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, 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 February 8, 2008 was 2,351,916 shares.
Transitional Small Business Disclosure Format: YES [ ] NO [X]
INDEX
THE INTERGROUP CORPORATION
PART I. FINANCIAL INFORMATION PAGE
Item 1. Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheet (Unaudited)
As of December 31, 2007 3
Condensed Consolidated Statements of Operations (Unaudited)
For the Three Months Ended December 31, 2007 and 2006 4
Condensed Consolidated Statements of Operations (Unaudited)
For the Six Months Ended December 31, 2007 and 2006 5
Condensed Consolidated Statements of Cash Flows (Unaudited)
For the Six Months Ended December 31, 2007 and 2006 6
Notes to Condensed Consolidated Financial Statements (Unaudited) 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 1. Legal Proceedings 26
Item 4. Unregistered Sales of Equity Securities and 26
Use of Proceeds
Item 6. Exhibits 27
SIGNATURES 28
-2-
PART I
FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
THE INTERGROUP CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
(UNAUDITED)
As of December 31, 2007
-----------
ASSETS
Investment in hotel, net $ 49,257,000
Investment in real estate, net 67,887,000
Property held for sale 5,231,000
Investment in marketable securities 15,233,000
Other investments 7,394,000
Cash and cash equivalents 550,000
Restricted cash 1,649,000
Prepaid expenses and other assets 4,111,000
Minority interest of Justice Investors 6,301,000
-----------
Total assets $157,613,000
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Accounts payable and other liabilities $ 12,226,000
Due to securities broker 6,803,000
Obligation for securities sold 199,000
Line of credit 3,958,000
Mortgage note payable - hotel 47,830,000
Mortgage note payable - real estate 64,195,000
Mortgage note payable - property held for sale 7,566,000
Deferred income taxes 3,323,000
-----------
Total liabilities 146,100,000
-----------
Minority interest 4,376,000
Commitments and contingencies
Shareholders' equity:
Preferred stock, $.01 par value, 100,000 shares
authorized; none issued -
Common stock, $.01 par value, 4,000,000 shares authorized;
3,200,093 issued, 2,352,316 outstanding 21,000
Additional paid-in capital 8,802,000
Retained earnings 7,368,000
Treasury stock, at cost, 847,777 shares (9,054,000)
-----------
Total shareholders' equity 7,137,000
-----------
Total liabilities and shareholders' equity $157,613,000
===========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
-3-
THE INTERGROUP CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the three months ended December 31, 2007 2006
(As Restated)
----------- -----------
Hotel operations:
Hotel and garage revenue $ 9,619,000 $ 8,116,000
Operating expenses (8,225,000) (7,043,000)
Real estate taxes (177,000) (202,000)
Interest expense (703,000) (805,000)
Depreciation and amortization (1,118,000) (1,040,000)
----------- -----------
Loss from hotel operations (604,000) (974,000)
----------- -----------
Real estate operations:
Rental income 3,319,000 2,895,000
Property operating expense (1,297,000) (2,074,000)
Real estate taxes (320,000) (401,000)
Mortgage interest expense (907,000) (939,000)
Depreciation (569,000) (472,000)
----------- -----------
Income(loss) from real estate operations 226,000 (991,000)
----------- -----------
Investment transactions:
Net gains on marketable securities 1,375,000 1,310,000
Dividend and interest income 59,000 89,000
Margin interest and trading expenses (373,000) (556,000)
----------- -----------
Income from investment transactions 1,061,000 843,000
----------- -----------
General and administrative expense (402,000) (346,000)
----------- -----------
Income(loss) before income tax and minority interest 281,000 (1,468,000)
Minority interest - Justice Investors, pre-tax 257,000 462,000
----------- -----------
Income(loss) before income tax 538,000 (1,006,000)
Income tax (expense)benefit (182,000) 432,000
----------- -----------
Income(loss) before minority interest 356,000 (574,000)
Minority interest, net of tax (68,000) (96,000)
----------- -----------
Income(loss) from continuing operations 288,000 (670,000)
----------- -----------
Income(loss) from discontinued operations,
net of tax 59,000 (39,000)
----------- -----------
Net income(loss) $ 347,000 $ (709,000)
=========== ===========
Net income(loss) per share from continuing operations
Basic $ 0.12 $ (0.28)
=========== ===========
Diluted $ 0.11 $ (0.28)
=========== ===========
Net income(loss) per share from discontinued operations
Basic $ 0.03 $ (0.02)
=========== ===========
Diluted $ 0.02 $ (0.02)
=========== ===========
Net income (loss) per share
Basic $ 0.15 $ (0.30)
=========== ===========
Diluted $ 0.13 $ (0.30)
=========== ===========
Weighted average number of shares outstanding 2,352,395 2,355,641
=========== ===========
Diluted weighted average number of shares
outstanding 2,735,645 2,724,641
=========== ===========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
-4-
THE INTERGROUP CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the six months ended December 31, 2007 2006
(As Restated)
----------- -----------
Hotel operations:
Hotel and garage revenue $ 19,405,000 $ 15,708,000
Operating expenses (16,607,000) (13,582,000)
Real estate taxes (354,000) (382,000)
Interest expense (1,405,000) (1,435,000)
Depreciation and amortization (2,201,000) (2,074,000)
----------- -----------
Loss from hotel operations (1,162,000) (1,765,000)
----------- -----------
Real estate operations:
Rental income 6,515,000 5,762,000
Property operating expense (2,497,000) (3,365,000)
Real estate taxes (734,000) (824,000)
Mortgage interest expense (1,897,000) (1,881,000)
Depreciation (1,141,000) (943,000)
----------- -----------
