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 March 31, 2007
[ ] 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 May 10, 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 March 31, 2007 (unaudited) 3
Consolidated Statements of Operations (unaudited)
For the Three Months Ended March 31, 2007 and 2006 4
Consolidated Statements of Operations (unaudited)
For the Nine Months Ended March 31, 2007 and 2006 5
Consolidated Statements of Cash Flows (unaudited)
For the Nine Months Ended March 31, 2007 and 2006 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 26
Part II. OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use
of Proceeds 27
Item 4. Submission of Matters to a Vote of Shareholders 27
Item 6. Exhibits and Reports on Form 8-K 28
SIGNATURES 29
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PART I
FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
THE INTERGROUP CORPORATION
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
As of March 31, 2007
-----------
ASSETS
Investment in hotel, at cost:
Land $ 1,124,000
Furniture and equipment 15,260,000
Building and improvements 42,961,000
Accumulated depreciation (17,812,000)
-----------
41,533,000
Investment in real estate, at cost:
Land 25,989,000
Buildings, improvements and equipment 69,898,000
Accumulated depreciation (21,907,000)
-----------
73,980,000
Property held for sale 3,636,000
-----------
77,616,000
Cash and cash equivalents 3,425,000
Restricted cash 2,274,000
Investment in marketable securities 18,740,000
Other investments 7,944,000
Prepaid expenses and other assets 14,379,000
-----------
Total assets $165,911,000
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Accounts payable and other liabilities 11,966,000
Due to securities broker $ 10,316,000
Obligation for securities sold 950,000
Line of credit 4,258,000
Mortgage note payable - hotel 48,316,000
Mortgage note payable - real estate 73,695,000
Mortgage note payable - property held for sale 4,043,000
Deferred income taxes 3,887,000
-----------
Total liabilities 157,431,000
-----------
Minority interest 1,124,000
-----------
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, 2,351,027 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 7,619,000
Treasury stock, at cost, 842,718 shares (8,970,000)
-----------
Total shareholders' equity 7,356,000
-----------
Total liabilities and shareholders' equity $165,911,000
===========
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, 2007 2006
----------- -----------
Justice Investors operations:
Hotel and garage revenue $ 7,654,000 $ -
Operating expenses (7,297,000) -
Interest expense (745,000) -
Real estate taxes (176,000) -
Depreciation and amortization (1,042,000) -
----------- -----------
Loss from Justice Investors operations (1,606,000) -
----------- -----------
Equity in net loss of Justice Investors - (1,564,000)
----------- -----------
Real estate operations:
Rental income 3,320,000 3,042,000
Property operating expense (1,618,000) (1,620,000)
Mortgage interest expense (1,035,000) (914,000)
Real estate taxes (452,000) (482,000)
Depreciation (847,000) (560,000)
----------- -----------
Loss from real estate operations (632,000) (534,000)
----------- -----------
Investment transactions:
Net gains on marketable securities 1,737,000 4,439,000
Dividend and interest income 98,000 170,000
Margin interest and trading expenses (577,000) (698,000)
----------- -----------
Income from investment transactions 1,258,000 3,911,000
----------- -----------
Other income(expense):
General and administrative expense (549,000) (338,000)
Other income(expense) (60,000) 172,000
----------- -----------
Other expense (609,000) (166,000)
----------- -----------
Income(loss) before provision for income taxes and
minority interest (1,589,000) 1,647,000
Provision for income tax benefit(expense) 668,000 (613,000)
----------- -----------
Income(loss) before minority interest (921,000) 1,034,000
Minority interest benefit(expense), net of tax 781,000 (135,000)
----------- -----------
Income(loss) from continuing operations $ (140,000) $ 899,000
----------- -----------
Discontinued operations:
Net income(loss)on discontinued operations $ 104,000 $ (22,000)
Gain on sale of real estate - 160,000
Provision for income tax expense (43,000) (55,000)
----------- -----------
Income from discontinued operations $ 61,000 $ 83,000
----------- -----------
Net income(loss) $ (79,000) $ 982,000
=========== ===========
Income(loss) per share from continuing operations
Basic $ (0.06) $ 0.38
Diluted $ (0.06) $ 0.33
=========== ===========
Income per share from discontinued operations
Basic $ 0.03 $ 0.03
Diluted $ 0.03 $ 0.03
=========== ===========
Income(loss) per share
Basic $ (0.03) $ 0.41
Diluted $ (0.03) $ 0.36
=========== ===========
Weighted average number of shares outstanding 2,351,246 2,378,643
=========== ===========
Diluted weighted average number of shares
outstanding 2,722,496 2,747,643
=========== ===========
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, 2007 2006
----------- -----------
Justice Investors operations:
Hotel and garage revenue $ 23,362,000 $ -
Operating expenses (20,760,000) -
Interest expense (2,180,000) -
Real estate taxes (558,000) -
Depreciation and amortization (3,116,000) -
----------- -----------
Loss from Justice Investors operations (3,252,000) -
----------- -----------
Equity in net loss of Justice Investors - (3,303,000)
----------- -----------
Real estate operations:
Rental income 9,801,000 9,054,000
Property operating expense (5,426,000) (4,777,000)
Mortgage interest expense (3,130,000) (2,801,000)
Real estate taxes (1,358,000) (1,355,000)
Depreciation (2,031,000) (1,768,000)
----------- -----------
Loss from real estate operations (2,144,000) (1,647,000)
----------- -----------
Investment transactions:
Net gains on marketable securities 2,167,000 5,735,000
Impairment loss on other investments - (299,000)
Dividend and interest income 245,000 594,000
Margin interest and trading expenses (1,613,000) (1,848,000)
----------- -----------
Income from investment transactions 799,000 4,182,000
----------- -----------
Other expense:
General and administrative expense (1,288,000) (1,145,000)
Other expense (179,000) (117,000)
----------- -----------
Other expense (1,467,000) (1,262,000)
----------- -----------
Loss before provision for income taxes and
minority interest (6,064,000) (2,030,000)
Provision for income tax benefit 2,486,000 801,000
----------- -----------
Loss before minority interest (3,578,000) (1,229,000)
Minority interest benefit, net of tax 1,694,000 379,000
----------- -----------
Loss from continuing operations $ (1,884,000) $ (850,000)
----------- -----------
Discontinued operations:
Net income(loss) on discontinued operations $ 259,000 $ (296,000)
Gain on sale of real estate - 1,321,000
Provision for income tax expense (106,000) (408,000)
----------- -----------
