
risks included here are not exhaustive. Some of the risks and uncertainties that may cause our actual results, performance, or
achievements to differ materially from those expressed or implied by forward-looking statements, include among others, the factors
listed and described in Part I, Item 1A. “Risk Factors” in the Company’s Annual Report on Form 10-K, which investors
should review. There have been no changes from the risk factors previously described in the Company’s Form 10-K for the
fiscal year ended December 31, 2020.
As
further set forth under the caption “Risk Factors” in Par I, Item 1A of the Form 10-K, the recent coronavirus (“COVID-19”)
pandemic as well as the response to mitigate its spread and effect, may adversely impact our Company. We will continue to actively
monitor the situation and make further actions as may be required by governmental authorities or that we determine are in the
best interest of the Company.
Other
sections of this report may also include suggested factors that could adversely affect our business and financial performance.
Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time and it is not
possible for management to predict all such matters; nor can we assess the impact of all such matters on our business or the extent
to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking
statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a
prediction of actual results. Investors should also refer to our quarterly reports on Form 10-Q for future periods and to other
materials we may furnish to the public from time to time through Forms 8-K or otherwise as we file them with the SEC.
Overview
We
are an externally advised and managed investment company. We have no employees.
Our
primary source of revenue is from the interest income on approximately $96.8 million of notes receivable due from related parties.
We
have historically engaged in, and may continue to engage in, certain business transactions with related parties, including but
not limited to asset acquisition and dispositions. Transactions involving related parties cannot be presumed to be carried out
on an arm’s length basis due to the absence of free market forces that naturally exist in business dealings between two
or more unrelated entities. Related party transactions may not always be favorable to our business and may include terms, conditions
and agreements that are not necessarily beneficial to or in our best interest.
Pillar
Income Asset Management, Inc. (“Pillar”) is the Company’s external Advisor and Cash Manager under a contractual
arrangement that is reviewed annually by our Board of Directors. The day-to-day operations of IOR are performed by Pillar, as
the contractual Advisor, under the supervision of the Board. Pillar’s duties include, but are not limited to, locating,
evaluating and recommending business and investment opportunities. Additionally, Pillar serves as a consultant to the Board with
regard to their decisions in connection with IOR’s business plan and investment policy. Pillar also serves as an Advisor
and Cash Manager to TCI and ARL.
Critical
Accounting Policies
We
present our Consolidated Financial Statements in accordance with generally accepted accounting principles in the United States
of America (“U.S. GAAP”). The Financial Accounting Standards Board (“FASB”) Accounting Standards Codification
(“ASC”) is the single source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental
entities in the preparation of financial statements in conformity with U.S. GAAP.
The
accompanying unaudited Consolidated Financial Statements include our accounts, our subsidiaries, generally all of which are wholly-owned,
and all entities in which we have a controlling interest. As of September 30, 2021, IOR is not the primary beneficiary of a VIE.
Recognition
of Revenue
Our
revenues are composed largely of interest income on notes receivable recorded in accordance with the terms of the notes.
Non-Performing
Notes Receivable
We
consider a note receivable to be non-performing when the maturity date has passed without principal repayment and the borrower
is not making interest payments in accordance with the terms of the agreement.
Allowance
for Estimated Losses
We
assess the collectability of notes receivable on a periodic basis, of which the assessment consists primarily of an evaluation
of cash flow projections of the borrower to determine whether estimated cash flows are sufficient to repay principal and interest
in accordance with the contractual terms of the note. We recognize impairments on notes receivable when it is probable that principal
and interest will not be received in accordance with the contractual terms of the loan. The amount of the impairment to be recognized
generally is based on the fair value of the partnership’s real estate that represents the primary source of loan repayment.
See Note 3 “Notes and Interest Receivable from Related Parties” for details on our notes receivable.
