UNITED STATES
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 December 31, 2006
[ ] 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 [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). YES [ ] NO [X]
The number of shares outstanding of the issuer's Common Stock, $.01 par value,
as of February 9, 2007 were 2,351,279 shares.
Transitional Small Business Disclosure Format: YES [ ] NO [X]
INDEX
THE INTERGROUP CORPORATION
PART I. FINANCIAL INFORMATION PAGE
Item 1. Consolidated Financial Statements:
Consolidated Balance Sheet
As Of December 31, 2006 (unaudited) 3
Consolidated Statements of Operations (unaudited)
For the Three Months Ended December 31, 2006 and 2005 4
Consolidated Statements of Operations (unaudited)
For the Six Months Ended December 31, 2006 and 2005 5
Consolidated Statements of Cash Flows (unaudited)
For the Six Months Ended December 31, 2006 and 2005 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 16
Item 3. Controls and Procedures 24
Part II. OTHER INFORMATION
Item 4. Unregistered Sales of Equity Securities and Use
of Proceeds 25
Item 5. Other Information 26
Item 6. Exhibits and Reports on Form 8-K 26
SIGNATURES 27
-2-
PART I
FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
THE INTERGROUP CORPORATION
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
As of December 31, 2006
-----------
ASSETS
Investment in hotel, at cost:
Land $ 1,124,000
Furniture and equipment 15,142,000
Building and improvements 42,325,000
Accumulated depreciation (16,694,000)
-----------
41,897,000
Investment in real estate, at cost:
Land 23,626,000
Buildings, improvements and equipment 61,433,000
Accumulated depreciation (20,868,000)
-----------
64,191,000
Property held for sale 14,089,000
-----------
78,280,000
Cash and cash equivalents 2,045,000
Restricted cash 3,117,000
Investment in marketable securities 18,857,000
Other investments 6,394,000
Prepaid expenses and other assets 13,607,000
-----------
Total assets $164,197,000
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Due to securities broker $ 8,983,000
Obligation for securities sold 1,597,000
Line of credit 4,258,000
Line of credit - Hotel 16,050,000
Accounts payable and other liabilities 12,058,000
Mortgage note payable - hotel 29,428,000
Mortgage note payable - real estate 66,759,000
Mortgage note payable - property held for sale 11,268,000
Deferred income taxes 3,887,000
-----------
Total liabilities 154,288,000
-----------
Minority interest 2,419,000
-----------
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, 2,353,883 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 7,698,000
Treasury stock, at cost, 839,862 shares (8,915,000)
-----------
Total shareholders' equity 7,490,000
-----------
Total liabilities and shareholders' equity $164,197,000
===========
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 December 31, 2006 2005
----------- -----------
Justice Investors operations:
Hotel and garage revenue $ 8,116,000 $ -
Operating expenses (7,103,000) -
Interest expense (686,000) -
Real estate taxes (202,000) -
Depreciation and amortization (1,040,000) -
----------- -----------
Loss from Justice Investors operations (915,000) -
----------- -----------
Equity in net loss of Justice Investors - (1,012,000)
----------- -----------
Real estate operations:
Rental income 3,151,000 2,984,000
Property operating expense (2,223,000) (1,706,000)
Mortgage interest expense (910,000) (937,000)
Real estate taxes (433,000) (434,000)
Depreciation (589,000) (588,000)
----------- -----------
Loss from real estate operations (1,004,000) (681,000)
----------- -----------
Investment transactions:
Net gains on marketable securities 1,310,000 1,307,000
Impairment loss on other investments - (241,000)
Dividend and interest income 89,000 115,000
Margin interest and trading expenses (556,000) (590,000)
----------- -----------
Income from investment transactions 843,000 591,000
----------- -----------
Other income(expense):
General and administrative expense (346,000) (469,000)
Other expense (59,000) (242,000)
----------- -----------
Other expense (405,000) (711,000)
----------- -----------
Loss before provision for income taxes and
minority interest (1,481,000) (1,813,000)
Provision for income tax benefit 635,000 684,000
----------- -----------
Loss before minority interest (846,000) (1,129,000)
Minority interest benefit, net of tax 270,000 193,000
----------- -----------
Loss from continuing operations $ (576,000) $ (936,000)
----------- -----------
Discontinued operations:
Net loss on discontinued operations $ (54,000) $ (133,000)
Gain on sale of real estate - 1,185,000
Provision for income tax benefit(expense) 23,000 (401,000)
----------- -----------
Income(loss) from discontinued operations $ (31,000) $ 651,000
----------- -----------
Net loss $ (607,000) $ (285,000)
=========== ===========
Loss per share from continuing operations
Basic $ (0.25) $ (0.39)
Diluted $ (0.25) $ (0.39)
=========== ===========
Income(loss) per share from discontinued operations
Basic $ (0.01) $ 0.27
Diluted $ (0.01) $ 0.24
=========== ===========
Loss per share
Basic $ (0.26) $ (0.12)
Diluted $ (0.26) $ (0.12)
=========== ===========
Weighted average number of shares outstanding 2,355,641 2,397,241
=========== ===========
Diluted weighted average number of shares
outstanding 2,724,641 2,764,741
=========== ===========
The accompanying notes are an integral part of the consolidated
financial statements.
-4-
THE INTERGROUP CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
For the Six Months ended December 31, 2006 2005
----------- -----------
Justice Investors operations:
Hotel and garage revenue $ 15,708,000 $ -
Operating expenses (13,463,000) -
Interest expense (1,435,000) -
Real estate taxes (382,000) -
Depreciation and amortization (2,074,000) -
----------- -----------
Loss from Justice Investors operations (1,646,000) -
----------- -----------
Equity in net loss of Justice Investors - (1,740,000)
----------- -----------
Real estate operations:
Rental income 6,324,000 6,012,000
Property operating expense (3,684,000) (3,134,000)
Mortgage interest expense (1,825,000) (1,874,000)
Real estate taxes (876,000) (873,000)
Depreciation (1,184,000) (1,208,000)
----------- -----------
Loss from real estate operations (1,245,000) (1,077,000)
----------- -----------
Investment transactions:
Net gains on marketable securities 430,000 1,296,000
Impairment loss on other investments - (299,000)
Dividend and interest income 147,000 410,000
Margin interest and trading expenses (1,036,000) (1,150,000)
----------- -----------
Income(loss) from investment transactions (459,000) 257,000
----------- -----------
Other expense:
General and administrative expense (740,000) (807,000)
Other expense (119,000) (288,000)
----------- -----------
Other expense (859,000) (1,095,000)
----------- -----------
Loss before provision for income taxes and
minority interest (4,209,000) (3,655,000)
Provision for income tax benefit 1,710,000 1,390,000
----------- -----------
Loss before minority interest (2,499,000) (2,265,000)
Minority interest benefit, net of tax 913,000 514,000
----------- -----------
Loss from continuing operations $ (1,586,000) $ (1,751,000)
----------- -----------
Discontinued operations:
Net loss on discontinued operations $ (112,000) $ (296,000)
Gain on sale of real estate - 1,161,000
Provision for income tax benefit(expense) 46,000 (329,000)
----------- -----------
Income(loss) from discontinued operations $ (66,000) $ 536,000
----------- -----------
Net loss $ (1,652,000) $ (1,215,000)
=========== ===========
Loss per share from continuing operations
Basic $ (0.67) $ (0.73)
Diluted $ (0.67) $ (0.73)
=========== ===========
Income(loss) per share from discontinued operations
Basic $ (0.03) $ 0.22
Diluted $ (0.03) $ 0.19
=========== ===========
Loss per share
Basic $ (0.70) $ (0.51)
Diluted $ (0.70) $ (0.51)
=========== ===========
Weighted average number of shares outstanding 2,356,393 2,400,216
=========== ===========
Diluted weighted average number of shares
outstanding 2,725,393 2,767,716
=========== ===========
The accompanying notes are an integral part of the consolidated
financial statements.