Income from discontinued operations $ 153,000 $ 617,000
----------- -----------
Net loss $ (1,731,000) $ (233,000)
=========== ===========
Loss per share from continuing operations
Basic $ (0.80) $ (0.36)
Diluted $ (0.80) $ (0.36)
=========== ===========
Income per share from discontinued operations
Basic $ 0.06 $ 0.26
Diluted $ 0.06 $ 0.22
=========== ===========
Loss per share
Basic $ (0.74) $ (0.10)
Diluted $ (0.74) $ (0.10)
=========== ===========
Weighted average number of shares outstanding 2,354,703 2,393,130
=========== ===========
Diluted weighted average number of shares
outstanding 2,725,953 2,762,130
=========== ===========
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, 2007 2006
----------- -----------
Cash flows from operating activities:
Net loss $ (1,731,000) $ (233,000)
Adjustments to reconcile net loss to
cash provided by(used in) operating
activities:
Depreciation and amortization 5,147,000 1,768,000
Depreciation - discontinued operations - 149,000
Impairment loss on other investments - 299,000
Gain on sale of real estate - (1,321,000)
Net unrealized loss(gains) on investments 586,000 (6,042,000)
Equity in net loss from Justice Investors - 3,303,000
Minority interest benefit, net of tax (1,694,000) (379,000)
Changes in assets and liabilities:
Restricted cash 438,000 692,000
Investment in marketable securities 9,860,000 (9,773,000)
Prepaid expenses and other assets (6,424,000) (2,000,000)
Accounts payable and other liabilities 1,914,000 (614,000)
Due to securities broker (1,216,000) 8,844,000
Obligation for securities sold (5,685,000) 3,328,000
----------- -----------
Net cash provided by(used in) operating activities 1,195,000 (1,979,000)
----------- -----------
Cash flows from investing activities:
Net proceeds from sale of real estate - 8,677,000
Additions to buildings, improvements
and equipment (2,110,000) (2,283,000)
Purchase of Santa Fe stock (18,000) (399,000)
Purchase of Portsmouth stock - (260,000)
----------- -----------
Net cash (used in)provided by investing activities (2,128,000) 5,735,000
----------- -----------
Cash flows from financing activities:
Borrowings from mortgage notes payable 19,325,000 -
Principal payments on mortgage notes payable (17,246,000) (2,424,000)
Payment on line of credit - (655,000)
Purchase of treasury stock (156,000) (907,000)
Distributions to minority partners (500,000) -
----------- -----------
Net provided by(cash used) in financing activities 1,423,000 (3,986,000)
----------- -----------
Net increase(decrease) in cash and cash equivalents 490,000 (230,000)
Cash and cash equivalents at beginning of
period 2,935,000 868,000
----------- -----------
Cash and cash equivalents at end of period $ 3,425,000 $ 638,000
=========== ===========
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. Basis of Presentation and Significant Accounting Policies
The consolidated financial statements included herein have been prepared by The
InterGroup Corporation ("InterGroup" or the "Company"), without audit,
according to the rules and regulations of the Securities and Exchange
Commission. Certain information and footnote disclosures normally included in
the consolidated financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to such
rules and regulations, although the Company believes the disclosures that are
made are adequate to make the information presented not misleading. Further,
the consolidated financial statements reflect, in the opinion of management,
all adjustments (which included only normal recurring adjustments) necessary
for a fair statement of the financial position, cash flows and results of
operations as of and for the periods indicated. It is suggested that these
financial statements be read in conjunction with the audited financial
statements and the notes therein included in the Company's Form 10-KSB for the
year ended June 30, 2006.
As of March 31, 2007, 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 nine months ended March 31, 2007
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 March 31, 2007, the Company
had one property classified as held for sale in accordance with Statement of
Financial Accounting Standards No. 144, Accounting for Impairment or Disposal
of Long-Lived Assets, which requires that depreciation on the property be
stopped.
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
-7-
options. Stock options are included in diluted earnings per share by
application of the treasury stock method. As of March 31, 2007, 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
March 31, 2006, 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 of dilutive shares were included in
the calculation for diluted earnings per share.
Stock-Based Compensation Plans
As of March 31, 2007, 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 nine months ended March 31, 2007, 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 March 31, 2007 405,000 $9.91
========== ===============
As of March 31, 2007, 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
---------------- -------------- ---------------- ----------------
March 31, 2007 $7.92-$29.63 $ 9.91 3.20 years
-8-
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 nine months ended March 31, 2006 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:
For the nine months ended March 31, 2006
------------
Net loss $ (233,000)
Stock based employee
Compensation expense* (48,000)
------------
Pro forma net loss $ (281,000)
============
Loss per share
Basic as reported $ (0.10)
Basic pro forma $ (0.12)
Diluted as reported $ (0.10)
Diluted pro forma $ (0.12)
2. Investment in Real Estate
During the quarter ended March 31, 2007, the Company determined it would no
longer sell its 30-unit apartment building located in Los Angeles, California
that was previously classified as held for sale. The apartment building was
reclassified from property held for sale to investment in real estate in the
accompanying consolidated balance sheets. The revenues and expenses from the
operation of this property for the periods ended March 31, 2007 and March 31,
2006 are included in real estate operations in the accompanying consolidated
statements of operations.
As of March 31, 2007, the Company has listed for sale its 224-unit apartment
building located in Irving, Texas. 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 nine months ended March 31, 2007 and March 31, 2006 and are 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 nine months ended March 31, 2007 and March
31, 2006, are summarized as follows:
For the three months ended March 31, 2007 2006
---------- ----------
Revenues $ 390,000 $ 364,000
Expenses (286,000) (386,000)
---------- ----------
Net income(loss) $ 104,000 $ (22,000)
========== ==========
Depreciation expense for the three months ended March 31, 2007 and March 31,
2006, was zero and $32,000, respectively.