Income(loss) from real estate operations 246,000 (1,251,000)
----------- -----------
Investment transactions:
Net(losses)gains on marketable securities (2,000) 430,000
Impairment loss on other investments (125,000) -
Dividend and interest income 112,000 147,000
Margin interest and trading expenses (805,000) (1,036,000)
----------- -----------
Loss from investment transactions (820,000) (459,000)
----------- -----------
General and administrative expense (831,000) (740,000)
----------- -----------
Loss before income tax and minority interest (2,567,000) (4,215,000)
Minority interest - Justice Investors, pre-tax 535,000 835,000
----------- -----------
Loss before income tax (2,032,000) (3,380,000)
Income tax benefit 805,000 1,368,000
----------- -----------
Loss before minority interest (1,227,000) (2,012,000)
Minority interest, net of tax 341,000 246,000
----------- -----------
Loss from continuing operations (886,000) (1,766,000)
Income(loss) from discontinued operations,
net of tax 2,496,000 (63,000)
----------- -----------
Net income(loss) $ 1,610,000 $ (1,829,000)
=========== ===========
Net loss per share from continuing operations
Basic $ (0.38) $ (0.75)
=========== ===========
Diluted $ (0.38) $ (0.75)
=========== ===========
Net income(loss) per share from discontinued operations
Basic $ 1.06 $ (0.03)
=========== ===========
Diluted $ 1.06 $ (0.03)
=========== ===========
Net income(loss) per share
Basic $ 0.68 $ (0.78)
=========== ===========
Diluted $ 0.68 $ (0.78)
=========== ===========
Weighted average number of shares outstanding 2,352,373 2,356,393
=========== ===========
Diluted weighted average number of shares
outstanding 2,735,623 2,725,393
=========== ===========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
-5-
THE INTEGROUP CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Six Months ended December 31, 2007 2006
(As Restated)
----------- -----------
Cash flows from operating activities:
Net income(loss) $ 1,610,000 $ (1,829,000)
Adjustments to reconcile net income(loss) to
cash (used in)provided by operating activities:
Depreciation and amortization 3,342,000 3,258,000
Impairment loss on other investments 125,000 -
Gain on sale of real estate (4,074,000) -
Net unrealized loss on investments 112,000 1,858,000
Minority interest benefit (876,000) (1,081,000)
Issuance of stock to directors 72,000 -
Changes in assets and liabilities:
Investment in marketable securities 2,418,000 8,461,000
Other investments (2,225,000) (2,050,000)
Prepaid expenses and other assets (343,000) (272,000)
Accounts payable and other liabilities (171,000) 1,934,000
Due to securities broker (1,332,000) (2,549,000)
Obligation for securities sold (1,286,000) (5,038,000)
Deferred tax liability 833,000 (1,411,000)
----------- -----------
Net cash (used in)provided by operating activities (1,795,000) 1,281,000
----------- -----------
Cash flows from investing activities:
Net proceeds from sale of real estate 7,739,000 -
Additions to buildings, improvements
and equipment (3,075,000) (1,249,000)
Purchase of Portsmouth stock (28,000) -
Purchase of Santa Fe stock (77,000) (18,000)
Restricted cash 2,460,000 (405,000)
----------- -----------
Net cash provided by(used in) investing activities 7,019,000 (1,672,000)
----------- -----------
Cash flows from financing activities:
Borrowings from mortgage notes payable 6,850,000 325,000
Principal payments on mortgage notes payable (12,880,000) (723,000)
Payment on line of credit (300,000) -
Distributions to minority partners (500,000) -
Purchase of treasury stock (2,000) (101,000)
----------- -----------
Net cash used in financing activities (6,832,000) (499,000)
----------- -----------
Net decrease in cash and cash equivalents (1,608,000) (890,000)
Cash and cash equivalents at beginning of
period 2,158,000 2,935,000
----------- -----------
Cash and cash equivalents at end of period $ 550,000 $ 2,045,000
=========== ===========
Supplemental information:
Margin interest paid $ 182,000 $ 324,000
Mortgage interest paid $ 3,577,000 $ 3,679,000
The accompanying notes are an integral part of these condensed consolidated
financial statements.
-6-
THE INTERGROUP CORPORATION
NOTES TO CONDENSED 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.
As of December 31, 2007, the Company had the power to vote 79.4% of the common
stock of Santa Fe Financial Corporation ("Santa Fe"), a public company (OTCBB:
SFEF). This percentage includes the power to vote an approximately 4% interest
in the common stock of Santa Fe owned by the Company's Chairman and President
pursuant to a voting trust agreement entered into on June 30, 1998.
Santa Fe's operations primarily consist of owning and managing the Company's
hotel property through its 68.8%-owned consolidated subsidiary, Portsmouth
Square, Inc. ("Portsmouth"), a public company (OTCBB: PRSI), in Justice
Investors ("Justice", the Hotel" or the "Partnership"), a California limited
partnership. InterGroup also directly owns approximately 11% of the common
stock of Portsmouth.
Portsmouth has a 50.0% limited partnership interest in Justice in which
Portsmouth serves as both a general and limited partner. The other general
partner, Evon Corporation ("Evon"), serves as the managing general partner of
Justice. In accordance with guidance set forth in the Financial Accounting
Standards Board directed Staff Position (FSP) SOP 78-9-1, the Company has
applied the principles of accounting applicable for investments in subsidiaries
due to its "kick out rights" and "substantive participating rights" arising
from its limited partnership and general partnership interests 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.
The Company also derives income from its rental properties and the investment
of its cash in marketable securities and other investments.
