U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-QSB
[X] Quarterly Report Under Section 13 Or 15 (d) of the
Securities Exchange Act of 1934
For the quarterly period ended March 31, 2004
[ ] Transition Report Under Section 13 Or 15 (d) of the
Securities Exchange Act of 1934
For the transition period from ______ to _____
Commission file number 1-10324
THE INTERGROUP CORPORATION
--------------------------
(Exact Name of Small Business Issuer as Specified in Its Charter)
DELAWARE 13-3293645
------------------------------ ------------------
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification No.)
820 Moraga Drive Los Angeles, CA 90049
--------------------------------------
(Address of Principal Executive Offices)
(310) 889-2500
-------------------------
(Issuer's Telephone Number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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 [ ]
The number of shares outstanding of the issuer's Common Stock, $.01 par value,
as of May 13, 2004 were 2,509,686 shares.
Transitional Small Business Disclosure Format: YES [ ] NO [X]
THE INTERGROUP CORPORATION
INDEX TO FORM 10-QSB
PART I. FINANCIAL INFORMATION PAGE
Item 1. Consolidated Financial Statements:
Consolidated Balance Sheet (unaudited)
As Of March 31, 2004 3
Consolidated Statements of Operations (unaudited)
For the Three Months Ended March 31, 2004 and 2003 4
Consolidated Statements of Operations (unaudited)
For the Nine months Ended March 31, 2004 and 2003 5
Consolidated Statements of Cash Flows (unaudited)
For the Nine months Ended March 31, 2004 and 2003 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 14
Item 3. Controls and Procedures 20
Part II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Shareholders 21
Item 5. Other Events 21
Item 6. Exhibits and Reports on Form 8-K 22
Signatures 22
-2-
THE INTERGROUP CORPORATION
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
As of March 31, 2004
-----------
ASSETS
Investment in real estate, at cost:
Land $ 26,124,000
Buildings, improvements and equipment 56,581,000
Property held for sale or development 944,000
-----------
83,649,000
Less: accumulated depreciation (20,661,000)
-----------
62,988,000
Investment in Justice Investors 8,815,000
Cash and cash equivalents 545,000
Restricted cash 2,839,000
Investment in marketable securities 82,030,000
Prepaid expenses and other assets 6,240,000
-----------
Total assets $163,457,000
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Mortgage notes payable $ 68,910,000
Due to securities broker 24,857,000
Obligation for securities sold 32,128,000
Accounts payable and other liabilities 3,543,000
Deferred income taxes 7,771,000
-----------
Total liabilities 137,209,000
-----------
Minority interest 8,842,000
-----------
Commitments and contingencies
Shareholders' equity:
Preferred stock, $.01 par value, 2,500,000 shares
authorized; none issued -
Common stock, $.01 par value, 4,000,000 shares authorized;
3,193,745 issued, 2,509,686 outstanding 21,000
Common stock, class A $.01 par value, 2,500,000 shares
authorized; none issued -
Additional paid-in capital 8,686,000
Retained earnings 15,341,000
Treasury stock, at cost, 684,059 shares (6,642,000)
-----------
Total shareholders' equity 17,406,000
-----------
Total liabilities and shareholders' equity $163,457,000
===========
The accompanying notes are an integral part of the consolidated
financial statements.
-3-
THE INTERGROUP CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
For the Three Months ended March 31, 2004 2003
----------- -----------
Real estate operations:
Rental income $ 3,353,000 $ 3,689,000
Rental expenses:
Property operating expenses (1,797,000) (1,589,000)
Mortgage interest expense (935,000) (873,000)
Real estate taxes (397,000) (408,000)
Depreciation (648,000) (690,000)
----------- -----------
(Loss)income from real estate operations (424,000) 129,000
----------- -----------
Equity in net income of Justice Investors 113,000 361,000
----------- -----------
Investment transactions:
Net investment gains(losses) 4,174,000 (1,341,000)
Dividend and interest income 224,000 119,000
Margin interest and trading expenses (1,346,000) (318,000)
----------- -----------
Income(loss) from investment transactions 3,052,000 (1,540,000)
----------- -----------
Other income(expense):
General and administrative expenses (440,000) (418,000)
Other, net 37,000 (37,000)
----------- -----------
Other expense (403,000) (455,000)
----------- -----------
Income(loss) before provision for income
taxes and minority interest 2,338,000 (1,505,000)
Provision for income tax (expense)benefit (935,000) 616,000
----------- -----------
Income(loss) before minority interest 1,403,000 (889,000)
Minority interest (expense)benefit (281,000) 191,000
----------- -----------
Net income(loss) $ 1,122,000 $ (698,000)
=========== ===========
Basic income(loss) per share $ 0.45 $ (0.26)
=========== ===========
Weighted average number of shares outstanding 2,509,686 2,704,300
=========== ===========
Diluted income(loss) per share $ 0.39 $ (0.26)
=========== ===========
Diluted weighted average number of shares
outstanding 2,842,686 2,704,300
=========== ===========
The accompanying notes are an integral part of the consolidated
financial statements.