-5-
THE INTEGROUP CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the Six Months ended December 31, 2006 2005
----------- -----------
Cash flows from operating activities:
Net loss $ (1,652,000) $ (1,215,000)
Adjustments to reconcile net loss to
cash provided by(used in) operating
activities:
Depreciation and amortization 3,258,000 1,328,000
Depreciation - discontinued operations - 117,000
Impairment loss on other investments - 299,000
Gain on sale of real estate - (1,161,000)
Net unrealized loss(gains) on investments 1,868,000 (1,419,000)
Equity in net loss from Justice Investors - 1,740,000
Minority interest benefit, net of tax (913,000) (514,000)
Changes in assets and liabilities:
Restricted cash (405,000) (127,000)
Investment in marketable securities 8,461,000 (6,789,000)
Prepaid expenses and other assets (4,088,000) (2,680,000)
Accounts payable and other liabilities 1,934,000 686,000
Due to broker (2,549,000) 6,137,000
Obligation for securities sold (5,038,000) 1,156,000
----------- -----------
Net cash provided by(used in) operating activities 876,000 (2,442,000)
----------- -----------
Cash flows from investing activities:
Net proceeds from sale of real estate - 8,240,000
Additions to buildings, improvements
and equipment (1,249,000) (1,831,000)
Purchase of Santa Fe stock (18,000) (125,000)
Purchase of Portsmouth stock - (260,000)
----------- -----------
Net cash (used in)provided by investing activities (1,267,000) 6,024,000
----------- -----------
Cash flows from financing activities:
Borrowings from mortgage notes payable 325,000 -
Principal payments on mortgage notes payable (723,000) (3,224,000)
Payment on line of credit - (255,000)
Purchase of treasury stock (101,000) (375,000)
----------- -----------
Net cash used in financing activities (499,000) (3,854,000)
----------- -----------
Net decrease in cash and cash equivalents (890,000) (272,000)
Cash and cash equivalents at beginning of
period 2,935,000 868,000
----------- -----------
Cash and cash equivalents at end of period $ 2,045,000 $ 596,000
=========== ===========
Supplemental disclosure of non-cash activities:
Consolidation of Justice Investors as of July 1, 2006
Gross components:
Assets(including cash of $2,352,000) $(42,975,000) $ -
Liabilities 52,366,000 -
Investment in Justice (7,321,000) -
Minority interest (2,343,000) -
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, 2006 audited consolidated financial statements and notes
thereto.
As of December 31, 2006, the Company had the power to vote 78.1%, of the voting
shares of Santa Fe Financial Corporation ("Santa Fe"), a public company (OTCBB:
SFEF). Santa Fe's revenue is primarily generated through its 68.8% owned
subsidiary, Portsmouth Square, Inc. ("Portsmouth"), a public company (OTCBB:
PRSI). Portsmouth's operations primarily consist of owning and managing a
hotel property as a general partner and a 50% limited partner in Justice
Investors, a California limited partnership ("Justice" or the "Partnership").
Santa Fe, Portsmouth and Justice are consolidated into the Company's financial
statements. See Note 4 regarding the consolidation of Justice.
Certain prior quarter balances have been reclassified to conform with the
current quarter presentation.
The results of operations for the three and six months ended December 31, 2006
are not necessarily indicative of results to be expected for the full fiscal
year ending June 30, 2007.
Property held for sale - Discontinued Operations
Properties are classified as held for sale when management commits to a plan to
sell the asset, the asset is available for immediate sale, an active program to
locate a buyer has been initiated, the sale of the asset is probable, the sale
of the asset is actively marketed and it is unlikely that significant changes
to the sale plan will be made or withdrawn. As of December 31, 2006, the
Company had two properties classified as held for sale.
Earnings Per Share
Basic earnings per share is 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 December 31, 2006, the Company
had 371,250 stock options that were considered potentially dilutive common
shares and 33,750 stock options that were considered anti-dilutive. As of
December 31, 2005, the Company had 367,500 stock options that were considered
potentially dilutive common shares and 37,500 stock options that were
considered anti-dilutive. These amounts were included in the calculation for
diluted earnings per share.
-7-
Stock-Based Compensation Plans
As of December 31, 2006, the Company has two stock option plans, which are more
fully described in Note 1 of the Company's Annual Report on Form 10-KSB for
fiscal year ended June 30, 2006. On July 1, 2006, the Company implemented
Statement of Financial Accounting Standards 123(R), "Share-Based Payments"
("SFAS No. 123R") which replaced SFAS No. 123 and supercedes Opinion No. 25 and
the related implementation guidance. SFAS No. 123R addresses accounting for
equity-based compensation arrangements, including employee stock options. The
Company adopted the "modified prospective method" where stock-based
compensation expense is recorded beginning on the adoption date and prior
periods are not restated. Under this method, compensation expense is recognized
using the fair-value based method for all new awards granted after July 1,
2006. Additionally, compensation expense for unvested stock options that are
outstanding at July 1, 2006 is recognized over the requisite service period
based on the fair value of those options as previously calculated at the grant
date under the pro-forma disclosures of SFAS 123. The fair value of each grant
is estimated using the Black-Scholes option pricing model.
During the six months ended December 31, 2006, there were no options granted,
exercised or vested. Accordingly, no stock-based compensation expense was
recognized during the period. Since inception of the two stock options plans,
there have been no options exercised. For the fiscal year ended June 30, 2007,
it is expected that 2,250 employee options will be vested. However, the fair
value of the vested options is considered immaterial.