Minority interest on the balance sheet represents the interest in subsidiaries
not owned by the Company. Minority interest on the statement of operations
represents the minority owner's share of income(loss). As of December 31,
2007, the Company had a minority interest asset balance on the balance sheet as
the result of the accumulated deficit at Justice Investors. Management
believes the accumulated deficit is considered temporary as the Hotel was
temporary closed to undergo major renovations from May 2005 to January 2006.
The Company expects the Hotel to be profitable, thereby reversing the
accumulated deficit in the future. Of the total minority interest liability of
$4,376,000 on the balance sheet, $3,230,000 is related to the minority
shareholders of Portsmouth and $1,146,000 is related to the minority
shareholders of Santa Fe.
-7-
Certain prior period balances have been reclassified to conform with the
current period presentation.
The results of operations for the three and six months ended December 31, 2007
are not necessarily indicative of results to be expected for the full fiscal
year ending June 30, 2008.
In July 2006, the FASB issued FASB Interpretation No. 48 ("FIN 48"), Accounting
for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109,
which clarifies the accounting for uncertainty in tax positions. FIN 48
requires that the Company recognize the impact of a tax position in the
Company's financial statements if that position is more likely than not of
being sustained on audit, based on the technical merits of the position. The
provisions of FIN 48 are effective as of the beginning of the Company's 2008
fiscal year, with the cumulative effect of the change in accounting principle
recorded as an adjustment to opening retained earnings. The adoption of FIN 48
did not have a material impact on the Company's consolidated financial
statements. The Company recognizes interest and penalties related to uncertain
income tax positions in income tax expense. There were no interest and
penalties related to uncertain income tax positions that were accrued as of
December 31, 2007 and during the period there were no changes in individual or
aggregate unrecognized tax positions. The Company's income tax returns for the
years ended June 30, 2004 up to present are subject to examination by certain
taxing authorities.
In September 2006, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 157, "Fair Value Measurements"
("SFAS 157"), which defines fair value, establishes a framework for measuring
fair value and expands disclosures about fair value measurements. SFAS 157 is
effective for as of the beginning of the Company's 2009 fiscal year. In
February 2007, the FASB issued Statement of Financial Accounting Standards No.
159, "The Fair Value Option for Financial Assets and Financial Liabilities -
Including an amendment of FASB Statement No. 115" ("SFAS 159"), which permits
entities to choose to measure many financial instruments and certain other
items at fair value. SFAS 159 is effective as of the beginning of the
Company's 2009 fiscal year. The Company is still evaluating the impact of SFAS
157 and 159 on the Company's consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), "Business
Combinations" ("SFAS 141R"), which replaces FAS 141. SFAS 141R establishes
principles and requirements for how an acquirer in a business combination
recognizes and measures in its financial statements the identifiable assets
acquired, the liabilities assumed, and any controlling interest; recognizes and
measures the goodwill acquired in the business combination or a gain from a
bargain purchase; and determines what information to disclose to enable users
of the financial statements to evaluate the nature and financial effects of the
business combination. SFAS 141R is to be applied prospectively to business
combinations for which the acquisition date is on or after an entity's fiscal
year that begins after December 15, 2008 (the Company's fiscal year 2010). The
Company is currently assessing the impact of SFAS 141R on its consolidated
financial statements.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in
Consolidated Financial Statements, and amendment to Accounting Research
Bulletin (ARB) No. 51," ("SFAS 160"). This standard prescribes the accounting
by a parent company for minority interests held by other parties in a
subsidiary of the parent company. SFAS 160 is effective for fiscal years
beginning after December 15, 2008, which will be effective for the Company
beginning July 1, 2009. The Company is currently assessing the impact of SFAS
160 on its consolidated financial statements.
-8-
Income (Loss) Per Share
Basic net income(loss) per share is computed by dividing net income(loss)
available to common stockholders by the weighted average number of common
shares outstanding. The computation of diluted net income(loss) per share is
similar to the computation of basic income(loss) 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 net
income(loss) per share by application of the treasury stock method. As of
December 31, 2007, the Company had 383,250 stock options that were considered
potentially dilutive common shares and 21,750 stock options that were
considered anti-dilutive. 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.
Stock-Based Compensation Plans
As of December 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, 2007. On July 1, 2006, the Company implemented
Statement of Financial Accounting Standards 123(Revised 2004), "Share-Based
Payments"("SFAS No. 123R") which replaced SFAS No. 123 and supercedes
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" 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 were
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 three and six months ended December 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 ending June
30, 2008, it is expected that 2,250 employee options will vest during the year.
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, 2007 405,000 $9.91
Granted - -
Exercised - -
Forfeited - -
---------- ---------------
Unexercised options
Outstanding at December 31, 2007 405,000 $9.91
========== ===============
-9-
As of December 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
---------------- -------------- ---------------- ----------------
December 31, 2007 $7.92-$29.63 $ 9.91 2.0 years
On February 21, 2007, the stockholders of the Company approved The InterGroup
Corporation 2007 Stock Compensation Plan for Non-Employee Directors (the "2007
Plan"), which was thereafter adopted by the Board of Directors. The 2007 Plan
was adopted to replace the 1998 Stock Option Plan for Non-Employee Directors.
Pursuant to the 2007 Plan, each non-employee director is entitled to an annual
grant of a number of shares of Common Stock of the Company equal in value to
$18,000 based on the fair market value of the Common Stock on the date of grant
and a grant of 600 shares of Common Stock upon the formal adoption of the 2007
Plan by the Board. The 2007 Plan is more fully described in Note 15 of the
Company's Annual Report on Form 10-KSB for fiscal year ended June 30, 2007.
For the six months ended December 31, 2007, the four non-employee directors of
the Company each received a grant of 987 shares of Common Stock pursuant to the
2007 Plan. The Company recorded an expense of approximately $72,000 related to
the issuance of the 3,948 shares of the Company's common stock.