-4-
THE INTERGROUP CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
For the Nine months ended March 31, 2004 2003
----------- -----------
Real estate operations:
Rental income $ 9,896,000 $ 10,677,000
Rental expenses:
Property operating expenses (5,349,000) (4,947,000)
Mortgage interest expense (2,689,000) (2,596,000)
Real estate taxes (1,156,000) (1,201,000)
Depreciation (1,965,000) (2,054,000)
----------- -----------
Loss from real estate operations (1,263,000) (121,000)
----------- -----------
Equity in net income of Justice Investors 557,000 1,232,000
----------- -----------
Investment transactions:
Net investment gains(losses) 12,785,000 (2,052,000)
Dividend and interest income 598,000 260,000
Margin interest and trading expenses (3,800,000) (782,000)
----------- -----------
Income(loss) from investment transactions 9,583,000 (2,574,000)
----------- -----------
Other income(expense):
General and administrative expenses (1,281,000) (1,394,000)
Other, net 99,000 9,000
----------- -----------
Other expense (1,182,000) (1,385,000)
----------- -----------
Income(loss) before provision for income
taxes and minority interest 7,695,000 (2,848,000)
Provision for income tax (expense)benefit (3,078,000) 1,139,000
----------- -----------
Income(loss) before minority interest 4,617,000 (1,709,000)
Minority interest (expense)benefit (938,000) 246,000
----------- -----------
Net income(loss) $ 3,679,000 $ (1,463,000)
=========== ===========
Basic income(loss) per share $ 1.46 $ (0.53)
=========== ===========
Weighted average number of shares outstanding 2,527,726 2,737,452
=========== ===========
Diluted income(loss) per share $ 1.29 $ (0.53)
=========== ===========
Diluted weighted average number of shares
outstanding 2,860,726 2,737,452
=========== ===========
The accompanying notes are an integral part of the consolidated
financial statements.
-5-
THE INTEGROUP CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the Nine months ended March 31, 2004 2003
----------- -----------
Cash flows from operating activities:
Net income(loss) $ 3,679,000 $ (1,463,000)
Adjustments to reconcile net income(loss) to
cash used in operating activities:
Depreciation of real estate 1,965,000 2,054,000
Net unrealized gains on investments (4,422,000) (2,033,000)
Equity in net income from Justice Investors (557,000) (1,232,000)
Minority interest 938,000 (246,000)
Changes in assets and liabilities:
Restricted cash 672,000 (510,000)
Investment in marketable securities (22,675,000) (3,481,000)
Prepaid expenses and other assets (2,848,000) (1,390,000)
Accounts payable and other liabilities (880,000) (545,000)
Due to broker 4,536,000 1,444,000
Obligation for securities sold 15,639,000 3,873,000
Deferred income taxes 2,300,000 1,066,000
----------- -----------
Net cash used in operating activities (1,653,000) (2,463,000)
----------- -----------
Cash flows from investing activities:
Investment in real estate (700,000) ( 53,000)
Additions to buildings, improvements
and equipment (1,283,000) (933,000)
Distributions from Justice Investors 874,000 1,498,000
Purchase of Santa Fe stock (923,000) -
----------- -----------
Net cash (used in)provided by
investing activities (2,032,000) 512,000
----------- -----------
Cash flows from financing activities:
Borrowings from mortgage notes payable 8,275,000 10,118,000
Principal payments on mortgage notes payable (5,481,000) (4,157,000)
Repayment of line of credit - (4,000,000)
Purchase of treasury stock (252,000) (799,000)
Dividends paid to minority shareholders (171,000) (126,000)
----------- -----------
Net cash provided by financing activities 2,371,000 1,036,000
----------- -----------
Net decrease in cash and cash equivalents (1,314,000) (915,000)
Cash and cash equivalents at beginning of
period 1,859,000 1,883,000
----------- -----------
Cash and cash equivalents at end of period $ 545,000 $ 968,000
=========== ===========
The accompanying notes are an integral part of the consolidated
financial statements.
-6-
THE INTERGROUP CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. General
The consolidated financial statements included herein are unaudited; however,
in the opinion of The InterGroup Corporation ("InterGroup" or the "Company"),
the interim financial information contains all adjustments, including normal
recurring adjustments, necessary to present fairly the results for the interim
period. These consolidated financial statements include the accounts of the
Company and its subsidiaries and should be read in conjunction with the
Company's June 30, 2003 audited consolidated financial statements and notes
thereto.
As of March 31, 2004, the Company had the power to vote 74.5% of the voting
shares of Santa Fe Financial Corporation ("Santa Fe"), a public company (Nasdaq
SmallCap: SFEF). Santa Fe's revenue is primarily generated through the
management of its 68.8% owned subsidiary, Portsmouth Square, Inc.
("Portsmouth"), which derives its revenue primarily as a general partner and a
49.8% limited partner in Justice Investors ("Justice"), a California limited
partnership. Justice owns the land, improvements and leaseholds known as the
Holiday Inn Financial District/Chinatown, a 565-room hotel in San Francisco,
California.
The results of operations for the three and nine months ended March 31, 2004
are not necessarily indicative of results to be expected for the full fiscal
year ending June 30, 2004.
Earnings Per Share
Basic earnings per share are computed by dividing net income available to
common stockholders by the weighted average number of common shares
outstanding. The computation of diluted earnings per share is similar to the
computation of basic earnings per share except that the weighted-average number
of common shares is increased to include the number of additional common shares
that would have been outstanding if potential dilutive common shares had been
issued. The Company's only potentially dilutive common shares are stock
options. Stock options are included in diluted earnings per share by
application of the treasury stock method. As of March 31, 2004, the Company
had 333,000 stock options that were considered potentially dilutive common
shares. These amounts were included in the calculation for diluted earnings
per share.
Stock-Based Compensation Plans
Statement of Financial Accounting Standards No. 123 (SFAS 123), Accounting for
Stock-Based Compensation, encourages all entities to adopt a fair value based
method of accounting for employee stock compensation plans, whereby
compensation cost is measured at the grant date based on the value of the award
and is recognized over the service period, which is usually the vesting period.
However, it also allows an entity to continue to measure compensation cost for
those plans using the intrinsic value based method of accounting prescribed by
Accounting Principles Board Opinion No.25 (APB 25), Accounting for Stock Issued
to Employees, whereby compensation cost is the excess, if any, of the quoted
market price of the stock at the grant date (or other measurement date) over
the amount an employee must pay to acquire the stock. Stock options issued
under the Company's stock option plan have no intrinsic value at the grant
date, and under APB 25 no compensation cost is recognized.