-9-
For the nine months ended March 31, 2007 2006
---------- ----------
Revenues $1,176,000 $ 1,159,000
Expenses (917,000) (1,455,000)
---------- ----------
Net income(loss) $ 259,000 $ (296,000)
========== ==========
Depreciation expense for the nine months ended March 31, 2007 and March 31,
2006, was zero and $149,000, respectively.
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 March 31, 2007, 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 March 31, 2007
Gross Gross Net Market
Investment Cost Unrealized Gain Unrealized Loss Unrealized Gain Value
---------- ----------- --------------- --------------- --------------- -----------
Equities $14,302,000 $5,492,000 ($1,054,000) $4,438,000 $18,740,000
As of March 31, 2007, the Company had $582,000 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 March 31, 2007, the Company had
obligations for securities sold (equities short) of $950,000.
Net gains on marketable securities on the statement of operations are comprised
of realized and unrealized gains(losses). Below is the composition of the two
components for the three and nine months ended March 31, 2007 and March 31,
2006, respectively.
For the three months ended March 31, 2007 2006
----------- -----------
Realized gains(losses) on marketable securities $ 455,000 $ (184,000)
Unrealized gains on marketable securities 1,282,000 4,623,000
----------- -----------
Net gains on marketable securities $ 1,737,000 $ 4,439,000
=========== ===========
For the nine months ended March 31, 2007 2006
----------- -----------
Realized gains(losses) on marketable securities $ 2,753,000 $ (307,000)
Unrealized (losses)gains on marketable securities (586,000) 6,042,000
----------- -----------
Net gains on marketable securities $ 2,167,000 $ 5,735,000
=========== ===========
-10-
4. Investment in Justice Investors:
Justice Investors owns the land, improvements and leaseholds known as the
Hilton San Francisco Financial District, a 545-room hotel located at 750 Kearny
Street, San Francisco, California (the "Hotel").
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 March 27, 2007, Justice entered into a second mortgage loan with The
Prudential Insurance Company of America (the "Second Prudential Loan") in a
principal amount of $19,000,000. The term of the Second Prudential Loan is for
approximately 100 months and matures on August 5, 2015, the same date as the
Partnership's first mortgage loan with Prudential. The Second Prudential Loan
is at a fixed interest rate of 6.42% per annum and calls for monthly
installments of principal and interest in the amount of approximately $119,000,
calculated on a 360 month amortization schedule. The Loan is collateralized by
a second 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.
As a condition of the Second Prudential Loan, Justice was required to obtain a
standby letter of credit in an amount of $1,500,000 to serve as security for
potential liabilities arising out of the litigation pending between the
Partnership and Allied Construction Management, Inc. and its subcontractors
(the "Allied Litigation") over disputed construction change orders. Justice
believes that it has good and meritorious defenses to the claims asserted in
the Allied Litigation and that the funds provided for by the letter of credit
will not have to be used.
From the proceeds of the Second Prudential Loan, Justice retired its existing
line of credit facility with United Commercial Bank ("UCB") paying off the
outstanding balance of principal and interest of approximately $16,403,000 on
March 27, 2007. The Partnership also obtained a new unsecured $3,000,000
revolving line of credit facility from UCB to be utilized by the Partnership to
meet any emergency or extraordinary cash flow needs arising from any disruption
of business due to labor issues, natural causes affecting tourism and other
unexpected events. The term of the new line of credit facility is for 60 months
at an annual interest rate, based on an index selected by Justice at the time
of advance, equal to the Wall Street Journal Prime Rate or the Libor Rate plus
-11-
two percent. As of March 31, 2007, there were no amounts borrowed by Justice
under the new line of credit; however, $1,500,000 of that line was utilized in
the form of a standby letter of credit related to the Allied Litigation. The
annual fee for the letter of credit is one and one half percent of $1,500,000,
which fee is to be paid in quarterly installments for the periods in which the
letter of credit is in effect.
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 nine months ended March 31, 2007, the results of operations
for Justice were consolidated with those of the Company. However, for the
three and nine months ended March 31, 2006, 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 nine months ended March
31, 2007 and March 31, 2006 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
any room or food and beverage revenues during the first six and one-half 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.
-12-
JUSTICE INVESTORS
STATEMENTS OF OPERATIONS
For the three months ended March 31, 2007 2006
---------- ----------
Revenues:
Hotel rooms $ 5,705,000 $ 2,461,000
Food and beverage 1,456,000 649,000
Rent - hotel garage 348,000 279,000
Other 145,000 266,000
Total revenues ---------- ----------
7,654,000 3,655,000
Operating expenses:
Hotel rooms (1,906,000) (1,215,000)
Food and beverage (1,494,000) (1,095,000)
Other operating expenses (2,420,000) (2,209,000)
Interest expense (745,000) (490,000)
Real estate taxes (176,000) (163,000)
Depreciation and amortization (1,042,000) (555,000)
General and administrative (1,628,000) (1,069,000)
---------- ----------
Total expenses (9,411,000) (6,796,000)
---------- ----------
(1,757,000) (3,141,000)
Intercompany eliminations 151,000 232,000
---------- ----------
Net loss $ (1,606,000) $(2,909,000)
========== ==========
JUSTICE INVESTORS
STATEMENTS OF OPERATIONS
For the nine months ended March 31, 2007 2006
---------- ----------
Revenues:
Hotel rooms $ 17,773,000 $ 2,460,000
Food and beverage 3,781,000 649,000
Rent - hotel garage 1,159,000 604,000
Other 649,000 301,000
Total revenues ---------- ----------
23,362,000 4,014,000
Operating expenses:
Hotel rooms (5,623,000) (1,400,000)
Food and beverage (4,138,000) (1,152,000)
Other operating expenses (7,520,000) (3,434,000)
Interest expense (2,180,000) (506,000)
Real estate taxes (558,000) (346,000)
Depreciation and amortization (3,116,000) (839,000)
General and administrative (3,656,000) (2,969,000)
---------- ----------
Total expenses (26,791,000) (10,646,000)
---------- ----------
(3,429,000) (6,632,000)
Intercompany eliminations 177,000 258,000
---------- ----------
Net loss $ (3,252,000) $(6,374,000)
========== ==========
During the three and nine months ended March 31, 2007, Portsmouth received
monthly general partner management fees in the amount of $151,000 and $177,000,
respectively, from Justice Investors. These amounts were eliminated from the
Justice operating expenses during consolidation.