NOTE 2 - INVESTMENT IN HOTEL, NET
Justice owns a 544 room hotel property located at 750 Kearny Street, San
Francisco, California 94108, known as the "Hilton San Francisco Financial
District" (the "Hotel") and related facilities, including a five level
underground parking garage. Justice serves as the owner/operator of the Hotel
with the assistance of a third party management company. The Partnership also
derives income from a lease of the garage with Evon and from a lease with Tru
Spa for a portion of the lobby level of the Hotel.
Land, property and equipment as of December 31, 2007 consisted of the
following:
Accumulated Net Book
Cost Depreciation Value
------------ ------------ ------------
Land $ 2,738,000 $ - $ 2,738,000
Furniture and equipment 15,937,000 (6,367,000) 9,570,000
Building and improvements 52,761,000 (15,812,000) 36,949,000
------------ ------------ ------------
$ 71,436,000 $(22,179,000) $ 49,257,000
============ ============ ============
NOTE 3 - INVESTMENT IN REAL ESTATE
As of December 31, 2007, investment in real estate included the following:
Land $ 25,202,000
Buildings, improvements and equipment 63,146,000
Accumulated depreciation (20,461,000)
----------
$ 67,887,000
==========
-10-
In August 2007, the Company refinanced its $7,203,000 construction loan on its
30-unit apartment complex located in Los Angeles, California and obtained a
mortgage note payable in the amount of $6,850,000. The term of the note is 15
years, with interest only for the first two years. The interest is fixed at
5.97%.
NOTE 4 - PROPERTY HELD FOR SALE
In August 2007, the Company sold its 224-unit apartment complex located in
Irving, Texas for $8,050,000 and recognized a gain on the sale of real estate
of $4,074,000. The Company received net proceeds after selling costs of
$7,739,000 and paid off the related outstanding mortgage note payable of
$4,007,000.
During the six months ended December 31, 2007, the Company had listed for sale
its 249-unit apartment building located in Austin, Texas (classified as Held
for Sale on the balance sheet) and sold 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 two
properties have been reclassified from continuing operations for the three and
six months ended December 31, 2007 and 2006 and are reported as income(loss)
from discontinued operations in the consolidated statements of operations.
The revenues and expenses from the operation of these two properties during the
three and six months ended December 31, 2007 and 2006, are summarized as
follows:
For the three months ended December 31, 2007 2006
---------- ----------
Revenues $ 469,000 $ 751,000
Expenses (380,000) (818,000)
---------- ----------
Income(loss) $ 89,000 $ (67,000)
========== ==========
For the six months ended December 31, 2007 2006
---------- ----------
Revenues $1,102,000 $ 1,505,000
Expenses (1,042,000) (1,611,000)
---------- ----------
Income(loss) $ 60,000 $ (106,000)
========== ==========
NOTE 5 - 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.
-11-
At December 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 December 31, 2007
Gross Gross Net Market
Investment Cost Unrealized Gain Unrealized Loss Unrealized Gain Value
---------- ----------- --------------- --------------- --------------- --------
---
Equities $11,150,000 $6,204,000 ($2,121,000) $4,083,000
$15,233,000
As of December 31, 2007, the Company had $278,000 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, 2007, the Company had
obligations for securities sold (equities short) of $199,000.
Net gains(losses) on marketable securities on the statement of operations are
comprised of realized and unrealized gains(losses). Below is the composition
of the net gains(losses) for the three and six months ended December 31, 2007
and 2006, respectively.
For the three months ended December 31, 2007 2006
----------- -----------
Realized gains on marketable securities $ 357,000 $ 1,826,000
Unrealized gains(losses) on marketable securities 1,018,000 (516,000)
----------- -----------
Net gains on marketable securities $ 1,375,000 $ 1,310,000
=========== ===========
For the six months ended December 31, 2007 2006
----------- -----------
Realized gains on marketable securities $ 110,000 $ 2,288,000
Unrealized losses on marketable securities (112,000) (1,858,000)
----------- -----------
Net (losses)gains on marketable securities $ (2,000) $ 430,000
=========== ===========
NOTE 6 - OTHER INVESTMENTS
As a part of its investment strategy, the Company may also invest, with the
approval of the Securities Investment Committee, in unlisted securities, such
as convertible notes, through private placements including private equity
investment funds. Those investments in non-marketable securities are carried
at cost on the Company's balance sheet as part of other investments and
reviewed for impairment on a periodic basis. As of December 31, 2007, the
Company had other investments of $7,394,000.
-12-
NOTE 7 - SEGMENT INFORMATION
The Company operates in three reportable segments, the operation of the hotel,
the operation of its multi-family residential properties and the investment of
its cash in marketable securities and other investments. 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, 2007 and 2006. Operating income for rental properties
consists of rental income. Operating income(loss) 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.