-7-
The Company has elected to continue with the accounting methodology in APB 25
and, as a result, has provided pro forma disclosures of net income and earnings
per share and other disclosures, as if the fair value based method of
accounting had been applied.
As required by FAS 123, the Company has determined the pro-forma information as
if the Company had accounted for stock options granted since January 1, 1998,
under the fair value method of FAS 123. The Black-Scholes option pricing model
was used with the following weighted-average assumptions for March 31, 2004;
risk-free interest rate of 2.61%; dividend yield of 0%; expected Common Stock
market price volatility factor of 36.4; and a expected life of the options of
10 years. The fair value of options granted in during the nine months ended
March 31, 2004 were $6.30 per option. The aggregate fair value of the options
granted during the nine months ended March 31, 2004, was $95,000.
Stock based compensation is accounted for under APB 25 and accordingly, no
compensation cost has been recognized for stock options in the financial
statements. Had compensation cost been determined based upon the fair value of
the stock options at grant date and consistent with FAS 123, the Company's pro
forma net income and net income per share (based on 15,000 options vesting
during the nine months ended March 31, 2004) are as follows:
Net income - as reported $ 3,679,000
Net income - pro forma $ 3,584,000
Income per share - as reported $ 1.46
Income per share - pro forma $ 1.42
2. Investment in Real Estate
In August 2003, the Company acquired a single-family house in Los Angeles,
California for $700,000. In October 2003, the Company obtained a mortgage loan
of $525,000 on this unencumbered property. The interest rate on the loan is
fixed at 5.75% for the first five years and is adjustable through maturity on
October 1, 2033.
In November 2003, the Company refinanced four mortgage loans totaling
$2,141,000 and obtained four new mortgage loans totaling $3,535,000. All four
loans have a fixed interest rate of 6.38% for the first ten years of the loan.
After ten years, the interest rate is adjustable through maturity on December
1, 2018.
3. Marketable Securities:
Marketable securities are stated at market value as determined by the most
recently traded price of each security at the balance sheet date. Marketable
securities are classified as trading with net change in unrealized gains or
losses included in earnings.
As part of the investment strategies, the Company may assume short positions in
marketable securities. Short sales are used by the Company to potentially
offset normal market risks undertaken in the course of its investing activities
or to provide additional return opportunities. The Company has no naked short
positions. As of March 31, 2004, the Company had obligations for securities
sold (equities short) of $32,128,000.
-8-
The Company may utilize margin for its marketable securities purchases through
the use of standard margin agreements with national brokerage firms. The use
of available leverage is guided by the business judgment of management.
Included in the net gains on marketable securities of $4,174,000 for the three
months ended March 31, 2004 are net unrealized losses of $897,000 and net
realized gains of $5,071,000. Included in the net losses on marketable
securities of $1,341,000 for the three months ended March 31, 2003 are net
unrealized gains of $249,000 and net realized losses of $1,590,000.
Included in the net gains on marketable securities of $12,785,000 for the nine
months ended March 31, 2004 are net unrealized gains of $4,422,000 and net
realized gains of $8,363,000. Included in the net losses on marketable
securities of $2,052,000 for the nine months ended March 31, 2003 are net
unrealized gains of $2,033,000 and net realized losses of $4,085,000.
4. Investment in Justice Investors:
The consolidated accounts include a 49.8% interest in Justice Investors, a
California limited partnership ("the partnership"), in which Portsmouth serves
as one of the two general partners. The other general partner, Evon Garage
Corporation ("Evon"), serves as the managing general partner. As a general and
limited partner, Portsmouth has significant control over the management and
operation of the assets of Justice Investors. All significant partnership
decisions require the active participation and approval of both general
partners. The Company and Evon jointly consult and determine the amount of
partnership reserves and the amount of cash to be distributed to the limited
partners.
The partnership derives most of its income from a lease of its San Francisco,
California hotel property to Felcor Lodging Trust, Inc. ("Felcor") and from a
lease of the garage portion of the property to Evon. As a general partner, the
Company and its subsidiaries are active in monitoring and overseeing the
operations of the hotel and parking garage.
Pursuant to the terms of the partnership agreement, voting rights of the
partners are determined according to the partners' entitlement to share in the
net profit and loss of the partnership. The Company is not entitled to any
additional voting rights by virtue of its position as a general partner.
The partnership agreement also provides that no portion of the partnership real
property can be sold without the written consent of the general and limited
partners entitled to more than 72% of the net profit.
The Company amortizes the difference between the cost basis of its investment
in Justice Investors and its share of the net assets allocable to depreciable
assets of Justice Investors over 40 yrs.
For the Company's investment in Justice, to the extent that projected future
undiscounted cash flows from the operation of the Company's hotel property are
less than the carrying value of the asset, the investment would be considered
permanently impaired and the carrying value of the asset would be reduced to
its fair value.
-9-
Condensed financial statements for Justice Investors are as follows:
JUSTICE INVESTORS
CONDENSED BALANCE SHEET
As of March 31, 2004
----------
Assets
Total current assets $ 145,000
Loan fees and deferred lease costs,
net of accumulated amortization of $251,000 21,000
Property, plant and equipment, net of
accumulated depreciation of $13,082,000 5,792,000
Construction in progress 567,000
Land 1,124,000
----------
Total assets $ 7,649,000
==========
Liabilities and partners' capital
Total current liabilities $ 272,000
Long term debt 4,462,000
Partners' capital 2,915,000
----------
Total liabilities and partners' capital $ 7,649,000
==========
JUSTICE INVESTORS
CONDENSED STATEMENTS OF OPERATIONS
For the three months ended March 31, 2004 2003
---------- ----------
Revenues $ 963,000 $ 938,000
Costs and expenses (615,000) (213,000)
---------- ----------
Net income $ 348,000 $ 725,000
========== ==========
For the nine months ended March 31, 2004 2003
---------- ----------
Revenues $ 3,280,000 $ 3,032,000
Costs and expenses (1,801,000) (558,000)
---------- ----------
Net income $ 1,479,000 $ 2,474,000
========== ==========
5. Related Parties
John V. Winfield serves as Chief Executive Officer and Chairman of the Company,
Portsmouth, and Santa Fe. Depending on certain market conditions and various
risk factors, the Chief Executive Officer, his family, Portsmouth and Santa Fe
may, at times, invest in the same companies in which the Company invests. The
Company encourages such investments because it places personal resources of the
Chief Executive Officer and his family members, and the resources of Portsmouth
and Santa Fe, at risk in connection with investment decisions made on behalf of
the Company.