The following table summarizes the stock option activity for the periods
indicated:
Number of Weighted-average
Shares Exercise Price
---------- ---------------
Unexercised options
Outstanding at July 1, 2006 405,000 $9.91
Granted - -
Exercised - -
Forfeited - -
---------- ---------------
Unexercised options
Outstanding at December 31, 2006 405,000 $9.91
========== ===============
As of December 31, 2006, of the total 405,000 unexercised options outstanding,
6,750 were not yet vested.
Unexercised Range of Weighted Average Weighted Average
Options Exercise Price Exercise Price Remaining Life
---------------- -------------- ---------------- ----------------
December 31, 2006 $7.92-$29.63 $ 9.91 3.20 years
Prior to the adoption to SFAS No 123R, the Company accounted for stock-based
awards using the intrinsic value method in accordance with APB Opinion No. 25,
Accounting for Stock Issued to Directors and Employees. The following table
illustrates the effect on the six months ended December 31, 2005 net income and
earnings per share if the Company had applied the fair value recognition
provisions of SFAS No. 123, as amended by SFAS No. 148:
-8-
For the six months ended December 31, 2005
------------
Net loss $(1,215,000)
Stock based employee
Compensation expense* (44,000)
------------
Pro forma net loss $(1,259,000)
============
Loss per share
Basic as reported $ (0.51)
Basic pro forma $ (0.52)
Diluted as reported $ (0.51)
Diluted pro forma $ (0.52)
2. Investment in Real Estate
As of December 31, 2006, the Company has listed for sale its 224-unit and its
30-unit apartment buildings located in Irving, Texas and Los Angeles,
California, respectively.
Under the provisions of the Statement of Financial Accounting Standards No.144,
Accounting for Impairment or Disposal of Long-Lived Assets, for properties
disposed of or listed for sale during the year, the revenues and expenses are
accounted for under discontinued operations in the statement of operations.
The revenues and expenses from the operation of these properties have been
reclassified from continuing operations for the three and six months ended
December 31, 2006 and December 31, 2005 and reported as income from
discontinued operations in the consolidated statements of operations.
The revenues and expenses from the operation of the properties that were sold
or listed for sale during three and six months ended December 31, 2006 and
December 31, 2005, are summarized as follows:
For the three months ended December 31, 2006 2005
---------- ----------
Revenues $ 495,000 $ 341,000
Expenses (549,000) (474,000)
---------- ----------
Net loss (54,000) (133,000)
========== ==========
Depreciation expense for the three months ended December 31, 2006 and December
31, 2005, was zero and $49,000, respectively.
For the six months ended December 31, 2006 2005
---------- ----------
Revenues $ 943,000 $ 795,000
Expenses (1,055,000) (1,091,000)
---------- ----------
Net loss (112,000) (296,000)
========== ==========
Depreciation expense for the six months ended December 31, 2006 and December
31, 2005, was zero and $117,000, respectively.
-9-
3. Investment in Marketable Securities:
The Company's investment in marketable securities consists primarily of
corporate equities. The Company has also invested in corporate bonds and income
producing securities, which may include interests in real estate based
companies and REITs, where financial benefit could inure to its shareholders
through income and/or capital gain.
At December 31, 2006, all of the Company's marketable securities are classified
as trading securities. In accordance with SFAS No. 115, "Accounting for
Certain Investments in Debt and Equity Securities," the change in the
unrealized gains and losses on these investments are included earnings.
Trading securities are summarized as follows:
As of December 31, 2006
Gross Gross Net Market
Investment Cost Unrealized Gain Unrealized Loss Unrealized Gain Value
---------- ----------- --------------- --------------- --------------- -----------
Equities $15,703,000 $4,840,000 ($1,686,000) $3,154,000 $18,857,000
As of December 31, 2006, the Company had $1,098,000 of unrealized losses
related to securities held for over one year.
As part of the investment strategies, the Company may assume short positions
against its long 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 December 31, 2006, the Company had
obligations for securities sold (equities short) of $1,597,000.
Net gains on marketable securities on the statement of operations are comprised
of realized and unrealized gains. Below is the composition of the two
components for the three and six months ended December 31, 2006 and December
31, 2005, respectively.
For the three months ended December 31, 2006 2005
----------- -----------
Realized gains on marketable securities $ 1,826,000 $ 58,000
Unrealized (losses)gains on marketable securities (516,000) 1,249,000
----------- -----------
Net gains on marketable securities 1,310,000 $ 1,307,000
=========== ===========
For the six months ended December 31, 2006 2005
----------- -----------
Realized gains(losses) on marketable securities $ 2,298,000 $ (123,000)
Unrealized (losses)gains on marketable securities (1,868,000) 1,419,000
----------- -----------
Net gains on marketable securities $ 430,000 $ 1,296,000
=========== ===========
-10-
4. Investment in Justice Investors:
Justice Investors owns the land, improvements and leaseholds known as the
Hilton San Francisco Financial District, located at 750 Kearny Street, San
Francisco, California (the "Hotel"). During the quarter ended December 30,
2006, the Partnership converted four of the less desirable rooms located on the
fifth floor of the Hotel to office space, reducing the total number of guest
rooms to 545.
The Company amortizes on a straight-line basis the step up in the asset values
which represents the excess purchase price over the underlying book value and
is allocable to the depreciable assets of its investment in Justice Investors
over 40 years, which approximates the remaining life of the primary asset, the
hotel building.
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. 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.
On December 22, 2006, Justice obtained an extension of the $2,000,000 short-
term portion of its credit facility with United Commercial Bank ("UCB") from
December 31, 2006 to March 2, 2007. On January 12, 2007, UCB increased the
amount of the short-term portion available to Justice to $2,500,000, making the
total amount available under its line of credit with UCB $17,000,000. As of
December 31, 2006, the total outstanding balance of both portions of its line
of credit was $16,050,000.
On July 14, 2005, the Financial Accounting Standards Board directed Staff
Position (FSP) SOP 78-9-1, "Interaction of AICPA Statement of Position 78-9 and
EITF Issue No. 04-5" to amend the guidance in AICPA Statement of Position 78-9,
"Accounting for Investments in Real Estate Ventures" (SOP 78-9) to be
consistent with the consensus in Emerging Issues Task Force Issue No. 04-5
"Determining Whether a General Partner, or General Partners as a Group,
Controls a Limited Partnership or Similar Entity When the Limited Partners Have
Certain Rights" (Issue 04-5). FSP SOP 78-9-1 eliminated the concept of
"important rights" in paragraph .09 of SOP 78-9 and replaces it with the
concepts of "kick out rights" and "substantive participating rights" as defined
in Issue 04-5. In accordance with guidance set forth in FSP SOP 78-9-1,
Portsmouth has applied the principles of accounting applicable for investments
in subsidiaries due to its substantial limited partnership interest and general
partnership rights and has consolidated the financial statements of Justice
with those of the Company effective with the first reporting period of its
fiscal year beginning July 1, 2006.