As of and for the
Three months ended Hotel Real Estate Investment Discontinued
December 31, 2007 Operations Operations Transactions Other Subtotal Operations Total
----------- ----------- ------------ ----------- ------------ ------------ ------------
Operating income $ 9,619,000 $ 3,319,000 $ 1,434,000 $ - $ 14,372,000 $ 469,000 $ 14,841,000
Operating expenses (10,223,000) (3,093,000) (373,000) - (13,689,000) (380,000) (14,069,000)
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net operating income(loss) (604,000) 226,000 1,061,000 - 683,000 89,000 772,000
General and administrative
Expense - - - (402,000) (402,000) - (402,000)
Income tax expense - - - (182,000) (182,000) (30,000) (212,000)
Minority interest 257,000 - - (68,000) 189,000 - 189,000
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net income(loss) $ (347,000) 226,000 $ 1,061,000 $ (652,000) $ 288,000 $ 59,000 $ 347,000
=========== =========== =========== =========== ============ ============ ============
Total Assets $52,268,000 $67,887,000 $22,627,000 $ 9,600,000 $ 152,382,000 $ 5,231,000 $157,613,000
=========== =========== =========== =========== ============ ============ ============
As of and for the
Three months ended Hotel Real Estate Investment Discontinued
December 31, 2006 Operations Operations Transactions Other Subtotal Operations Total
(As Restated) ----------- ----------- ------------ ----------- ------------ ------------ ------------
Operating income $ 8,116,000 $ 2,895,000 $ 1,399,000 $ - $ 12,410,000 $ 751,000 $ 13,161,000
Operating expenses (9,090,000) (3,886,000) (556,000) - (13,532,000) (818,000) (14,350,000)
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net operating income(loss) (974,000) (991,000) 843,000 - (1,122,000) (67,000) (1,189,000)
General and administrative
Expense - - - (346,000) (346,000) - (346,000)
Income tax benefit - - - 432,000 432,000) 28,000 460,000
Minority interest 462,000 - - (96,000) 366,000 - 366,000
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net income(loss) $ (512,000) (991,000) $ 843,000 $ (10,000) $ (670,000) $ (39,000) $ (709,000)
=========== =========== =========== =========== ============ ============ ============
Total Assets $46,240,000 $69,228,000 $25,251,000 $14,189,000 $ 154,908,000 $ 9,052,000 $163,960,000
=========== =========== =========== =========== ============ ============ ============
-13-
As of and for the
Six months ended Hotel Real Estate Investment Discontinued
December 31, 2007 Operations Operations Transactions Other Subtotal Operations Total
----------- ----------- ------------ ----------- ------------ ------------ ------------
Operating income $19,405,000 $ 6,515,000 $ (15,000) $ - $ 25,905,000 $ 1,102,000 $ 27,007,000
Operating expenses (20,567,000) (6,269,000) (805,000) - (27,641,000) (1,042,000) (28,683,000)
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net operating income(loss) (1,162,000) 246,000 (820,000) - (1,736,000) 60,000 (1,676,000)
Gain on sale of reale estate - - - - - 4,074,000 4,074,000
General and administrative
Expense - - - (831,000) (831,000) - (831,000)
Income tax expense - - - 805,000 805,000 (1,638,000) (833,000)
Minority interest 535,000 - - 341,000 876,000 - 876,000
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net income(loss) $ (627,000) 246,000 $ (820,000) $ 315,000 $ (886,000) $ 2,496,000 $ 1,610,000
=========== =========== =========== =========== ============ ============ ============
Total Assets $52,268,000 $67,887,000 $22,627,000 $ 9,600,000 $ 152,382,000 $ 5,231,000 $157,613,000
=========== =========== =========== =========== ============ ============ ============
As of and for the
Six months ended Hotel Real Estate Investment Discontinued
December 31, 2006 Operations Operations Transactions Other Subtotal Operations Total
(As Restated) ----------- ----------- ------------ ----------- ------------ ------------ ------------
Operating income $15,708,000 $ 5,762,000 $ 577,000 $ - $ 22,047,000 $ 1,505,000 $ 23,552,000
Operating expenses (17,473,000) (7,013,000) (1,036,000) - (25,522,000) (1,611,000) (27,133,000)
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net operating loss (1,765,000) (1,251,000) (459,000) - (3,475,000) (106,000) (3,581,000)
General and administrative
Expense - - - (740,000) (740,000) - (740,000)
Income tax benefit - - - 1,368,000 1,368,000 43,000 1,411,000
Minority interest 835,000 - - 246,000 1,081,000 - 1,081,000
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net income(loss) $ (930,000) (1,251,000) $ (459,000) $ 874,000 $ (1,766,000) $ (63,000) $ (1,829,000)
=========== =========== =========== =========== ============ ============ ============
Total Assets $46,240,000 $69,228,000 $25,251,000 $14,189,000 $ 154,908,000 $ 9,052,000 $163,960,000
=========== =========== =========== =========== ============ ============ ============
NOTE 8 - 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.
The garage lessee, Evon, is the Partnership's managing general partner. Under
the terms of the lease agreement, Evon paid the Partnership $421,000 and
$380,000 for the three months ended December 31, 2007 and 2006, respectively.
For the six months ended December 31, 2007 and 2006, Evon paid the Partnership
$836,000 and $811,000, respectively.
-14-
NOTE 9 - RESTATEMENTS
As disclosed in Item 4.02(a) of the Company's Form 8-K dated February 13, 2008,
as filed with the Securities and Exchange Commission ("SEC") on February 19,
2008, the Company detected an error in the calculation and presentation of the
tax effects on the minority interest related to Justice Investors in the
comparative three and six month periods ended December 31, 2006 as presented in
the Company's previously issued Quarterly Report on Form 10-QSB for the period
ended December 31, 2006. Specifically, the minority interest line item in the
Consolidated Statement of Operations was mistakenly recorded and presented as
"net of tax" instead of pre-tax. The errors resulted in an overstatement of the
tax benefit related to the minority interest for the three and six months ended
December 31, 2006. After further review, the Company determined that similar
errors occurred in the quarterly periods ended September 30, 2006 and March 31,
2007.
The errors do not affect the Company's reported revenues, expenses, income
(loss) before income taxes or cash flows, and do not impact the Company's
operations. There were no such errors in the Company's audited financial
statements included in its Annual Report on Form 10-KSB for the fiscal year
ended June 30, 2007, and as such that Annual Report will not be amended.