-10-
6. Segment Information
The Company operates in three reportable segments, the operations of its multi-
family residential properties, the operation of Justice Investors, and the
investment of its cash and securities assets. These three operating segments,
as presented in the financial statements, reflect how management internally
reviews each segment's performance. Management also makes operational and
strategic decisions based on this information.
Information below represents reported segments for the three and nine months
ended March 31, 2004 and the three and nine months ended March 31, 2003.
Operating income for rental properties consists of rental income. Operating
income from Justice Investors consists of the operations of the hotel and
garage included in the equity in net income of Justice Investors. Operating
income (losses) for investment transactions consist of net investment
gains(losses)and dividend and interest income.
Real Estate
-------------------------
Three months ended Rental Justice Investment
March 31, 2004 Properties Investors Transactions Other Total
----------- ----------- ------------ ----------- ------------
Operating income $ 3,353,000 $ 113,000 $ 4,398,000 $ - $ 7,864,000
Operating expenses (1,797,000) - (1,346,000) - (3,143,000)
Real estate taxes (397,000) - - - (397,000)
----------- ----------- ----------- ----------- ------------
Net operating income 1,159,000 113,000 3,052,000 - 4,324,000
Mortgage interest expenses (935,000) - - - (935,000)
Depreciation (648,000) - - - (648,000)
General and administrative
expenses - - - (440,000) (440,000)
Other income - - - 37,000 37,000
Income tax expense - - - (935,000) (935,000)
Minority interest - - - (281,000) (281,000)
----------- ----------- ----------- ----------- ------------
Net income(loss) $ (424,000) $ 113,000 $ 3,052,000 $(1,619,000) $ 1,122,000
=========== =========== =========== =========== ============
Total Assets $62,988,000 $ 8,815,000 $84,646,000 $ 7,008,000 $163,457,000
=========== =========== =========== =========== ============
Real Estate
-------------------------
Three months ended Rental Justice Investment
March 31, 2003 Properties Investors Transactions Other Total
----------- ----------- ------------ ----------- ------------
Operating income(loss) $ 3,689,000 $ 361,000 $(1,222,000) $ - $ 2,828,000
Operating expenses (1,589,000) - (318,000) - (1,907,000)
Real estate taxes (408,000) - - (408,000)
----------- ----------- ----------- ----------- ------------
Net operating income(loss) 1,692,000 361,000 (1,540,000) - 513,000
Mortgage interest expenses (873,000) - - - (873,000)
Depreciation (690,000) - - - (690,000)
General and administrative
expenses - - - (418,000) (418,000)
Other income - - - (37,000) (37,000)
Income tax benefit - - - 616,000 616,000
Minority interest - - - 191,000 191,000
----------- ----------- ----------- ----------- ------------
Net income(loss) $ 129,000 $ 361,000 $(1,540,000) $ 352,000 $ (698,000)
=========== =========== =========== =========== ============
Total Assets $62,885,000 $ 9,482,000 $13,208,000 $ 4,748,000 $ 90,323,000
=========== =========== =========== =========== ============
-11-
Real Estate
-------------------------
Nine months ended Rental Justice Investment
March 31, 2004 Properties Investors Transactions Other Total
----------- ----------- ------------ ----------- ------------
Operating income $ 9,896,000 $ 557,000 $13,383,000 $ - $ 23,836,000
Operating expenses (5,349,000) - (3,800,000) - (9,149,000)
Real estate taxes (1,156,000) - - - (1,156,000)
----------- ----------- ----------- ----------- ------------
Net operating income 3,391,000 557,000 9,583,000 - 13,531,000
Mortgage interest expenses (2,689,000) - - - (2,689,000)
Depreciation (1,965,000) - - - (1,965,000)
General and administrative
expenses - - - (1,281,000) (1,281,000)
Other income - - - 99,000 99,000
Income tax expense - - - (3,078,000) (3,078,000)
Minority interest - - - (938,000) (938,000)
----------- ----------- ----------- ----------- ------------
Net income(loss) $(1,263,000) $ 557,000 $ 9,583,000 $(5,198,000) $ 3,679,000
=========== =========== =========== =========== ============
Total Assets $62,988,000 $ 8,815,000 $84,646,000 $ 7,008,000 $163,457,000
=========== =========== =========== =========== ============
Real Estate
-------------------------
Nine months ended Rental Justice Investment
March 31, 2003 Properties Investors Transactions Other Total
----------- ----------- ----------- ----------- ------------
Operating income(loss) $10,677,000 $ 1,232,000 $(1,792,000) $ - $ 10,117,000
Operating expenses (4,947,000) - (782,000) - (5,729,000)
Real estate taxes (1,201,000) - - (1,201,000)
----------- ----------- ----------- ----------- ------------
Net operating income(loss) 4,529,000 1,232,000 (2,574,000) - 3,187,000
Mortgage interest expenses (2,596,000) - - - (2,596,000)
Depreciation (2,054,000) - - - (2,054,000)
General and administrative
expenses - - - (1,394,000) (1,394,000)
Other income - - - 9,000 9,000
Income tax benefit - - - 1,139,000 1,139,000
Minority interest - - - 246,000 246,000
----------- ----------- ----------- ----------- ------------
Net income (loss) $ (121,000) $ 1,232,000 $(2,574,000) $ - $ (1,463,000)
=========== =========== =========== =========== ============
Total Assets $62,885,000 $ 9,482,000 $13,208,000 $ 4,748,000 $ 90,323,000
=========== =========== =========== =========== ============
7. Subsequent Events
---------------------
In April 2004, the Company obtained a revolving $5,000,000 line of credit
("LOC") and that LOC was drawn on in the full amount. The LOC carries a
variable interest rate of 4.75%. Interest is paid on a monthly basis. The LOC
and all accrued unpaid interest are due in May 2005.