-13-
Below are the comparative standalone statements of operations for the Hotel for
the indicated periods.
For the three months ended March 31, 2007 2006
----------- ----------
Operating revenue:
Room $ 5,705,000 $ 2,461,000
Food and beverage 1,456,000 649,000
Other operating revenue 110,000 232,000
----------- ----------
Total operating revenue 7,271,000 3,342,000
----------- ----------
Operating expenses:
Rooms (1,906,000) (1,215,000)
Food and beverage (1,494,000) (1,095,000)
Other operating expenses (3,371,000) (2,804,000)
----------- ----------
Total operating expenses (6,771,000) (5,114,000)
----------- ----------
Net income(loss) from Hotel operations 500,000 (1,772,000)
Net expenses at Justice Investors (2,106,000) (1,137,000)
----------- ----------
Net loss from Justice Investors $ (1,606,000) $(2,909,000)
=========== ==========
For the nine months ended March 31, 2007 2006
----------- ----------
Operating revenue:
Room $ 17,773,000 $ 2,460,000
Food and beverage 3,781,000 649,000
Other operating revenue 459,000 240,000
----------- ----------
Total operating revenue 22,013,000 3,349,000
----------- ----------
Operating expenses:
Rooms (5,623,000) (1,400,000)
Food and beverage (4,138,000) (1,152,000)
Other operating expenses (10,288,000) (4,763,000)
----------- ----------
Total operating expenses (20,049,000) (7,315,000)
----------- ----------
Net income(loss) from Hotel operations 1,964,000 (3,966,000)
Net expenses at Justice Investors (5,216,000) (2,408,000)
----------- ----------
Net loss from Justice Investors $ (3,252,000) $(6,374,000)
=========== ==========
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.
-14-
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, 2007 and March 31, 2006. 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 for
investment transactions consist of net investment gains(losses)and dividend and
interest income.
Real Estate
-------------------------
Three months ended Rental Justice Investment Discontinued
March 31, 2007 Properties Investors Transactions Other Subtotal Operations Total
----------- ----------- ------------ ----------- ------------ ------------ ------------
Operating income $ 3,320,000 $ 7,654,000 $ 1,835,000 $ - $ 12,809,000 $ 390,000 $ 13,199,000
Operating expenses (1,618,000) (7,297,000) (577,000) - (9,492,000) (164,000) (9,656,000)
Real estate taxes (452,000) (176,000) - - (628,000) (48,000) (676,000)
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net operating income 1,250,000 181,000 1,258,000 - 2,689,000 178,000 2,867,000
Mortgage interest expense (1,035,000) (745,000) - - (1,780,000) (74,000) (1,854,000)
Depreciation and amort. (847,000) (1,042,000) - - (1,889,000) - (1,889,000)
General and administrative
Expense - - - (549,000) (549,000) - (549,000)
Other expense - (60,000) - (60,000) - (60,000)
Income tax benefit(expense) - - - 668,000 668,000 (43,000) 625,000
Minority interest - 1,714,000 - (933,000) 781,000 - 781,000
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net income(loss) $ (632,000) 48,000 $ 1,258,000 $ (814,000) $ (140,000) $ 61,000 $ (79,000)
=========== =========== =========== =========== ============ ============ ============
Total Assets $73,980,000 $46,679,000 $26,684,000 $14,943,000 $ 162,286,000 $ 3,636,000 $165,922,000
=========== =========== =========== =========== ============ ============ ============
Real Estate
-------------------------
Three months ended Rental Justice Investment Discontinued
March 31, 2006 Properties Investors Transactions Other Subtotal Operations Total
----------- ----------- ------------ ----------- ------------ ------------ ------------
Operating income(loss) $ 3,042,000 $(1,564,000) $ 4,609,000 $ - $ 6,087,000 $ 364,000 $ 6,451,000
Operating expenses (1,620,000) - (698,000) - (2,318,000) (212,000) (2,530,000)
Real estate taxes (482,000) - - - (482,000) (66,000) (548,000)
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net operating income(loss) 940,000 (1,564,000) 3,911,000 - 3,287,000 86,000 3,373,000
Mortgage interest expense (914,000) - - - (914,000) (76,000) (990,000)
Depreciation (560,000) - - - (560,000) (32,000) (592,000)
Gain on sale of real estate - - - - - 160,000 160,000
General and administrative
Expense - - - (338,000) (338,000) - (338,000)
Other income(expense) - (60,000) - 232,000 172,000 - 172,000
Income tax expense - - - (613,000) (613,000) (55,000) (668,000)
Minority interest benefit - - - (135,000) (135,000) - (135,000)
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net income(loss) $ (534,000) $(1,564,000) $ 3,911,000 $ (914,000) $ 899,000 $ 83,000 $ 982,000
=========== =========== =========== =========== ============ ============ ============
Total Assets $78,876,000 $ 6,518,000 $40,028,000 $ 8,663,000 $ 134,085,000 - $134,085,000
=========== =========== =========== =========== ============ ============ ============
-15-
Real Estate
-------------------------
Nine months ended Rental Justice Investment Discontinued
March 31, 2007 Properties Investors Transactions Other Subtotal Operations Total
----------- ----------- ------------ ----------- ------------ ------------ ------------
Operating income $ 9,801,000 $23,362,000 $ 2,412,000 $ - $ 35,575,000 $ 1,176,000 $ 36,751,000
Operating expenses (5,426,000) (20,760,000) (1,613,000) - (27,799,000) (551,000) (28,350,000)
Real estate taxes (1,358,000) (558,000) - - (1,916,000) (143,000) (2,059,000)
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net operating income(loss) 3,017,000 2,044,000 799,000 - 5,860,000 482,000 6,342,000
Mortgage interest expense (3,130,000) (2,180,000) - - (5,310,000) (223,000) (5,533,000)
Depreciation and amort. (2,031,000) (3,116,000) - - (5,147,000) - (5,147,000)
General and administrative
Expense - - - (1,288,000) (1,288,000) - (1,288,000)
Other expense - (179,000) - (179,000) - (179,000)
Income tax benefit - - - 2,486,000 2,486,000 (106,000) 2,380,000
Minority interest - 879,000 - 815,000 1,694,000 - 1,694,000
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net income(loss) $(2,144,000) (2,552,000) $ 799,000 $ 2,013,000 $ (1,884,000) $ 153,000 $ (1,731,000)