For the three and six months ended December 31, 2006, the results of operations
for Justice were consolidated with those of the Company. However, for the
three and six months ended December 31, 2005, the Company's investment in
Justice was accounted for under the equity method. For comparative purposes,
the statement of operations for Justice for the three and six months ended
December 31, 2006 and December 31, 2005 are disclosed below.
Significant to note is the operations of the Hotel were temporarily closed down
effective May 31, 2005, to complete the substantial renovations of the Hotel
required by the Hilton Franchise Agreement. Thus, the Hotel did not generate
-11-
any room or food and beverage revenues during the first six months of fiscal
2006. The below ground parking garage and Tru Spa located on the lobby level of
the Hotel, both of which are lessees of the Partnership, remained open during
the renovation work. As of January 12, 2006 the Hotel renovation work was
substantially completed, at which time Justice obtained approval from Hilton to
open the Hotel as the "Hilton San Francisco Financial District". The Hotel
opened with a limited number of rooms available to rent, which increased as the
Hotel transitioned into full operations by the end of February 2006.
JUSTICE INVESTORS
STATEMENTS OF OPERATIONS
For the three months ended December 31, 2006 2005
---------- ----------
Revenues:
Hotel rooms $ 6,186,000 $ -
Food and beverage 1,311,000 -
Rent - hotel garage 380,000 168,000
Other 239,000 76,000
Total revenues ---------- ----------
8,116,000 244,000
Operating expenses:
Hotel rooms (1,800,000) (90,000)
Food and beverage (1,343,000) (43,000)
Other operating expenses (2,768,000) (914,000)
Interest expense (686,000) (42,000)
Real estate taxes (201,000) (51,000)
Depreciation and amortization (1,040,000) (143,000)
General and administrative (1,206,000) (992,000)
---------- ----------
Total expenses (9,044,000) (2,275,000)
---------- ----------
(928,000) (2,031,000)
Intercompany eliminations 13,000 13,000
---------- ----------
Net loss $ (915,000) $(2,018,000)
========== ==========
JUSTICE INVESTORS
STATEMENTS OF OPERATIONS
For the six months ended December 31, 2006 2005
---------- ----------
Revenues:
Hotel rooms $ 12,067,000 $ -
Food and beverage 2,325,000 -
Rent - hotel garage 811,000 325,000
Other 505,000 192,000
Total revenues ---------- ----------
15,708,000 517,000
Operating expenses:
Hotel rooms (3,717,000) (185,000)
Food and beverage (2,644,000) (57,000)
Other operating expenses (5,100,000) (1,223,000)
Interest expense (1,435,000) (176,000)
Real estate taxes (382,000) (184,000)
Depreciation and amortization (2,074,000) (283,000)
General and administrative (2,028,000) (1,900,000)
---------- ----------
Total expenses (17,380,000) (4,008,000)
---------- ----------
(1,672,000) (3,491,000)
Intercompany eliminations 26,000 26,000
---------- ----------
Net loss $ (1,646,000) $(3,465,000)
========== ==========
-12-
During the three and six months ended December 31, 2006, Portsmouth received
monthly general partner management fees in the amount of $13,000 and $26,000,
respectively, from Justice Investors. This amount was eliminated from Justice
operating expenses during consolidation.
Below are the comparative standalone statements of operations for the Hotel for
the indicated periods.
For the three months ended December 31, 2006 2005
----------- ----------
Operating revenue:
Room $ 6,186,000 $ -
Food and beverage 1,311,000 -
Other operating revenue 151,000 9,000
----------- ----------
Total operating revenue 7,648,000 9,000
----------- ----------
Operating expenses:
Rooms (1,800,000) (90,000)
Food and beverage (1,343,000) (43,000)
Other operating expenses (3,682,000) (1,065,000)
----------- ----------
Total operating expenses (6,825,000) (1,198,000)
----------- ----------
Net income(loss) from Hotel operations 823,000 (1,189,000)
Net expenses at Justice Investors (1,738,000) (829,000)
----------- ----------
Net loss from Justice Investors $ (915,000) $(2,018,000)
=========== ==========
For the six months ended December 31, 2006 2005
----------- ----------
Operating revenue:
Room $ 12,067,000 $ -
Food and beverage 2,325,000 -
Other operating revenue 329,000 6,000
----------- ----------
Total operating revenue 14,821,000 6,000
----------- ----------
Operating expenses:
Rooms (3,717,000) (185,000)
Food and beverage (2,644,000) (57,000)
Other operating expenses (6,896,000) (1,580,000)
----------- ----------
Total operating expenses (13,357,000) (1,822,000)
----------- ----------
Net income(loss) from Hotel operations 1,464,000 (1,816,000)
Net expenses at Justice Investors (3,110,000) (1,649,000)
----------- ----------
Net loss from Justice Investors $ (1,646,000) $(3,465,000)
=========== ==========
-13-
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.
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 six months
ended December 31, 2006 and December 31, 2005. Operating income for rental
properties consists of rental income. Operating income from Justice Investors
consists of the operations of the hotel and garage. Operating income(loss) for
investment transactions consist of net investment gains(losses)and dividend and
interest income.