In April 2004, the Company purchased a 358-unit apartment complex in Irving,
Texas for $27,000,000 in a tax-deferred exchange with the St. Louis, Missouri
property sold in August 2001. To finance the purchase, the Company obtained a
nine year $20,000,000 mortgage note with a fixed rate of 4.99%. After nine
years, the loan is extendable at a variable interest rate for one additional
year.
-12-
On May 3, 2004, Justice Investors entered into a Settlement Agreement by and
among Felcor and others to resolve disputes regarding certain obligations of
FelCor and others under the lease of the Partnership's hotel property commonly
known as the Holiday Inn Select Downtown & Spa, San Francisco (the "Hotel").
Pursuant to the terms of the Settlement, Felcor will pay to Justice $5,000,000
towards the costs of capital repairs, replacements and improvements necessary
to place the Hotel in the condition required by the lease at the end of its
term. Felcor will also transfer to Justice and terminate its leasehold estate
and its option right under the lease, effective June 30, 2004. In addition, the
parties to the Settlement agreed to mutual releases and to cooperate for a
smooth transition of the operations of the Hotel.
The Partnership also signed a term sheet to enter into a third party management
agreement with Dow Hotel Company ("Dow") for the operation of the Hotel as well
as a letter of intent with Starwood Hotels & Resorts Worldwide, Inc.
("Starwood") for a license agreement to convert the property to a Sheraton
Hotel. It is expected that the Partnership will enter into a definitive
management agreement with Dow, and a License Agreement with The Sheraton
Corporation, by June 30, 2004.
In May 2004, the Company refinanced a loan in the amount of $2,576,000 on one
of its Los Angeles, California properties and obtained a new construction loan
in the amount of $6,268,000. The interest rate on the loan is the 30-day LIBOR
plus 220 basis points and is adjustable on a monthly basis. The interest only
loan matures in June 2006.
-13-
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS AND PROJECTIONS
The discussion below and elsewhere in the Report includes forward-looking
statements about the future business results and activities of the Company,
which, by their very nature, involve a number of risks and uncertainties. When
used in this discussion, the words "estimate", "project", "anticipate" and
similar expressions, are subject to certain risks and uncertainties, such as
the impact of terrorism and war on the national and international economies,
including tourism and the securities markets, changes in general economic
conditions, interest rates, local real estate markets, and competition, as well
as uncertainties relating to uninsured losses, securities markets, and
litigation, including those discussed below and in the Company's Form 10-KSB
for the fiscal year ended June 30, 2003 that could cause actual results to
differ materially from those projected. Readers are cautioned not to place
undue reliance on these forward-looking statements. The Company undertakes no
obligation to publicly release the results of any revisions to those forward-
looking statements, which may be made to reflect events or circumstances after
the date hereof or to reflect the occurrence of unanticipated events.
RESULTS OF OPERATIONS
For the Three Months Ended March 31, 2004 Compared to the
Three Months Ended March 31, 2003
The Company had a net income of $1,122,000 for the three months ended March 31,
2004 compared to net loss of $698,000 for the three months ended March 31,
2003. The change was primarily due to the increase in gains on marketable
securities, an increase in dividend and interest income partially offset by a
higher loss from real estate operations, a decrease in equity in net income
from Justice Investors, and an increase in margin and trading expenses.
Rental income decreased to $3,353,000 from $3,689,000 due to higher vacancies
and higher rent concessions given to tenants due to a soft rental market.
Rental rates and rental concessions are determined by market conditions and
competitors. The low interest rate environment over the last three years
promoted a boom in the single-family housing market which in turn had a
negative impact in the apartment industry by virtue of prospective tenants as
well as existing tenants choosing to acquire a home over renting an apartment.
Apartment complexes throughout the country were forced to reduce rental rates
as well as provide rental concessions in order to maintain occupancy. This
resulted in the reduction of rental income.
The equity in net income of Justice Investors decreased to $113,000 from
$361,000. That decrease was primarily attributable to increased partnership
costs in the current quarter for consultants, experts and legal services
relating to the partnership's enforcement of the lessee's obligations under the
lease and additional depreciation and interest costs related to the build-out
of the new spa and meeting rooms in the hotel and other capital improvements.
Partnership revenues increased modestly to $963,000 for the three months ended
March 31, 2004 from $939,000 for the three months ended, March 31, 2003. Many
of the factors identified in fiscal 2003 continued to significantly impact the
hotel operations in fiscal 2004. Unlike other areas in California, the Bay
Area has been especially slow to recover from the devastating impact that the
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terrorist attacks of September 11, 2001, had on tourism and the hospitality
industry. The continued weakness in the Bay Area due to the failure of numerous
internet and technology companies, has also resulted in a decrease in business
travel and a reduction by airlines in the number of flights into San Francisco.
The hotel has also faced more competition from new properties and from higher
end properties that provide greater amenities to its guests, especially for the
business traveler. These properties have also reduced room rates as hotel
operators struggle to obtain occupancy. Average daily room rates for the three
months ended March 31, 2004 decreased modestly to approximately $91, compared
to $93 for the three months ended March 31, 2003, while average monthly
occupancy rates increased to approximately 60.5% compared to 57.4% during the
same three month period of fiscal 2003. Based on industry reports, management
is expecting a slow recovery in the San Francisco hotel marketplace.