=========== =========== =========== =========== ============ ============ ============
Total Assets $73,980,000 $46,679,000 $26,684,000 $14,943,000 $ 162,286,000 $ 3,636,000 $165,922,000
=========== =========== =========== =========== ============ ============ ============
Real Estate
-------------------------
Nine months ended Rental Justice Investment Discontinued
March 31, 2006 Properties Investors Transactions Other Subtotal Operations Total
----------- ----------- ------------ ----------- ------------ ------------ ------------
Operating income(loss) $ 9,054,000 $(3,303,000) $ 6,030,000 $ - $ 11,781,000 $ 1,159,000 $ 12,940,000
Operating expenses (4,777,000) - (1,848,000) - (6,625,000) (808,000) (7,433,000)
Real estate taxes (1,355,000) - - - (1,355,000) (194,000) (1,549,000)
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net operating income(loss) 2,922,000 (3,303,000) 4,182,000 - 3,801,000 157,000 3,958,000
Mortgage interest expense (2,801,000) - - - (2,801,000) (304,000) (3,105,000)
Depreciation (1,768,000) - - - (1,768,000) (149,000) (1,917,000)
Gain on sale of real estate - - - - - 1,321,000 1,321,000
General and administrative
Expense - - - (1,145,000) (1,145,000) - (1,145,000)
Other income(expense) - (179,000) - 62,000 (117,000) - (117,000)
Income tax benefit(expense) - - - 801,000 801,000 (408,000) 393,000
Minority interest benefit - - - 379,000 379,000 - 379,000
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net income(loss) $(1,647,000) $(3,303,000) $ 4,182,000 $ (82,000) $ (850,000) $ 617,000 $ (233,000)
=========== =========== =========== =========== ============ ============ ============
Total Assets $78,876,000 $ 6,518,000 $40,028,000 $ 8,663,000 $ 134,085,000 - $134,085,000
=========== =========== =========== =========== ============ ============ ============
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.
-16-
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 Irving, Texas property, 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, known as the Hilton
San Francisco Financial District hotel (the "Hotel"). 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 Prism Hospitality L.P. ("Prism Hospitality") to perform the day-
to-day management functions.
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.
-17-
Recent Developments
On February 9, 2007, Justice 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. Prism is an experienced Hilton approved operator of upscale and
luxury hotels throughout the Americas and the Caribbean. The management
agreement with Prism is 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 ninety days written notice. The effective date of the
transition of the management agreement to Prism was February 10, 2007. The
operations of the Hotel continued uninterrupted as if no termination had
occurred and Justice honored all bookings and contracts for the use of the
Hotel and retained all of the on-site employees with the exception of one
management position. Justice continues to work with Dow to finalize the
prorations and allocations of certain insurance costs and management fees.
On March 27, 2007, Justice entered into a second mortgage loan with The
Prudential Insurance Company of America (the "Second Prudential Loan") in a
principal amount of $19,000,000. The term of the Second Prudential Loan is for
approximately 100 months and matures on August 5, 2015, the same date as the
Partnership's first mortgage loan with Prudential. The Second Prudential Loan
is at a fixed interest rate of 6.42% per annum and calls for monthly
installments of principal and interest in the amount of approximately $119,000,
calculated on a 360 month amortization schedule. The Loan is collateralized by
a second 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.
As a condition of the Second Prudential Loan, Justice was required to obtain a
standby letter of credit in an amount of $1,500,000 to serve as security for
potential liabilities arising out of the litigation pending between the
Partnership and Allied Construction Management, Inc. and its subcontractors
(the "Allied Litigation") over disputed construction change orders. Justice
believes that it has good and meritorious defenses to the claims asserted in
the Allied Litigation and that the funds provided for by the letter of credit
will not have to be used.
From the proceeds of the Second Prudential Loan, Justice retired its existing
line of credit facility with United Commercial Bank ("UCB") paying off the
outstanding balance of principal and interest of approximately $16,403,000 on
March 27, 2007. The Partnership also obtained a new unsecured $3,000,000
revolving line of credit facility from UCB to be utilized by the Partnership to
meet any emergency or extraordinary cash flow needs arising from any disruption
of business due to labor issues, natural causes affecting tourism and other
unexpected events. The term of the new line of credit facility is for 60 months
at an annual interest rate, based on an index selected by Justice at the time
of advance, equal to the Wall Street Journal Prime Rate or the Libor Rate plus
two percent. As of March 31, 2007, there were no amounts borrowed by Justice
under the new line of credit; however, $1,500,000 of that line was utilized in
the form of a standby letter of credit related to the Allied Litigation. The
annual fee for the letter of credit is one and one half percent of $1,500,000,
which fee is to be paid in quarterly installments for the periods in which the
letter of credit is in effect.
-18-
On March 28, 2007, Justice paid a special limited partnership distribution in a
total amount of $1,000,000, of which, $500,000 is eliminated in consolidation.
The general partners believed that operations of the Hotel had stabilized under
the Hilton brand and new management and cash flows were sufficient to warrant
that special distribution, especially with the new financings in place to meet
any additional capital needs. The general partners are expected to conduct a
review each quarter to set the amount of any quarterly distribution that may be
appropriate based on the results of operations of the Hotel and other factors.