Real Estate
-------------------------
Three months ended Rental Justice Investment Discontinued
December 31, 2006 Properties Investors Transactions Other Subtotal Operations Total
----------- ----------- ------------ ----------- ------------ ------------ ------------
Operating income $ 3,151,000 $ 8,116,000 $ 1,399,000 $ - $ 12,666,000 $ 495,000 $ 13,161,000
Operating expenses (2,223,000) (7,103,000) (556,000) - (9,882,000) (275,000) (10,157,000)
Real estate taxes (433,000) (202,000) - - (635,000) (64,000) (699,000)
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net operating income 495,000 811,000 843,000 - 2,149,000 156,000 2,305,000
Mortgage interest expense (910,000) (686,000) - - (1,596,000) (210,000) (1,806,000)
Depreciation and amort. (589,000) (1,040,000) - - (1,629,000) - (1,629,000)
General and administrative
Expense - - - (346,000) (346,000) - (346,000)
Other expense - (59,000) - (59,000) - (59,000)
Income tax benefit - - - 635,000 635,000 23,000 658,000
Minority interest - 372,000 - (102,000) 270,000 - 270,000
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net income(loss) $(1,004,000) (602,000) $ 843,000 $ 187,000 $ (576,000) $ (31,000) $ (607,000)
=========== =========== =========== =========== ============ ============ ============
Total Assets $64,191,000 $56,615,000 $25,251,000 $ 4,051,000 $ 150,108,000 $ 14,089,000 $164,197,000
=========== =========== =========== =========== ============ ============ ============
Real Estate
-------------------------
Three months ended Rental Justice Investment Discontinued
December 31, 2005 Properties Investors Transactions Other Subtotal Operations Total
----------- ----------- ------------ ----------- ------------ ------------ ------------
Operating income(loss) $ 2,984,000 $(1,011,000) $ 1,181,000 $ - $ 3,154,000 $ 341,000 $ 3,495,000
Operating expenses (1,706,000) - (590,000) - (2,296,000) (269,000) (2,565,000)
Real estate taxes (434,000) - - - (434,000) (58,000) (492,000)
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net operating income(loss) 844,000 (1,011,000) 591,000 - 424,000 14,000 438,000
Mortgage interest expense (937,000) - - - (937,000) (98,000) (1,035,000)
Depreciation (588,000) - - - (588,000) (49,000) (637,000)
Gain on sale of real estate - - - - - 1,185,000 1,185,000
General and administrative
Expense - - - (469,000) (469,000) - (469,000)
Other expense - (60,000) - (183,000) (243,000) - (243,000)
Income tax benefit - - - 684,000 684,000 (401,000) 283,000
Minority interest benefit - - - 193,000 193,000 - 193,000
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net income(loss) $ (681,000) $(1,071,000) $ 591,000 $ 225,000 $ (936,000) $ 651,000 $ (285,000)
=========== =========== =========== =========== ============ ============ ============
Total Assets $79,293,000 $ 7,991,000 $32,242,000 $10,118,000 $ 129,644,000 - $129,644,000
=========== =========== =========== =========== ============ ============ ============
-14-
Real Estate
-------------------------
Six months ended Rental Justice Investment Discontinued
December 31, 2006 Properties Investors Transactions Other Subtotal Operations Total
----------- ----------- ------------ ----------- ------------ ------------ ------------
Operating income $ 6,324,000 $15,708,000 $ 577,000 $ - $ 22,609,000 $ 943,000 $ 23,552,000
Operating expenses (3,684,000) (13,463,000) (1,036,000) - (18,183,000) (511,000) (18,694,000)
Real estate taxes (876,000) (382,000) - - (1,258,000) (125,000) (1,383,000)
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net operating income(loss) 1,764,000 1,863,000 (459,000) - 3,168,000 307,000 3,475,000
Mortgage interest expense (1,825,000) (1,435,000) - - (3,260,000) (419,000) (3,679,000)
Depreciation and amort. (1,184,000) (2,074,000) - - (3,258,000) - (3,258,000)
General and administrative
Expense - - - (740,000) (740,000) - (740,000)
Other expense - (119,000) - (119,000) - (119,000)
Income tax benefit - - - 1,710,000 1,710,000 46,000 1,756,000
Minority interest - 892,000 - 21,000 913,000 - 913,000
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net income(loss) $(1,245,000) (873,000) $ (459,000) $ 991,000 $ (1,586,000) $ (66,000) $ (1,652,000)
=========== =========== =========== =========== ============ ============ ============
Total Assets $64,191,000 $56,615,000 $25,251,000 $ 4,051,000 $ 150,108,000 $ 14,089,000 $164,197,000
=========== =========== =========== =========== ============ ============ ============
Real Estate
-------------------------
Six months ended Rental Justice Investment Discontinued
December 31, 2005 Properties Investors Transactions Other Subtotal Operations Total
----------- ----------- ------------ ----------- ------------ ------------ ------------
Operating income(loss) $ 6,012,000 $(1,738,000) $ 1,407,000 $ - $ 5,681,000 $ 795,000 $ 6,476,000
Operating expenses (3,134,000) - (1,150,000) - (4,284,000) (619,000) (4,903,000)
Real estate taxes (873,000) - - - (873,000) (128,000) (1,001,000)
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net operating income(loss) 2,005,000 (1,738,000) 257,000 - 524,000 48,000 572,000
Mortgage interest expense (1,874,000) - - - (1,874,000) (227,000) (2,101,000)
Depreciation (1,208,000) - - - (1,208,000) (117,000) (1,325,000)
Gain on sale of real estate - - - - - 1,161,000 1,161,000
General and administrative
Expense - - - (807,000) (807,000) - (807,000)
Other expense - (120,000) - (170,000) (290,000) - (290,000)
Income tax benefit - - - 1,390,000 1,390,000 (329,000) 1,061,000
Minority interest benefit - - - 514,000 514,000 - 514,000
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net income(loss) $(1,077,000) $(1,858,000) $ 257,000 $ 927,000 $ (1,751,000) $ 536,000 $ (1,215,000)
=========== =========== =========== =========== ============ ============ ============
Total Assets $79,293,000 $ 7,991,000 $32,242,000 $10,118,000 $ 129,644,000 - $129,644,000
=========== =========== =========== =========== ============ ============ ============
7. Subsequent event
On February 9, 2007, Justice Investors entered into an agreement with Dow Hotel
Company, to mutually terminate its management agreement and to transition the
day-to-day management responsibilities of the Hotel to another management
company, Prism Hospitality, L.P. ("Prism"). The management agreement with Prism
will be on the same general terms and conditions as the agreement with Dow,
with the exception of certain provisions unique to renovation and transition of
the Hotel that are no longer applicable. Like the Dow agreement, the management
agreement with Prism can be terminated by the Partnership upon sixty days
written notice. The effective date of the transition of the management to Prism
will commence on February 10, 2007 and that process should be completed on or
before March 31, 2007.
-15-
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 "anticipate," "estimate," "expect,"
"project," "intend," "plan," "believe," "may," "could," "might" and similar
expressions, are intended to identify forward-looking statements. These
statements are subject to certain risks and uncertainties, such as the impact
of terrorism and war on the national and international economies, including
tourism and securities markets, natural disasters, general economic conditions
and competition in the hotel industry in the San Francisco area, labor
relations and labor disruptions, partnership distributions, the ability to
obtain financing at favorable interest rates and terms, securities markets,
regulatory factors, litigation and other factors, including those discussed
below and in the Company's Form 10-KSB for the fiscal year ended June 30, 2006
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
The Company's principal business is the ownership and operation of real estate.
Properties include nineteen apartment complexes, the Hotel operations of
Justice Investors (Justice" or the "Partnership"), two commercial real estate
properties, and two single-family houses as strategic investments. The real
estate properties are located throughout the United States, but are
concentrated in Texas and Southern California. The Company also has
investments in unimproved real property. All of the Company's residential
rental properties, with exception of its Austin, Texas and Irving, Texas
properties, are managed by professional third party property management
companies.
The Company acquires its investments in real estate and other investments
utilizing cash, securities or debt, subject to approval or guidelines of the
Board of Directors. The Company also invests in income-producing instruments,
equity and debt securities and will consider other investments if such
investments offer growth or profit potential.