Net investment gains(losses) on marketable securities changed to net gains of
$4,174,000 for the three months ended March 31, 2004 from net losses of
$1,341,000 for the three months ended March 31, 2003. For the three months
ended March 31, 2004, the Company had net unrealized losses of $897,000 and net
realized gains of $5,071,000. For the three months ended March 31, 2003, the
Company had net unrealized gains of $249,000 and net realized losses of
$1,590,000. Gains and losses on marketable securities may fluctuate
significantly from period to period in the future and could have a significant
impact on the Company's net income. However, the amount of gain or loss on
marketable securities for any given period may have no predictive value and
variations in amount from period to period may have no analytical value. For a
more detailed description of the composition of the Company's marketable
securities please see the Marketable Securities section below.
Dividend and interest income increased to $224,000 from $119,000 as a result of
the increased investment in dividend yielding securities.
Margin interest and trading expenses increased to $1,346,000 from $318,000
primarily due to a $757,000 in performance-based compensation earned by the
Company's CEO for his management of the Company's investment portfolio for the
three months ended March 31, 2004. The remaining increase was due to the
maintenance of higher margin balances and increased trading activity. Margin
interest expense increased to $388,000 from $162,000.
Income tax (expense)benefit changed to a tax expense of $935,000 from a tax
benefit of $616,000 as the result of income generated in the current quarter
ended March 31, 2004 versus a loss in the quarter ended March 31, 2003.
Minority interest changed to an expense of $281,000 from a benefit of $191,000
due to income generated by the Company's subsidiary in the current quarter
ended March 31, 2004 versus a loss generated in the quarter ended March 31,
2003.
For the Nine months Ended March 31, 2004 Compared to the
Nine months Ended March 31, 2003
The Company had a net income of $3,679,000 for the nine months ended March 31,
2004 compared to net loss of $1,463,000 for the nine months ended March 31,
2003. The change was primarily due to the increase in gains on marketable
securities, an increase in dividend and interest income partially offset by a
higher loss from real estate operations, a decrease in equity in net income
from Justice Investors, and an increase in margin and trading expenses.
Rental income decreased to $9,896,000 from $10,677,000 due to higher vacancies
and higher rent concessions given to tenants due to a soft rental market.
Rental rates and rental concessions are determined by market conditions and
-15-
competitors. The low interest rate environment over the last three years
promoted a boom in the single-family housing market which in turn had a
negative impact in the apartment industry by virtue of prospective tenants as
well as existing tenants choosing to acquire a home over renting an apartment.
Apartment complexes throughout the country were forced to reduce rental rates
as well as provide rental concessions in order to maintain occupancy. This
resulted in the reduction of rental income.
The equity in net income of Justice Investors decreased significantly to
$557,000 from $1,232,000. That decrease was primarily attributable to
increased partnership costs during the first nine months of the current fiscal
year for consultants, experts and legal services relating the physical
inspection of the hotel and the partnership's enforcement of the lessee's
obligations under the lease and additional depreciation and interest costs
related to the build-out of the new spa and meeting rooms in the hotel and
other capital improvements.
Although partnership revenues increased to approximately $3,280,000 for the
nine months ended March 31, 2004 from $3,032,000 for the nine months ended,
March 31, 2003, that increase was attributable to a to a $296,000 payment by
the hotel lessee, in December 2003, for part of the replacement costs of the
sloped window system of the hotel, which amount was recorded as other income by
Justice Investors. Absent that nonrecurring payment, partnership revenues
would have been down approximately $48,000. Many of the factors identified in
fiscal 2003 continued to significantly impact the hotel operations in fiscal
2004. Unlike other areas in California, the Bay Area has been especially slow
to recover from the devastating impact that the terrorist attacks of September
11, 2001, had on tourism and the hospitality industry. The continued weakness
in the Bay Area due to the failure of numerous internet and technology
companies, has also resulted in a decrease in business travel and a reduction
by airlines in the number of flights into San Francisco. The hotel has also
faced more competition from new properties and from higher end properties that
provide greater amenities to its guests, especially for the business traveler.
These properties have also reduced room rates as hotel operators struggle to
obtain occupancy. Average daily room rates declined slightly to approximately
$91 for the nine months ended March 31, 2004 from approximately $92 for the
nine months ended March 31, 2003, while average monthly occupancy rates
increased to approximately 68% from approximately 67% in the prior period.
Based on industry reports, management is expecting a slow recovery in the San
Francisco hotel marketplace.
Net investment gains(losses) on marketable securities changed to net gains of
$12,785,000 for the nine months ended March 31, 2004 from net losses $2,052,000
for the nine months ended March 31, 2003. For the nine months ended March 31,
2004, the Company had net unrealized gains of $4,422,000 and net realized gains
of $8,363,000. For the nine months ended March 31, 2003, the Company had net
unrealized gains of $2,033,000 and net realized losses of $4,085,000. Gains
and losses on marketable securities may fluctuate significantly from period to
period in the future and could have a significant impact on the Company's net
income. However, the amount of gain or loss on marketable securities for any
given period may have no predictive value and variations in amount from period
to period may have no analytical value. For a more detailed description of the
composition of the Company's marketable securities please see the Marketable
Securities section below.
Dividend and interest income increased to $598,000 from $260,000 as a result of
the increased investment in dividend yielding securities.
-16-
Margin interest and trading expenses increased to $3,800,000 from $782,000
primarily due to a $1,949,000 in performance-based compensation earned by the
Company's CEO for his management of the Company's investment portfolio for the
nine months ended March 31, 2004. The remaining increase was due to the
maintenance of higher margin balances and increased trading activity. Margin
interest expense increased to $1,054,000 from $352,000. Trading related
expenses increased to $797,000 from $430,000.