During the quarter ended March 31, 2007, the Company settled tenant litigation
incident to the operations of its rental properties. The settlement costs, in
the approximate amount of $560,000, were fully reserved by the Company in prior
periods.
Three Months Ended March 31, 2007 Compared to the
Three Months Ended March 31, 2006
The Company had a net loss of $79,000 for the three months ended March 31, 2007
compared to net income of $982,000 for the three months ended March 31, 2006.
As discussed below, the significant change was primarily due to the
the decrease in the net gains from marketable securities offset by the
reduction in the net loss from the operations of Justice Investors.
The net loss from the operations of Justice Investors was $1,606,000 for the
three months ended March 31, 2007, compared to a net loss of $2,909,000 for the
three months ended March 31, 2006 (see Footnote 4 for more details). The
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 did not reopen until January 12, 2006 after undergoing major
renovations, and from higher garage rental income in the current quarter.
Those results were partially offset by greater depreciation and amortization
expenses, interest costs, insurance costs and real estate taxes resulting from
the renovation of the Hotel and from higher general and administrative expenses
primarily due to increased legal and consulting fees related to the Allied
Litigation, the termination and transition of the Hotel management agreement
from Dow to Prism, and zoning issues.
For the three months ended March 31, 2007, the operations of the Hotel (on a
standalone basis (see Footnote 4) generated net income of $500,000 on total
operating revenues of approximately $7,271,000 compared to a loss from Hotel
operations of $1,772,000 on total operating revenues of $3,342,000 during the
three months ended March 31, 2006, when the Hotel first reopened on a limited
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 in December, January and February, which are typically three of the slower
months in the San Francisco market. We believe that many of the new programs
implemented to increase revenues and efficiencies at the Hotel, as well as
certain management personnel changes, have helped improve operations. While the
Hotel's food and beverage operations remain challenging, management was able to
further reduce losses in that department during 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.
-19-
The loss from real estate operations increased to $632,000 for the three months
ended March 31, 2007 from $534,000 for the three months ended March 31, 2006
primarily as the result of the increase in the mortgage interest and
depreciation expenses partially offset by the increase in rental income.
Rental income increased to $3,320,000 from $3,042,000 as the result of the
improved occupancy and increased rental income from the Company's real estate
portfolio due to the improving rental housing market and the leasing of a
portion of the Company's 30-unit apartment building located in Los Angeles, CA,
which finished undergoing major renovations in June 2006. The increase in the
mortgage interest and depreciation expenses was primarily as the result of
placing this 30-unit complex into operations in July 2006.
As of March 31, 2007, the Company has listed for sale its 224-unit apartment
building located in Irving, Texas. The revenues and expenses related to this
property are classified under discontinued operations. During the quarter
ended March 31, 2007, there were no sales of real estate. During the quarter
ended March 31, 2006, the Company sold one property and realized a gain on the
sale of real estate of $160,000. The revenues and expenses related to this
property are also classified under discontinued operations.
The Company had net gains on marketable securities of $1,737,000 for the three
months ended March 31, 2007 compared to net gains on marketable securities of
$4,439,000 for the three months ended March 31, 2006. For the three months
ended March 31, 2007, the Company had net realized gains of $455,000 and net
unrealized gains of $1,282,000. For the three months ended March 31, 2006, the
Company had net realized losses of $184,000 and net unrealized gains of
$4,623,000. 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 $98,000 for the three months ended
March 31, 2007 from $170,000 for the three months ended March 31, 2006 as a
result of the decreased investment in income yielding securities during the
quarter ended March 31, 2007.
Margin interest and trading expenses decreased to $577,000 for the three months
ended March 31, 2007 from $698,000 for the three months ended March 31, 2006
primarily as the result of the decrease in trading and management related
expenses to $385,000 from $495,000.
General and administrative expenses increased to $549,000 for the three months
ended March 31, 2007 from $338,000 for the three months ended March 31, 2006
primarily due to a $90,000 in Board authorized meeting fees paid to the members
of Portsmouth's Special Hotel Committee for their active oversight and
involvement in the renovation and repositioning of the Hotel and the increase
in the auditing and accounting related expenses.
The provision for income tax benefit(expenses) changed to a tax benefit of
$625,000 for the three months ended March 31, 2007 from a tax expense of
$668,000 for the three months ended March 31, 2006 as the result of the
significant pre-tax loss incurred by the Company during the current quarter
ended March 31, 2007.
Minority interest benefit(expense) changed to a benefit of $781,000 from an
expense of $135,000 primarily as the result of the $879,000 minority interest
benefit recognized during the quarter ended March 31, 2007 related to the
consolidation of Justice Investors. For the three months ended March 31, 2006,
the Company's investment in Justice Investors was recorded on an equity basis.
-20-
Nine Months Ended March 31, 2007 Compared to the
Nine Months Ended March 31, 2006
The Company had a net loss of $1,731,000 for the nine months ended March 31,
2007 compared to a net loss of $233,000 for the nine months ended March 31,
2006. As discussed below, the significant change was primarily due to the
the decrease in the net gains from marketable securities and the increase in
the net loss from real estate operations, partially offset by the reduction in
the net loss from the operations of Justice Investors.
The net loss from the operations of Justice Investors was $3,252,000 for the
nine months ended March 31, 2007, compared to a net loss of $6,374,000 for the
nine months ended March 31, 2006 (see Footnote 4 for more details). The
decrease was primarily attributable to net income generated from the operations
of the Hotel during the current period compared to the comparable nine months
when the Hotel was temporarily closed for major renovations for approximately
six and one-half months of that period and from higher garage rental income in
the current period. Those results were partially offset by greater depreciation
and amortization expenses, interest costs, insurance costs and real estate
taxes resulting from the renovation of the Hotel and from higher general and
administrative expenses primarily due to increased legal and consultant fees
related to the Allied Litigation, the termination and transition of the Hotel
management agreement from Dow to Prism, and zoning issues.