Fair
Value of Financial Instruments
We
apply the guidance in ASC Topic 820, “Fair Value Measurements and Disclosures and includes three levels defined as follows:”
|
|
Level 1 –
|
Unadjusted
quoted prices for identical and unrestricted assets or liabilities in active markets.
|
|
|
Level 2 –
|
Quoted
prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either
directly or indirectly, for substantially the full term of the financial instrument.
|
|
|
Level 3 –
|
Unobservable
inputs that are significant to the fair value measurement.
|
A
financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant
to the fair value measurement.
Related
Parties
We
apply ASC Topic 805, “Business Combinations,” to evaluate business relationships. Related parties are persons or entities
who have one or more of the following characteristics, which include entities for which investments in their equity securities
would be required, trust for the benefit of persons including principal owners of the entities and members of their immediate
families, management personnel of the entity and members of their immediate families and other parties with which the entity may
deal if one party controls or can significantly influence the decision making of the other to an extent that one of the transacting
parties might be prevented from fully pursuing its own separate interests, or affiliates of the entity.
Newly
Issued Accounting Pronouncements
On
April 10, 2020, the FASB issued a Staff Q&A (“Q&A”) related to the application of the lease guidance in ASC
842 for the accounting impact of lease concessions related to the COVID-19 pandemic. The Q&A, allows an entity to make an
election to account for lease concessions related to the effects of the COVID-19 as though enforceable rights and obligations
for those concessions existed. As a result of this election, an entity will not have to analyze each lease to determine whether
enforceable rights and obligations for concessions exist in the lease and can elect to apply or not apply the lease modification
guidance in ASC 842, as long as the concessions do not result in a substantial increase in the rights of the lessor or the obligations
of the lessee. Our election of the guidance of the Q&A has not had a significant impact on our consolidated financial statements
during the nine months ended September 30, 2021.
Results
of Operations
The
following discussion is based on our “Statement of Operations” for the three and nine months ended September 30, 2021,
and 2020, as included in Part I, Item 1. “Financial Statements” of this report. It is not meant to be an all-inclusive
discussion of the changes in our net income applicable to common shares. Instead, we have focused on significant fluctuations
within our operations that we feel are relevant to obtain an overall understanding of the change in income applicable to common
shareholders.
Our
primary business is currently investing in mortgage receivables. Our principal source of revenue is interest income generated
from notes receivables due from related parties. We also receive interest income from the funds deposited with our Advisor at
a rate of prime plus 1%. Our operating expenses consist mainly of general and administration costs related to the Company.
Comparison
of the three months ended September 30, 2021, to the same period ended 2020:
We
had net income of $712 thousand or $0.17 per diluted share for the three months ended September 30, 2021, compared to net income
of $761 thousand or $0.18 per diluted share for the same period ended 2020.
Expenses
General
and administrative expenses were $88 thousand for the three months ended September 30, 2021. This represents a decrease of $6
thousand, compared to general and administrative expenses of $94 thousand for the three months ended September 30, 2020. This
decrease was primarily driven by a decrease in cost reimbursements to our Advisor of approximately $5 thousand.
Advisory
fees were $201 thousand for the three months ended September 30, 2021, compared to $194 thousand for the same period in 2020 for
an increase of $7 thousand. Advisory fees are computed based on a gross asset fee of 0.0625% per month (0.75% per annum) of the
average of the gross asset value.
Net
income fee to related party was $56 thousand for the three months ended September 30, 2021. This represents an increase of $5
thousand, compared to the net income fee of $51 thousand for the three months ended September 30, 2020. The net income fee paid
to our Advisor is calculated at 7.5% of net income.
Other
income (expense)
Interest
income decreased to $1.2 million for the three months ended September 30, 2021, compared to $1.3 million for the same period in
2020. The decrease of $100 thousand was primarily due to a decrease in interest recognized due to some notes being
paid off in 1Q 2021.