Income tax (expense)benefit changed to a tax expense of $3,078,000 from a tax
benefit of $1,139,000 as the result of income generated in the nine months
ended March 31, 2004 versus a loss in the nine months ended March 31, 2003.
Minority interest changed to an expense of $938,000 from a benefit of $246,000
due to income generated by the Company's subsidiary in during the nine months
ended March 31, 2004 as compared to a loss generated during the nine months
ended March 31, 2003.
MARKETABLE SECURITIES
The Company's investment portfolio is diversified with 173 different equity
positions. Only two equity securities are more than 5% of the equity value of
the portfolio, with the largest being 8.8%. The amount of the Company's
investment in any particular issuer may increase or decrease, and additions or
deletions to its securities portfolio may occur, at any time. While it is the
internal policy of the Company to limit its initial investment in any single
equity to less than 5% of its total portfolio value, that investment could
eventually exceed 5% as a result of equity appreciation or reduction of other
positions. Marketable securities are stated at market value as determined by
the most recently traded price of each security at the balance sheet date.
As of March 31, 2004, the Company had investments in marketable equity
securities of $82,030,000. The following table shows the composition of the
Company's marketable securities portfolio by selected industry groups as of
March 31, 2004.
% of Total
Investment
Industry Group Market Value Securities
-------------- ------------ ----------
Electric, pipelines, oil and gas $15,717,000 19.2%
Telecommunications and media 14,155,000 17.3%
Pharmaceuticals and medical 11,851,000 14.4%
Insurance and banks 9,248,000 11.3%
REITs, Lodging, home builders, and
Hotels 8,966,000 10.9%
Semiconductor, software, internet,
and computer 8,126,000 9.9%
Apparel, food and consumer goods 6,952,000 8.5%
Chemicals, materials, metals,
and mining 3,125,000 3.8%
Airlines and defense 2,419,000 2.9%
Other 1,471,000 1.8%
---------- ------
$82,030,000 100.0%
========== ======
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The following table shows the net gain or loss on the Company's marketable
securities and the associated margin interest and trading expenses for the
three and nine months ended March 31, 2004 and March 31, 2003, respectively.
Three months ended Three months ended
March 31, 2004 March 31, 2003
------------ ------------
Net gains(losses) on marketable
securities $ 4,174,000 $ (1,341,000)
Dividend & interest income 224,000 119,000
Margin interest expense (388,000) (156,000)
Trading and management expenses (958,000) (162,000)
------------ ------------
Investment income(loss) $ 3,052,000 $ (1,540,000)
============ ============
Nine months ended Nine months ended
March 31, 2004 March 31, 2003
------------ ------------
Net gains(losses) on marketable
securities $ 12,785,000 $ (2,052,000)
Dividend & interest income 598,000 260,000
Margin interest expense (1,054,000) (352,000)
Trading and management expenses (2,746,000) (430,000)
------------ ------------
Investment income(loss) $ 9,583,000 $ (2,574,000)
============ ============
FINANCIAL CONDITION AND LIQUIDITY
The Company's cash flows are generated primarily from its real estate
activities, sales of investment securities and borrowings related to both.
During the nine months ended March 31, 2004, the Company used net cash flow of
$1,653,000 from operating activities, used net cash flow of $2,032,000 from
investing activities, and generated net cash flow of $2,371,000 from financing
activities.
During the nine months ended March 31, 2004, the Company made property
improvements in the aggregate amount of $1,283,000. Management believes the
improvements to its properties will enhance market values, maintain the
competitiveness of the Company's properties and potentially enable the Company
to obtain a higher yield through higher rents.
In July 2003, the Company refinanced a $2,141,000 real estate loan and obtained
a new $4,215,000 loan on one of its Los Angeles, California properties. The
interest rate on the loan is fixed at 4.35% for the first five years and is
adjustable through maturity on July 1, 2033.
In October 2003, the Company obtained a new mortgage loan on one of its
unencumbered properties in the amount of $525,000. The interest rate on the
loan is fixed at 5.75% for the first five years and is adjustable through
maturity on October 1, 2033.
In November 2003, the Company refinanced four mortgage loans totaling
$2,141,000 and obtained four new mortgage loans totaling $3,535,000. All four
loans share a fixed interest rate of 6.38% for the first ten years of the loan.
After ten years, the interest rate is adjustable through maturity on December
1, 2018.
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In April 2004, the Company obtained a revolving $5,000,000 line of credit
("LOC") and that LOC was drawn on in the full amount. The LOC carries a
variable interest rate of 4.75%. Interest is paid on a monthly basis. The LOC
and all accrued unpaid interest are due in May 2005.
In April 2004, the Company purchased a 358-unit apartment complex in Irving,
Texas for $27,000,000 in a tax-deferred exchange with the St. Louis, Missouri
property sold in August 2001. To finance the purchase, the Company obtained a
nine year $20,000,000 mortgage note with a fixed rate of 4.99%. After nine
years, the loan is extendable at a variable interest rate for one additional
year.
In May 2004, the Company refinanced a loan in the amount of $2,576,000 on one
of its Los Angeles, California and obtained a new construction loan in the
amount of $6,268,000. The interest rate on the loan is the 30-day LIBOR plus
220 basis points and is adjustable on a monthly basis. The interest only loan
matures in June 2006.
The Company's Board of Directors has given the Company the authority to
repurchase, from time to time, shares of its Common Stock. Such repurchases
may be made at the discretion of management and depending on market conditions.
During the nine months ended March 31, 2004, the Company purchased 20,698
shares of its stock for $252,000.
The Company has invested in short-term, income-producing instruments and in
equity and debt securities when deemed appropriate. The Company's marketable
securities are classified as trading with unrealized gains and losses recorded
through the statement of operations.
Management believes that the net cash flow generated from future operating
activities and its capital resources will be adequate to meet its current and
future obligations.