The Company's subsidiary, Portsmouth, has a 50.0% interest in the Justice and
serves as one of the general partners. Justice owns the land, improvements and
leaseholds at 750 Kearny Street, San Francisco, California, now known as the
Hilton San Francisco Financial District hotel (the "Hotel"). The financial
statements of Justice have been consolidated with those of the Company,
effective as of July 1, 2006. See Note 4 to the Consolidated Financial
Statements.
The Hotel is operated by the Partnership, with the assistance of a Management
Agreement with Dow Hotel Company, LLC. ("Dow") to perform the day-to-day
management. As discussed below, Justice and Dow have agreed to a mutual
termination of that Agreement and to the transition the day-to-day management
responsibilities of the Hotel to another management company effective February
10, 2007.
-16-
The Partnership also derives income from the lease of the garage portion of the
property to Evon Corporation ("Evon"), the managing general partner of Justice,
and from a lease with Tru Spa for a portion of the lobby level of the Hotel.
The Company also receives management fees as a general partner of Justice for
its services in overseeing and managing the Partnership's assets.
On December 10, 2004, Justice entered into a Franchise License Agreement for
the right to operate the Hotel property as a Hilton brand hotel. Prior to
operating the hotel as a Hilton, the Partnership was required to make
substantial renovations to the hotel to meet Hilton standards in accordance
with a product improvement plan agreed upon by Hilton and the Partnership, as
well as complying with other brand standards. The term of the Agreement is for
a period of 15 years commencing on the opening date, with an option to extend
the license term for another five years, subject to certain conditions.
Effective May 31, 2005, the Partnership temporarily closed down its Hotel
operations to complete the renovations of the Hotel as required by the Hilton
Agreement. The below ground parking garage and Tru Spa located on the lobby
remained open during the renovation work, although the operations of both were
impacted during that period of time.
As of January 12, 2006 the Hotel renovation work was substantially completed,
at which time the Partnership obtained approval from Hilton to open the Hotel
as the "Hilton San Francisco Financial District". The Hotel opened with a
limited number of rooms available to rent, which increased as the Hotel
transitioned into full operations by the end of February 2006.
Recent Developments
During the quarter ended December 31, 2006, Justice converted four of the less
desirable guest rooms located on the fifth floor of the Hotel into office space
for the Hotel's sales department. The conversion of those rooms to office space
reduced the total number of guest rooms in the Hotel to 545. The conversion of
those guest rooms is not expected to have any negative impact on Hotel revenues
and will provide needed space for the sales department to operate more
efficiently and generate more business.
On December 22, 2006, Justice obtained an extension of the $2,000,000 short-
term portion of its credit facility with United Commercial Bank ("UCB") from
December 31, 2006 to March 2, 2007. On January 12, 2007, UCB increased the
amount of the short-term portion available to Justice to $2,500,000, making the
total amount available under the Partnership's credit facility with UCB
$17,000,000. As of December 31, 2006, the total outstanding balance of both
portions of its line of credit was $16,050,000.
On February 9, 2007, Justice entered into an agreement with Dow, to mutually
terminate its management agreement and to transition the day-to-day management
responsibilities of the Hotel to another management company, Prism Hospitality,
L.P. ("Prism"). Prism is an experienced Hilton approved operator of upscale and
luxury hotels throughout the Americas and the Caribbean. The management
agreement with Prism will be on the same general terms and conditions as the
agreement with Dow, with the exception of certain provisions unique to
renovation and transition of the Hotel that are no longer applicable. Like the
Dow agreement, the management agreement with Prism can be terminated by the
Partnership upon sixty days written notice. The effective date of the
transition of the management to Prism will commence on February 10, 2007 and
that process should be completed on or before March 31, 2007. The operation of
the Hotel is expected to continue uninterrupted as if no termination had
occurred and Justice will honor all bookings and contracts for the use of the
Hotel and will retain all of the on-site management and employees.
-17-
For the Three Months Ended December 31, 2006 Compared to the
Three Months Ended December 31, 2005
The Company had a net loss of $607,000 for the three months ended December 31,
2006 compared to a net loss of $285,000 for the three months ended December 31,
2005. As discussed below, during the quarter ended December 31, 2006 as
compared to the quarter ended December 31, 2005, the Company had a decrease in
the loss from Justice Investors, an increase in the loss from real estate
operations, an increase in the income from investment transactions and a
decrease in other expenses.
The net loss from the operations of Justice Investors decreased to $915,000
(before minority interest of $462,000) for the three months ended December 31,
2006, compared equity in net loss of Justice Investors of $1,012,000 for the
three months ended December 31, 2005. That decrease was primarily attributable
to net income generated from the operations of the Hotel during the current
quarter compared to the comparable quarter when the Hotel was temporarily
closed for major renovations and from higher garage rental income in the
current quarter. Those results were partially offset by higher interest costs,
insurance costs, property taxes and greater depreciation and amortization
expenses resulting from the renovation of the Hotel.
For the three months ended December 31, 2006, the operations of the Hotel (on a
standalone basis) generated net income of $823,000 on total operating revenues
of approximately $7,648,000, while there were no revenues from the operations
of the Hotel during the three months ended December 31, 2005. Garage rent
increased to $380,000 from $168,000 primarily due to the Hotel being open
during the current quarter. The average daily room rate for the Hotel was
approximately $160 and the average occupancy rate was approximately 76% for the
three months ended December 31, 2006.
Average daily room rates have continued to improve since the Hotel's reopening
in January 2006 and average occupancy rates have held steady this fiscal year
even with December, one of the typically slower months, included in those
averages. We believe that many of the new programs implemented to increase
revenues and efficiencies at the Hotel, as well as certain personnel changes,
have helped improve operations. While food and beverage remains problematic,
the losses attributable to those operations were reduced in the current
quarter. Due to brand requirements of maintaining a three-meal, full service
restaurant, the associated costs of union labor, and the intense competition in
the San Francisco market for restaurants, food and beverage operations will
continue to be challenging. Management will continue to work to address those
issues and to explore all options to improve the operations of the Hotel.
The loss from real estate operations increased to $1,004,000 for the three
months ended December 31, 2006 from $681,000 for the three months ended
December 31, 2005 primarily as the result of the increase in property operating
expenses, partially offset by the increase in rental income. Rental income
increased to $3,151,000 from $2,984,000 primarily as the result of the improved
occupancy and increased rental income from the Company's real estate portfolio
as the result of the improving rental housing market. Operating expenses also
increased to $2,223,000 for the quarter ended December 31, 2006 from $1,706,000
for the quarter ended December 31, 2005 primarily as the result of a $560,000
legal reserve related to its real estate operations. The remaining increase in
operating expense is related to the increase in the occupancy of the Company's
apartments.