Pending completion of this current filing of the Company's Form 10-QSB for the
three and six months ended December 31, 2007, we will file the following
amended filings:
* Form 10-QSB/A for the three and nine months ended March 31, 2007
* Form 10-QSB/A for the three months ended September 30, 2007.
Within the current filing, we are restating the Condensed Consolidated
Statements of Operations for the three and six months ended December 31, 2006.
The table below presents the changes to the Condensed Consolidated Statement of
Operations for the three and six months ended December 31, 2006 and the changes
to the Condensed Consolidated Balance Sheet as of December 31, 2006.
For the three months ended December 31, 2006 As Reported As Restated
----------- -----------
Income tax benefit $ 658,000 $ 460,000
Minority interest - Justice Investors, pre-tax $ - $ 462,000
Minority interest, net of tax $ 270,000 $ (96,000)
Net loss $ (607,000) $ (709,000)
Basic loss per share $ (0.26) $ (0.30)
Diluted loss per share $ (0.26) $ (0.30)
For the six months ended December 31, 2006 As Reported As Restated
----------- -----------
Income tax benefit $ 1,756,000 $ 1,411,000
Minority interest - Justice Investors, pre-tax $ - $ 835,000
Minority interest, net of tax $ 913,000 $ 246,000
Net loss $(1,652,000) $(1,829,000)
Basic loss per share $ (0.70) $ (0.78)
Diluted loss per share $ (0.70) $ (0.78)
Balance Sheet Line Items as of December 31, 2006 As Reported As Restated
------------ ------------
Prepaid expenses and other assets $ 13,607,000 $ 13,370,000
Minority interest $ 2,419,000 $ 2,358,000
Retained earnings $ 7,698,000 $ 7,521,000
-15-
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS AND PROJECTIONS
The Company may from time to time make forward-looking statements and
projections concerning future expectations. 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, seasonality, 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 discussed below in this Report and in the
Company's Annual Report on Form 10-KSB for the fiscal year ended June 30, 2007,
that could cause actual results to differ materially from those projected.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which speak only as to the date hereof. 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 sources of revenue continue to be derived from the
investment of its 68.8% owned subsidiary, Portsmouth, in the Justice Investors
limited partnership ("Justice" or the "Partnership"), rental income from the
operations of its multi-family real estate properties and income derived from
investment of its cash in marketable securities and other investments.
Portsmouth has a 50.0% limited partnership interest in 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 (the "Hotel"). The financial statements of Justice
have been consolidated with those of the Company, effective as of July 1, 2006.
See Note 1 to the Condensed Consolidated Financial Statements.
The Hotel is operated by the Partnership as a full service Hilton brand hotel
pursuant to a Franchise License Agreement with Hilton Hotels Corporation. The
term of the Agreement is for a period of 15 years commencing on January 12,
2006, with an option to extend the term for another five years, subject to
certain conditions. Justice also has a Management Agreement with Prism
Hospitality L.P. ("Prism") to perform the day-to-day management functions of
the Hotel.
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.
Portsmouth also receives management fees as a general partner of Justice for
its services in overseeing and managing the Partnership's assets. Those fees
are eliminated in consolidation.
-16-
Recent Developments
On October 1, 2007 and November 23, 2007, Justice paid special distributions to
its limited partners in the total amounts of $400,000 and $600,000,
respectively, of which one half of each such distribution was received by
Portsmouth. The general partners expect to conduct regular reviews to set the
amount of any future distributions that may be appropriate based on the results
of operations of the Hotel and other factors.
In November 2007, the Company listed for sale its 249-unit apartment complex
located in Austin, Texas. This property is classified as held for sale on the
balance sheet with the results of its operations classified as discontinued
operations.
Three Months Ended December 31, 2007 Compared to the Three Months Ended
December 31, 2006
The Company had net income of $347,000 for the three months ended December 31,
2007 compared to a net loss of $709,000 for the three months ended December 31,
2006. As discussed below, the change is due to the improvement in the
Company's real estate operations, the reduction in the loss from hotel
operations and the increase in income from investment transactions.
The loss from hotel operations was $604,000 for the three months ended December
31, 2007, compared to a loss of $974,000 for the three months ended December
31, 2006. The decrease in the loss was primarily attributable to greater income
generated from the operations of the Hotel during the second quarter. For the
three months ended December 31, 2007, the operations of the Hotel on a
standalone basis generated operating income of approximately $1,175,000 on
operating revenues of approximately $9,104,000, compared to operating income of
approximately $822,000 on operating revenues of approximately $7,648,000 for
the three months ended December 31, 2006, primarily due to a higher average
daily room rate and an increase in occupancy percentage.
The following table sets forth the average daily room rate, average occupancy
percentage and room revenue per available room ("RevPar") of the Hotel for the
three months ended December 31, 2007 and 2006.
Three Months Ended Average Average
December 31, Daily Rate Occupancy% RevPar
----------------- ---------- ---------- ---------
2007 $170.61 85.1% $145.77
2006 $159.79 75.7% $122.37
Average daily room rates and occupancy have continued to improve since the
Hotel's reopening in January 2006. As a result, the Hotel was able to achieve a
more than $23 increase in RevPar for the three months ended December 31, 2007
compared the three months ended December 31, 2006. 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.
The Hotel's food and beverage operations remain challenging and management is
expected to explore new concepts in its efforts to improve the operations in
that department. Management will also continue to focus on ways to reduce
operating costs and other expenses in its efforts to increase the net operating
income of the Hotel.