The Company has no off balance sheet arrangements. The Company also does not
have any material contractual obligations or commercial commitments.
IMPACT OF INFLATION
The Company's residential and commercial rental properties provide income from
short-term operating leases and no lease extends beyond one year. Rental
increases are expected to offset anticipated increased property operating
expenses.
Hotel room rates are typically impacted by supply and demand factors, not
inflation, since rental of a hotel room is usually for a limited number of
nights. Room rates can be, and usually are, adjusted to account for
inflationary cost increases. To the extent that the hotel lessee is able to
adjust room rates, there should be minimal impact on partnership revenues due
to inflation. Partnership revenues are also subject to interest rate risks,
which may be influenced by inflation. For the two most recent fiscal years,
the impact of inflation on the Company's income is not viewed by management as
material.
-19-
CRITICAL ACCOUNTING POLICIES
The Company reviews its long-lived assets and other investments for impairment
when circumstances indicate that a potential loss in carrying value may have
occurred. To the extent that projected future undiscounted cash flows from the
operation of the Company's hotel property, owned through the Company's
investment in Justice Investors, and rental properties are less than the
carrying value of the asset, the carrying value of the asset is reduced to its
fair value. For other investments, the Company reviews the investment's
operating results, financial position and other relevant factors to determine
whether the estimated fair value of the asset is less than the carrying value
of the asset.
Marketable securities are stated at market value as determined by the most
recently traded price of each security at the balance sheet date. Marketable
securities are classified as trading with net unrealized gains or losses
included in earnings.
Item 3. Controls and Procedures
(a) Disclosure Controls and Procedures.
The Company's management, with the participation of the Company's Chief
Executive Officer and the Chief Financial Officer, has evaluated the
effectiveness of the Company's disclosure controls and procedures (as defined
in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the
fiscal period covered by this Quarterly Report on Form 10-QSB. Based upon such
evaluation, the Chief Executive Officer and Chief Financial Officer have
concluded that, as of the end of such period, the Company's disclosure controls
and procedures are effective in ensuring that information required to be
disclosed in this filing is accumulated and communicated to management and is
recorded, processed, summarized and reported in a timely manner and in
accordance with Securities and Exchange Commission rules and regulations.
(b) Internal Control Over Financial Reporting.
There have been no changes in the Company's internal control over financial
reporting during the last quarterly period covered by this Quarterly Report on
Form 10-QSB that have materially affected, or are reasonably likely to
materially affect, the Company's internal control over financial reporting.
-20-
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Shareholders.
The Annual Meeting of the Shareholders of the Company was held on February 25,
2004 at the Luxe Summit Hotel Bel-Air, 11461 Sunset Blvd., Los Angeles,
California 90049. At that meeting, two Class A Directors, John V. Winfield and
Josef A. Grunwald, were elected to serve a three year term expiring at the
Fiscal 2006 Annual Meeting. Each nominee received in excess of 98% of the
shares voted. Gary N. Jacobs, John C. Love, William J. Nance and Mildred Bond
Roxborough continue their terms as the Company's other directors. At the Annual
Meeting, the shareholders also voted in favor of the ratification of the Audit
Committee's selection of PricewaterhouseCoopers LLP as the independent auditors
of the Company for the fiscal year ending June 30, 2004. A tabulation of the
vote follows:
Proposal (1) - Directors: Votes For Withheld
--------- --------
John V. Winfield 2,240,326 25,324
Josef A. Grunwald 2,240,746 24,904
Proposal (2) - Accountants: Votes For Against Abstained
--------- ------- ---------
PricewaterhouseCoopers LLP 2,240,220 20,816 4,614
Item 5. Other Information
--------------------------
On April 30, 2004, the Company purchased a 358-unit apartment complex in the
Las Colinas section of Irving, Texas for $27,000,000 in a tax deferred exchange
for its St. Louis, Missouri property that was acquired by the City of St. Louis
in August 2001 in an eminent domain proceeding. The property was acquired from
Prudential Insurance Company of America and there was no relationship between
the seller and the Company or any of its affiliates. The property had been
listed at $29,000,000 and both parties were represented by real estate brokers.
The amount of consideration was determined by negotiations with the seller,
based on the listing price, sales of similar properties and other economic
factors.
To finance the purchase of the property, the Company obtained a $20,000,000
nine-year term mortgage note from Freddie Mac with a fixed interest rate of
4.99% per annum. After nine years, the note automatically extends for a term
of one additional year at a variable interest rate. The balance of the
purchase price was paid utilizing a revolving line of credit ("LOC") the
Company obtained from Pacific Western National Bank in the amount of $5,000,000
and cash from the Company in the amount of $2,000,000. The LOC has a variable
interest rate of 4.75%, which is based on the bank's base rate plus 0.75%.
Interest is paid on a monthly basis and the LOC and any accrued unpaid interest
is due in May 2005.
-21-
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
31.1 Certification of Chief Executive Officer of Periodic Report
Pursuant to Rule 13a-14(a) and Rule 15d-14(a).
31.2 Certification of Chief Financial Officer of Periodic Report
Pursuant to Rule 13a-14(a) and Rule 15d-14(a).
32.1 Certification of Chief Executive Officer Pursuant to 18
U.S.C. Section 1350.
32.2 Certification of Chief Financial Officer Pursuant to 18
U.S.C. Section 1350.
(b) Registrant did not file any reports on Form 8-K during the period
covered by this report.
SIGNATURES
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.
THE INTERGROUP CORPORATION
(Registrant)
Date: May 13, 2004 by /s/ John V. Winfield
----------------------------
John V. Winfield, President,
Chairman of the Board and
Chief Executive Officer
Date: May 13, 2004 by /s/ David T. Nguyen
------------------------------
David T. Nguyen, Treasurer
and Controller
(Principal Accounting Officer)
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