As of December 31, 2006, the Company has listed for sale its 224-unit and its
30-unit apartment buildings located in Irving, Texas and Los Angeles,
California, respectively. The revenues and expenses related to these
-18-
properties are classified under discontinued operations. During the quarter
ended December 31, 2006, there were no sales of real estate. During the quarter
ended December 31, 2005, the Company sold two properties and realized a gain on
the sale of real estate of $1,185,000.
The Company had net gains on marketable securities of $1,310,000 for the three
months ended December 31, 2006 compared to net gains on marketable securities
of $1,307,000 for the three months ended December 31, 2005. For the three
months ended December 31, 2006, the Company had net realized gains of
$1,826,000 and net unrealized losses of $516,000. For the three months ended
December 31, 2005, the Company had net realized gains of $58,000 and net
unrealized gains of $1,249,000. 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 decreased to $89,000 for the three months ended
December 31, 2006 from $115,000 for the three months ended December 31, 2005 as
a result of the decreased investment in income yielding securities during the
quarter ended December 31, 2006.
Other expense decreased to $59,000 for the three months ended December 31, 2006
from $242,000 for the three months ended December 31, 2005 primarily as the
result of the $189,000 in litigation expenses and reserves recorded in the
quarter ended December 31, 2005 related to the Company's operations.
The provision for income tax benefit increased to $658,000 for the three months
ended December 31, 2006 from $283,000 for the three months ended December 31,
2005 as the result of the higher pre-tax loss incurred by the Company during
the current quarter ended December 31, 2006.
Minority interest benefit, increased to $270,000 from $193,000 primarily as the
result of the $462,000 minority interest benefit recognized during the quarter
ended December 31, 2006 related to the consolidation of Justice Investors. For
the three months ended December 31, 2005, the Company's investment in Justice
Investors was recorded on an equity basis.
For the Six Months Ended December 31, 2006 Compared to the
Six Months Ended December 31, 2005
The Company had a net loss of $1,652,000 for the six months ended December 31,
2006 compared to a net loss of $1,215,000 for the six months ended December 31,
2005. As discussed below, during the six months ended December 31, 2006 as
compared to the six months ended December 31, 2005, the Company had a decrease
in the loss from Justice Investors, a significant change in the income from
investment transactions, an increase in the net loss from real estate
operations and a decrease in other expenses.
The net loss from the operations of Justice Investors decreased to $1,646,000
(before minority interest of $835,000) for the six months ended December 31,
2006 from equity in net loss of Justice Investors of $1,740,000 for the six
months ended December 31, 2005. That decrease was primarily attributable to net
income generated from the operations of the Hotel during the current period
compared to the comparable six months when the Hotel was temporarily closed for
major renovations and from higher garage rental income in the current period.
Those results were partially offset by higher interest costs, insurance costs,
property taxes and greater depreciation and amortization expenses resulting
from the renovation of the Hotel.
-19-
Dividend and interest income decreased to $147,000 for the six months ended
December 31, 2006 from $410,000 for the six months ended December 31, 2005 as a
result of the decreased investment in income yielding securities during the six
months ended December 31, 2006.
Other expense decreased to $119,000 for the six months ended December 31, 2006
from $288,000 for the months ended December 31, 2005 primarily as the result of
the $189,000 in litigation expenses and reserves recorded in the six months
ended December 31, 2005 related to the Company's operations.
The provision for income tax benefit increased to $1,756,000 for the six months
ended December 31, 2006 from $1,390,000 for the six months ended December 31,
2005 as the result of the higher pre-tax loss incurred by the Company during
the six months ended December 31, 2006.
Minority interest benefit increased to $913,000 from $514,000 primarily as the
result of the $835,000 minority interest benefit recognized during the six
months ended December 31, 2006 related to the consolidation of Justice
Investors. For the six months ended December 31, 2005, the Company's
investment in Justice Investors was recorded on an equity basis.
MARKETABLE SECURITIES
The Company's investment portfolio is diversified with 61 different equity
positions. The portfolio contains four individual equity securities that are
more than 5% of the equity value of the portfolio with the largest security
being 10.4% of the value of the portfolio. 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 December 31, 2006, the Company had investments in marketable equity
securities of $18,857,000. The following table shows the composition of the
Company's marketable securities portfolio by selected industry groups as of
December 31, 2006.
% of Total
Investment
Industry Group Market Value Securities
-------------- ------------ ----------
Telecommunications and media $ 3,783,000 20.1%
Retail and consumer goods 2,733,000 14.5%
Dairy products 2,475,000 13.1%
REITs and building materials 2,146,000 11.4%
Services 2,061,000 10.9%
Newspapers and paper mills 996,000 5.3%
Insurance, banks and brokers 899,000 4.8%
Utilities and energy 893,000 4.7%
Pharmaceuticals and healthcare 688,000 3.6%
Other 2,183,000 11.6%
------------ ----------
$18,857,000 100.0%
============ ==========
-21-
The following table shows the investment income(loss) on the Company's
marketable securities and the associated margin interest and trading expenses
for the indicated periods.
For the three months ended December 31, 2006 2005
-------------- --------------
Net gains on marketable securities $ 1,310,000 $ 1,307,000
Impairment loss on other investments - (241,000)
Dividend & interest income 89,000 115,000
Margin interest expense (150,000) (148,000)
Trading and management expenses (406,000) (442,000)
------------ ------------
$ 843,000 $ 591,000
============ ============
For the six months ended December 31, 2006 2005
-------------- --------------
Net gains on marketable securities $ 430,000 $ 1,296,000
Impairment loss on other investments - (299,000)
Dividend & interest income 147,000 410,000
Margin interest expense (324,000) (321,000)
Trading and management expenses (712,000) (829,000)
------------ ------------
$ (459,000) $ 257,000
============ ============
FINANCIAL CONDITION AND LIQUIDITY
The Company's cash flows are generated primarily from the Hotel operations of
Justice, its real estate activities, sales of investment securities and
borrowings related to both. During the six months ended December 31, 2006,
operating activities provided cash of $948,000, financing activities used cash
of $571,000 and investing activities used cash of $1,267,000.
During the six months ended December 31, 2006, the Company made property
improvements in the aggregate amount of $1,249,000. 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.
Prior to operating the hotel as a Hilton, the Partnership was required to make
substantial renovations to the hotel to meet Hilton standards in accordance
with a product improvement plan agreed upon by Hilton and the Partnership, as
well as complying with other brand standards. The total cost of the
construction-renovation project of the Hotel was approximately $36.4 million,
which excludes approximately $630,000 in interest costs incurred during for the
construction phase that were capitalized.