Absent a downturn in the economy, we expect that the operating results of the
Hotel will continue to improve over fiscal 2007 as the Hotel approaches full
stabilization and gets further penetration into the Financial District hotel
-17-
market. We anticipate a reduction in Partnership general and administrative
expenses for legal and consulting fees in fiscal 2008, as many of those
expenses were attributable to certain nonrecurring legal matters that
originated in fiscal 2007 and which we expect to be resolved in fiscal 2008. If
cash flows from the Hotel operations continue to improve, the Partnership could
make additional distributions to its limited partners in fiscal 2008.
Income(loss) from real estate operations changed to income of $226,000 for the
three months ended December 31, 2007 as compared to a loss of $991,000 for the
three months ended December 31, 2006 primarily as the result of the increase in
rental income coupled with the decrease in property operating expenses. Rental
income from the Company's California real estate portfolio increased by
$222,000 while rental income from the Company's properties located outside of
California increased by $202,000. The increase the rental income from the
California real estate portfolio is primary attributable to the significant
increase in the occupancy of the Company's newly renovated 30-unit apartment
complex located in Los Angeles, California and the improvement in the occupancy
and rental rates in the Los Angeles area. The increase in the rental income
from the properties located outside of California was primarily due to improved
occupancy as the result of the improving rental housing market. Property
operating expenses decreased to $1,297,000 for the three months ended December
31, 2007 from $2,074,000 for the three months ended December 31, 2006 primarily
as the result of $560,000 in real estate related legal expenses incurred during
the three months ended December 31, 2006 and management's overall effort to
reduce property operating expenses across the Company's entire real estate
portfolio.
The Company had net gains on marketable securities of $1,375,000 for the three
months ended December 31, 2007 compared to net gains of $1,310,000 for the
three months ended December 31, 2006. For the three months ended December 31,
2007, the Company had net realized gains of $357,000 and net unrealized gains
of $1,018,000. 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. 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
results of operations. 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.
Margin interest and trading expenses decreased to $373,000 for the three months
ended December 31, 2007 from $556,000 for the three months ended December 31,
2006 as the result of the decrease in margin interest expense to $65,000 from
$150,000 and the decrease in trading related expenses to $308,000 from
$406,000. The decrease in margin interest expense is the result the reduction
in the use of margin in the Company's investment activities during the most
recent quarter.
Minority interest related to Justice Investors decreased to $257,000 for the
three months ended December 31, 2007 from $462,000 for the three months ended
December 31, 2006 as the result of the lower loss incurred by the hotel
operations during the most recent quarter.
The provision for income tax changed to an tax expense of $212,000 for the
three months ended December 31, 2007 from a tax benefit of $460,000 for the
three months ended December 31, 2006 primarily due to the pre-tax income
generated by the Company as compared to a pre-tax loss.
-18-
Six Months Ended December 31, 2007 Compared to the Six Months Ended December
31, 2006
The Company had net income of $1,610,000 for the six months ended December 31,
2007 compared to a net loss of $1,829,000 for the six months ended December 31,
2006. As discussed below, the significant change is due to the large gain
recognized on the sale of real estate, the improvement in the real estate
operations and the reduction in the loss from the hotel operations, partially
offset by the loss from investment transactions.
The loss from hotel operations was $1,162,000 for the six months ended December
31, 2007, compared to a loss of $1,765,000 for the six months ended December
31, 2006. The decrease in the loss was primarily attributable to greater income
generated from the operations of the Hotel during the current period, partially
offset by higher general and administrative expenses at the Justice level
primarily due to certain nonrecurring legal and consulting fees in the current
period.
For the six months ended December 31, 2007, the operations of the Hotel on a
standalone basis generated operating income of approximately $2,612,000 on
operating revenues of approximately $18,454,000, compared to operating income
of approximately $1,526,000 on operating revenues of approximately $14,735,000
for the six months ended December 31, 2006, primarily due to a higher average
daily room rate and an increase in occupancy percentage.
The following table sets forth the average daily room rate, average occupancy
percentage and room revenue per available room ("RevPar") of the Hotel for the
six months ended December 31, 2007 and 2006.
Six Months Ended Average Average
December 31, Daily Rate Occupancy% RevPar
----------------- ---------- ---------- ---------
2007 $173.74 87.0% $151.56
2006 $155.41 76.3% $119.53
Average daily room rates and occupancy have continued to improve since the
Hotel's reopening in January 2006. As a result, the Hotel was able to achieve
an approximately $32 increase in RevPar for the six months ended December 31,
2007 compared the six months ended December 31, 2006. 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. The Hotel's food and beverage operations remain challenging and
management is expected to explore new concepts in its efforts to improve the
operations in that department. Management will also continue to focus on ways
to reduce operating costs and other expenses in its efforts to increase the net
operating income of the Hotel.
Absent a downturn in the economy, we expect that the operating results of the
Hotel will continue to improve over fiscal 2007 as the Hotel approaches full
stabilization and gets further penetration into the Financial District hotel
market. We anticipate a reduction in Partnership general and administrative
expenses for legal and consulting fees in fiscal 2008, as many of those
expenses were attributable to certain nonrecurring legal matters that
originated in fiscal 2007 and which we expect to be resolved in fiscal 2008. If
cash flows from the Hotel operations continue to improve, the Partnership could
make additional distributions to its limited partners in fiscal 2008.