Comparison
of the nine months ended September 30, 2021, to the same period ended 2020:
We
had net income of $2.9 million or $0.69 earnings per diluted share for the nine months ended September 30, 2021, as well as net
income of $2.9 million or $0.69 earnings per diluted share for the same period in 2020.
Expenses
General
and administrative expenses were $376 thousand for the nine months ended September 30, 2021, compared to $361 thousand for the
nine months ended September 30, 2020, for an increase of $15 thousand. The increase was primarily due to an increase in cost reimbursements
to our Advisor of approximately $29 thousand plus an increase in stock transfer fees of approximately $7 thousand partially offset
by a decrease in legal fees of $18 thousand.
Advisory
fees were $599 thousand for the nine months ended September 30, 2021, compared to $574 thousand for the same period of 2020 for
an increase of $25 thousand. Advisory fees are computed based on a gross asset fee of 0.0625% per month (0.75% per annum) of the
average of the gross asset value.
Net
income fee to related party increased by $1 thousand to $250 thousand for the nine months ended September 30, 2021, compared to
$249 thousand for the same period in 2020. The net income fee paid to our Advisor is calculated at 7.5% of net income.
Other
income (expense)
Interest
income was $3.7 million for the nine months ended September 30, 2021. This represents a decrease of $400 thousand as compared
to interest income of $4.1 million for the nine months ended September 30, 2020, as a result of a decrease in interest recognized
due to some notes being paid off in 1Q 2021.
Other
income was $1.2 million for the nine months ended September 30, 2021, due to the collection of a note previously written off.
Other income of $742 thousand for the nine months ended September 30, 2020, was due to a tax increment reimbursement from the
City of Farmers Branch, Texas for previous infrastructure development performed by the Company.
Liquidity
and Capital Resources
General
Our
principal liquidity needs are to fund normal recurring expenses. And our principal sources of cash are and will continue to be
the collection of mortgage notes receivables, and the collections of receivables and interest from related companies.
Cash
Flow Summary
The
following summary discussion of our cash flows is based on the Consolidated Statements of Cash Flows from Part I, Item 1.
“Financial Statements” and is not meant to be an all-inclusive discussion of the changes in our cash flows (dollars
in thousands):
|
|
|
For the Nine Months Ended
June 30,
|
|
|
|
|
|
2021
|
|
2020
|
|
Variance
|
|
|
|
(dollars in thousands)
|
|
|
|
Net cash provided by operating activities
|
|
$
|
5,302
|
|
|
$
|
3,307
|
|
|
$
|
1,995
|
|
|
Net cash used in investing activities
|
|
$
|
(5,301
|
)
|
|
$
|
(3,254
|
)
|
|
$
|
(2,047
|
)
|
The
primary use of cash for operations is daily operating costs, general and administrative expenses, and advisory fees. Our primary
source of cash for operations is from interest income on notes receivable.
Our
primary cash outlays for investing activities are for investment of excess cash with our Advisor. The investing activity in the
current period was mainly due to the proceeds received on the notes receivable. We invested more cash with our Advisor in the
current period.
We
did not pay quarterly dividends during the nine months ended September 30, 2021, and 2020.
Environmental
Matters
Under
various federal, state and local environmental laws, ordinances and regulations, we 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 our business,
assets or results of operations.
Inflation
The
effects of inflation on our operations are not quantifiable. Fluctuations in the rate of inflation 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.
Tax
Matters
IOR
is a member of the May Realty Holdings, Inc., (“MRHI”) consolidated group for federal income tax reporting.
There is a tax sharing and compensating agreement between American Realty Investors, Inc. (“ARL”), Transcontinental
Realty Investors, Inc. (“TCI”), and IOR.
Financial
statement income varies from taxable income principally due to the accounting for income and losses of investees, gains and losses
from asset sales, amortization of discounts on notes receivable and payable and the difference in the allowance for estimated
losses. IOR has taxable income for the first nine months of 2021 on a standalone basis. The income tax expense for the nine
months ending September 30, 2021, was $768 thousand.