To meet its substantial financial commitments for the renovation project and
transition of the Hotel to a Hilton, Justice had to rely on borrowings to meet
its obligations. On July 27, 2005, Justice entered into a first mortgage loan
(the "Prudential Loan") with The Prudential Insurance Company of America in a
principal amount of $30,000,000. The term of the Loan is for 120 months at a
fixed interest rate of 5.22% per annum. The Loan calls for monthly installments
of principal and interest in the amount of approximately $165,000, calculated
on a 360 month amortization schedule. The Loan is collateralized by a first
deed of trust on the Partnership's Hotel property, including all improvements
and personal property thereon and an assignment of all present and future
leases and rents. The Loan is without recourse to the limited and general
partners of Justice.
-22-
On July 27, 2005, Justice also obtained a $10,000,000 Revolving Line of Credit
("LOC") from United Commercial Bank ("UCB"). The term of the LOC is for 60
months at an annual interest rate, based on an index selected by Justice at the
time of the advance, equal to the Wall Street Journal Prime Rate or the Libor
Rate plus 2% (7.35% as of 12/31/06), fixed for the period selected by the
Partnership. The LOC is collateralized by a second deed of trust on the Hotel
property. Interest only is payable monthly with principal and accrued interest
due at maturity. On January 20, 2006, the Partnership obtained a $4,500,000
increase in its LOC, raising the total amount available to the Partnership to
$14,500,000. The increase in the credit line is on the same terms as the
existing line of credit. On May 23, 2006, Justice obtained a short-term
increase in the amount available under its LOC of $2,000,000, which was raised
to $2,500,000 on January 12, 2007, making the total amount available to the
Partnership under its credit facility with UCB $17,000,000. If the short-term
portion of its LOC is not paid off by March 2, 2007, UCB has the right to
record a lien on the Hotel property for the additional $2,500,000. That
increase is also on the same terms as the existing LOC, with additional
documentation fees of $1,000. As of December 31, 2006, approximately
$16,050,000 of the LOC was utilized.
The Prudential Loan and the LOC have provided Justice with sufficient financial
resources for the Partnership to complete the substantial renovations to the
Hotel required by its Franchise License Agreement with Hilton and to meet its
debt service requirements and operating capital needs through the reopening of
the Hotel and the period of time necessary to ramp up operations. The Hotel
started to generate net operating income from its operations in June 2006,
which have continued to improve during the first six months of the Company's
current fiscal year. Management believes that the revenues expected to be
generated from the Hotel operations and the garage lease will be sufficient to
meet all of the Partnership's current and future obligations and financial
requirements. Management also believes that there is sufficient equity in the
Hotel assets to support future borrowings if necessary to fund any new capital
improvements and other requirements.
The additional amount of leverage related to the Prudential Loan and the
utilization of the LOC and the associated debt service create additional risk
for the Company and its ability to generate cash flows in the future since the
Hotel asset has been virtually debt free for many years. Justice also does not
anticipate paying any partnership distributions until net income from the
operations of the Hotel and capital requirements warrant such distributions.
As a result, the Company may have to continue to rely on revenues generated
from the investment of its cash and securities assets during that transition
period.
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.
OFF-BALANCE SHEET ARRANGEMENTS
The Company has no off balance sheet arrangements.
-23-
MATERIAL CONTRACTUAL OBLIGATIONS
The Company also does not have any material contractual obligations or
commercial commitments other than the mortgages of its rental properties and
Justice Investors' first mortgage loan with Prudential and its LOC with United
Commercial Bank.
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 Dow 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.
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.
-24-
(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.
PART II.
OTHER INFORMATION
Item 4. Unregistered Sales of Equity Securities and Use of Proceeds
(a) None.
(b) Not applicable.
(c) Purchases of equity securities by the small business issuer and affiliated
purchasers.
SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES
(c)Total Number (d)Maximum Number
(a)Total (b) of Shares Purchased of Shares that May
Number of Average as Part of Publicly Yet Be Purchased
2006 Shares Price Paid Announced Plans Under the Plans
Period Purchased Per Share or Programs or Programs
--------------------------------------------------------------------------------------
Month #1
(Oct. 1- 294 $16.77 294 32,319
Oct. 31)
--------------------------------------------------------------------------------------
Month #2
(Nov. 1- 200 $18.07 200 32,119
Nov. 30)
--------------------------------------------------------------------------------------
Month #3
(Dec. 1- 1,981 $18.28 1,981 30,138
Dec. 31)
--------------------------------------------------------------------------------------
Total 2,475 $18.08 2,475 30,138
--------------------------------------------------------------------------------------
The Company currently has only one stock repurchase program. The program was
initially announced on January 13, 1998 and was first amended on February 10,
2003. The total number of shares authorized to be repurchased was 720,000,
adjusted for stock splits. On October 12, 2004, the Board of Directors
authorized the Company to purchase up to an additional 150,000 shares of
Company's common stock, increasing the total remaining number of shares
authorized for repurchase to 152,941. The program has no expiration date and
can be amended from time to time in the discretion of the Board of Directors.
No plan or program expired during the period covered by the table.
-25-
Item 5. Other Information
On February 9, 2007, Justice Investors entered into an agreement with Dow Hotel
Company, to mutually terminate its management agreement and to transition the
day-to-day management responsibilities of the Hotel to another management
company, Prism Hospitality, L.P. ("Prism"). Prism is an experienced Hilton
approved operator of upscale and luxury hotels throughout the Americas and the
Caribbean. The management agreement with Prism will be on the same general
terms and conditions as the agreement with Dow, with the exception of certain
provisions unique to renovation and transition of the Hotel that are no longer
applicable. Like the Dow agreement, the management agreement with Prism can be
terminated by the Partnership upon sixty days written notice. The effective
date of the transition of the management to Prism will commence on February 10,
2007 and that process should be completed on or before March 31, 2007. The
operation of the Hotel is expected to continue uninterrupted as if no
termination had occurred and Justice will honor all bookings and contracts for
the use of the Hotel and will retain all of the on-site management and
employees.
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) Reports on Form 8-K:
-------------------
The Company filed the following reports on Form 8-K during the last quarter of
the period covered by this Report:
Date of Report Item Number Events Reported
----------------- ------------ ---------------------------------------
October 2, 2006 Items 3.01 Notice of Receipt of Staff Deficiency
and 9.01 letter from NASDAQ and Press Release
October 16, 2006 Items 3.01 Notice of Transfer of Listing of
And 9.01 Common Stock to MASDAQ Capital Market
and Press Release
-26-
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: February 13, 2007 by /s/ John V. Winfield
----------------------------
John V. Winfield, President,
Chairman of the Board and
Chief Executive Officer
Date: February 13, 2007 by /s/ David T. Nguyen
------------------------------
David T. Nguyen, Treasurer
and Controller
(Principal Accounting Officer)
-27-