For the nine months ended March 31, 2007, the operations of the Hotel (on a
standalone basis (see Footnote 4) generated net income of $1,964,000 on total
operating revenues of approximately $22,013,000, while revenues from the
operations of the Hotel during the nine months ended March 31, 2006 were
limited to approximately two and a half months after the Hotel reopened on a
limited basis on January 12, 2006. Garage rent increased to $1,159,000 from
$604,000 primarily due to the Hotel being open during the entire current
period. The average daily room rate for the Hotel was approximately $158 and
the average occupancy rate was approximately 75% for the nine months ended
March 31, 2007, compared to an average daily rate of approximately $147 and an
average occupancy rate of approximately 37% during the two and one-half months
the Hotel was only open on a limited basis in the prior period.
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 in December, January and February, which are typically three of the slower
months in the San Francisco market. We believe that many of the new programs
implemented to increase revenues and efficiencies at the Hotel, as well as
certain management personnel changes, have helped improve operations. While the
Hotel's food and beverage operations remain challenging, management was able to
further reduce losses in that department, particularly 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 $2,144,000 for nine months
ended March 31, 2007 from $1,647,000 for the nine months ended March 31, 2006
primarily as the result of the increase in property operating expenses,
mortgage interest expense and depreciation expense, partially offset by the
increase in rental income. Rental income increased to $9,801,000 from
$9,054,000 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 and the leasing of a portion of the Company's
30-unit apartment located in Los Angeles, CA, which finished undergoing major
renovations in June 2006. Operating expenses increased to $5,426,000 for the
nine months ended March 31, 2007 from $4,777,000 for the nine months ended
-21-
March 31, 2006 primarily as the result of $707,000 in settlement expenses and
attorneys' fees arising out of tenant litigation related to operations of the
Company's rental properties. All such claims were settled and the litigation
costs are not expected to be recurring. The increase in the mortgage interest
and depreciation expenses was primarily as the result of placing the 30-unit
complex into operations in July 2006.
As of March 31, 2007, the Company has listed for sale its 224-unit apartment
building located in Irving, Texas. The revenues and expenses related to this
property are classified under discontinued operations. During the nine months
ended March 31, 2007, there were no sales of real estate. During nine months
ended March 31, 2006, the Company sold three properties and a parcel of land
and realized a net gain on the sales of real estate of $1,321,000. The revenues
and expenses related to these properties are also classified under discontinued
operations.
The Company had net gains on marketable securities of $2,167,000 for the nine
months ended March 31, 2007 compared to net gains on marketable securities of
$5,735,000 for the nine months ended March 31, 2006. For the nine months ended
March 31, 2007, the Company had net realized gains of $2,753,000 and net
unrealized losses of $586,000. For the nine months ended March 31, 2006, the
Company had net realized losses of $307,000 and net unrealized gains of
$6,042,000. 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.
During the nine months ended March 31, 2006, the Company recorded an impairment
loss on other investments (private placement investments) of $299,000. There
were no such impairments during the nine months ended March 31, 2007. The
Company reviews its other investments for impairment on a periodic basis.
Dividend and interest income decreased to $245,000 for the nine months ended
March 31, 2007 from $594,000 for the nine months ended March 31, 2006 as a
result of the decreased investment in income yielding securities during the
nine months ended March 31, 2007.
Margin interest and trading expenses decreased to $1,613,000 for the nine
months ended March 31, 2007 from $1,848,000 for the nine months ended March 31,
2006 primarily as the result of the decrease in trading and management expenses
to $1,097,000 from $1,324,000.
General and administrative expenses increased to $1,288,000 for the nine months
ended March 31, 2007 from $1,145,000 for the nine months ended March 31, 2006
primarily due to a $90,000 in Board authorized meeting fees paid to the members
of Portsmouth's Special Hotel Committee for their active oversight and
involvement in the renovation and repositioning of the Hotel.
The provision for income tax benefit increased to $2,380,000 for the nine
months ended March 31, 2007 from $393,000 for the nine months ended March 31,
2006 as the result of the higher pre-tax loss incurred by the Company during
the nine months ended March 31, 2007.
Minority interest benefit increased to $1,694,000 for the nine months ended
March 31, 2007 from $379,000 for the nine months ended March 31, 2006 primarily
as the result of the $1,714,000 minority interest benefit recognized during the
nine months ended March 31, 2007 related to the consolidation of Justice
Investors. For the nine months ended March 31, 2006, the Company's investment
in Justice Investors was recorded on an equity basis.
-22-
MARKETABLE SECURITIES
The Company's investment portfolio is diversified with 36 different equity
positions. The portfolio contains eight individual equity securities that are
more than 5% of the equity value of the portfolio with the largest security
being 14.2% 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 March 31, 2007, the Company had investments in marketable equity
securities of $18,740,000. The following table shows the composition of the
Company's marketable securities portfolio by selected industry groups as of
March 31, 2007.
% of Total
Investment
Industry Group Market Value Securities
-------------- ------------ ----------
Insurance, banks and brokers $ 3,799,000 20.3%
Dairy products 3,010,000 16.1%
Retail and consumer goods 2,894,000 15.4%
REITs and building materials 2,278,000 12.2%
Telecommunications and media 1,916,000 10.2%
Services 1,511,000 8.1%
Investment funds 1,399,000 7.5%
Pharmaceuticals and healthcare 514,000 2.7%
Other 1,419,000 7.5%
------------ ----------
$18,740,000 100.0%
============ ==========
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
indicated periods.
For the three months ended March 31, 2007 2006
-------------- --------------
Net gains on marketable securities $ 1,737,000 $ 4,439,000
Dividend & interest income 98,000 170,000
Margin interest expense (192,000) (203,000)
Trading and management expenses (385,000) (495,000)
------------ ------------
$ 1,258,000 $ 3,911,000
============ ============
For the nine months ended March 31, 2007 2006
-------------- --------------
Net gains on marketable securities $ 2,167,000 $ 5,735,000
Impairment loss on other investments - (299,000)
Dividend & interest income 245,000 594,000
Margin interest expense (516,000) (524,000)
Trading and management expenses (1,097,000) (1,324,000)
------------ ------------
$ 799,000 $ 4,182,000
============ ============
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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 nine months ended March 31, 2007,
operating activities provided cash of $1,195,000, financing activities provided
cash of $1,423,000 and investing activities used cash of $2,128,000.
During the nine months ended March 31, 2007, the Company made property
improvements in the aggregate amount of $2,110,000. 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. As of March 31, 2007, the total amount outstanding of the
Prudential Loan was approximately $29,316,000.
On March 27, 2007, Justice entered into a second mortgage loan with The
Prudential Insurance Company of America (the "Second Prudential Loan") in a
principal amount of $19,000,000. The term of the Second Prudential Loan is for
approximately 100 months and matures on August 5, 2015, the same date as the
Partnership's first mortgage loan with Prudential. The Second Prudential Loan
is at a fixed interest rate of 6.42% per annum and calls for monthly
installments of principal and interest in the amount of approximately $119,000,
calculated on a 360 month amortization schedule. The Loan is collateralized by
a second 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. As a condition of the Second Prudential Loan,
Justice was required to obtain a standby letter of credit to serve as security
for potential liabilities arising out of the litigation pending between the
Partnership and Allied Construction Management, Inc. and its subcontractors
(the "Allied Litigation").
From the proceeds of the Second Prudential Loan, Justice retired its existing
line of credit facility with United Commercial Bank ("UCB") paying off the
outstanding balance of principal and interest of approximately $16,403,000 on
March 27, 2007. The Partnership also obtained a new unsecured $3,000,000
revolving line of credit facility from UCB to be utilized by the Partnership to
meet any emergency or extraordinary cash flow needs arising from any disruption
-24-
of business due to labor issues, natural causes affecting tourism and other
unexpected events. The term of the new line of credit facility is for 60 months
at an annual interest rate, based on an index selected by Justice at the time
of advance, equal to the Wall Street Journal Prime Rate or the Libor Rate plus
two percent. As of March 31, 2007, there were no amounts borrowed by Justice
under the new line of credit; however, $1,500,000 of that line was utilized in
the form of a standby letter of credit related for the Allied Litigation. The
annual fee for the letter of credit is one and one half percent of $1,500,000,
which fee is to be paid in quarterly installments for the periods in which the
letter of credit is in effect.
The Hotel started to generate net operating income from its operations in June
2006, which have continued to improve during the first nine months of the
Company's current fiscal year. As a result, Justice was able to pay a special
limited partnership distribution in a total amount of $1,000,000 on March 28,
2007, of which Portsmouth received $500,000. The general partners believed that
operations of the Hotel had stabilized under the Hilton brand and new
management, and that cash flows were sufficient to warrant a special
distribution, especially with the new financings in place to meet any
additional capital needs. The general partners expect to conduct a review each
quarter to set the amount of any quarterly distribution that may be appropriate
based on the results of operations of the Hotel and other factors.
While the debt service requirements related to the two Prudential Loans, as
well as any utilization of the UCB line of credit, may create some additional
risk for the Company and its ability to generate cash flows in the future since
the partnership's assets had been virtually debt free for an number of years,
management believes that cash flows from the operations of the Hotel and the
garage lease will continue to 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 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.
MATERIAL CONTRACTUAL OBLIGATIONS
The Company does not have any material contractual obligations or commercial
commitments other than the mortgages of its rental properties, its line of
credit and Justice Investors' mortgage loans with Prudential.
-25-
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 Prism 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.
(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.
-26-
PART II.
OTHER INFORMATION
Item 2. 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
2007 Shares Price Paid Announced Plans Under the Plans
Period Purchased Per Share or Programs or Programs
--------------------------------------------------------------------------------------
Month #1
(Jan. 1- 2,856 $19.20 2,856 27,282
Jan. 31)
--------------------------------------------------------------------------------------
Month #2
(Feb. 1- - $ - - 27,282
Feb. 28)
--------------------------------------------------------------------------------------
Month #3
(Mar. 1- - $ - - 27,282
Mar. 31)
--------------------------------------------------------------------------------------
Total 2,856 $19.20 2,856 27,282
--------------------------------------------------------------------------------------
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.
Item 4. Submission of Matters to a Vote of Shareholders.
The Fiscal 2006 Annual Meeting of the Shareholders of the Company was held on
February 21, 2007 at the Hilton San Francisco Financial District, 750 Kearny
Street, San Francisco, California. At that meeting, John V. Winfield and Josef
A. Grunwald were elected as Class A Directors, each to serve a three year term
expiring at the Fiscal 2009 Annual Meeting. Gary N. Jacobs, John C. Love and
William J. Nance continue their terms as the Company's other directors. At the
-27-
Annual Meeting, the shareholders also voted in favor of the ratification of the
Audit Committee's selection of PricewaterhouseCoopers LLP as the Company's
independent registered public accounting firm for the fiscal year ending June
30, 2007 and also approved The InterGroup Corporation 2007 Stock Compensation
Plan for Non-Employee Directors. A tabulation of the vote follows:
Proposal (1) - Class A Directors: Votes For Withheld
--------- --------
John V. Winfield 1,383,863 17,093
Josef A. Grunwald 1,386,499 13,457
Proposal (2) - Accountants: Votes For Against Abstained
--------- ------- ---------
PricewaterhouseCoopers LLP 1,398,379 320 1,257
Proposal (3) - Approval of 2007 Votes For Against Abstained
Stock Compensation Plan for --------- ------- ---------
Non-Employee Directors: 1,352,168 41,571 6,217
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
----------------- ------------ ---------------------------------------
March 23, 2007 Items 3.01 Withdrawal from NYSE Arca, Inc. and
and 9.01 termination of dual listing of Common
Stock; Press Release of March 28, 2007.
-28-
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 11, 2007 by /s/ John V. Winfield
----------------------------
John V. Winfield, President,
Chairman of the Board and
Chief Executive Officer
Date: May 11, 2007 by /s/ David T. Nguyen
------------------------------
David T. Nguyen, Treasurer
and Controller
(Principal Accounting Officer)
-29-