Income(loss) from real estate operations changed to income of $246,000 for the
six months ended December 31, 2007 as compared to a loss of $1,250,000 for the
six months ended December 31, 2006 primarily as the result of the increase in
rental income coupled with the decrease in property operating expenses. Rental
-19-
income from the Company's California real estate portfolio increased by
$497,000 while rental income from the Company's properties located outside of
California increased by $256,000. The increase the rental income from the
California real estate portfolio is primary attributable to the significant
increase in the occupancy of the Company's newly renovated 30-unit apartment
complex located in Los Angeles, California and the improvement in the occupancy
and rental rates in the Los Angeles area. The increase in the rental income
from the properties located outside of California was primarily due to improved
occupancy as the result of the improving rental housing market. Property
operating expenses decreased to $2,497,000 for the six months ended December
31, 2007 from $3,365,000 for the six months ended December 31, 2006 primarily
as the result of $560,000 in real estate related legal expenses incurred during
the three months ended December 31, 2006 and management's overall effort to
reduce property operating expenses across the Company's entire real estate
portfolio.
In August 2007, the Company sold its 224-unit apartment complex located in
Irving, Texas for $8,050,000 and recognized a gain on the sale of real estate
of $4,074,000. The Company received net proceeds after selling costs of
$7,739,000. The operations and the related gain on the sale of real estate are
classified under discontinued operations in the statement of operations.
Net gains(losses) on marketable securities changed to net losses of $2,000 for
the six months ended December 31, 2007 compared to net gains of $430,000 for
the six months ended December 31, 2006. For the six months ended December 31,
2007, the Company had net realized gains of $110,000 and net unrealized gains
of $112,000. For the six months ended December 31, 2006, the Company had net
realized gains of $2,288,000 and net unrealized losses of $1,858,000. 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
results of operations. 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 see the
Marketable Securities section below.
During the six months ended December 31, 2007, the Company performed an
impairment analysis of its other investments and determined that one of its
investments had an other than temporary impairment and recorded an impairment
loss on other investments of $125,000. There was no impairment loss recorded
for the six months ended December 31, 2006.
Margin interest and trading expenses decreased to $805,000 for the six months
ended December 31, 2007 from $1,036,000 for the six months ended December 31,
2006 as the result of the decrease in margin interest expense to $182,000 from
$324,000 and the decrease in trading related expenses to $623,000 from
$712,000. The decrease in margin interest expense is the result the reduction
in the use of margin in the Company's investment activities during the most
recent period.
Minority interest related to Justice Investors decreased to $535,000 for the
six months ended December 31, 2007 from $835,000 for the six months ended
December 31, 2006 as the result of the lower loss incurred by the hotel
operations during the most recent quarter.
The provision for income tax benefit(expense) changed to a tax expense of
$833,000 for the six months ended December 31, 2007 from a tax benefit of
$1,411,000 for the six months ended December 31, 2006 primarily due to the
significantly higher pre-tax income generated during the six months ended
December 31, 2007 compared to significant pre-tax losses incurred during the
comparable six months ended December 31, 2006.
-20-
MARKETABLE SECURITIES
The Company's investment portfolio is diversified with 43 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 18% 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, 2007, the Company had investments in marketable equity
securities of $15,233,000. The following table shows the composition of the
Company's marketable securities portfolio by selected industry groups as of
December 31, 2007.
% of Total
Investment
Industry Group Market Value Securities
-------------- ------------ ----------
Technology $ 3,748,000 24.6%
Insurance, banks and brokers 1,695,000 11.1%
Services 1,683,000 11.0%
Dairy products 1,384,000 9.1%
Consumer goods and retail 1,200,000 7.9%
REITs and building materials 1,095,000 7.2%
Holding companies 1,011,000 6.6%
Telecommunications and media 546,000 3.6%
Other 2,871,000 18.9%
------------ ----------
$15,233,000 100.0%
============ ==========
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 December 31, 2007 2006
-------------- --------------
Net gains on marketable securities $ 1,375,000 $ 1,310,000
Dividend & interest income 59,000 89,000
Margin interest expense (65,000) (150,000)
Trading and management expenses (308,000) (406,000)
------------ ------------
$ 1,061,000 $ 843,000
============ ============
For the six months ended December 31, 2007 2006
-------------- --------------
Net (losses)gains on marketable securities $ (2,000) $ 430,000
Impairment loss on other investments (125,000) -
Dividend & interest income 112,000 147,000
Margin interest expense (182,000) (324,000)
Trading and management expenses (623,000) (712,000)
------------ ------------
$ (820,000) $ (459,000)
============ ============
-21-
FINANCIAL CONDITION AND LIQUIDITY
The Company's cash flows are primarily generated from the hotel operations. The
Company also generates revenues from its real estate operations and from the
investment of its cash and marketable securities. Since the operations of the
Hotel were temporarily suspended on May 31, 2005, and significant amounts of
money were expended to renovate and reposition the Hotel as a Hilton, Justice
did not pay any partnership distributions until the end of March 2007. As a
result, the Company had to depend more on the revenues generated from its real
estate operations and the investment of its cash and marketable securities
during that transition period.
The Hotel started to generate cash flows from its operations in June 2006,
which have continued to improve since that time. 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
that special distribution, especially with financings in place to meet any
additional capital needs. On October 1, 2007, Justice paid a second special
limited partnership distribution in the amount of $400,000 and an additional
special limited partnership distribution in the amount of $600,000 on November
23, 2007, of which Portsmouth received $200,000 and $300,000 respectively. The
general partners expect to conduct regular reviews to set the amount of any
future distributions that may be appropriate based on the results of operations
of the Hotel and other factors. If cash flows from the Hotel operations
continue to improve, the Partnership could be in a position to make regular
distributions to its limited partners in fiscal 2008.
To meet its substantial financial commitments for the renovation 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
with The Prudential Insurance Company of America in a principal amount of
$30,000,000 (the "Prudential Loan"). The term of the Prudential Loan is for 120
months at a fixed interest rate of 5.22% per annum. The Prudential Loan calls
for monthly installments of principal and interest in the amount of
approximately $165,000, calculated on a 30 year amortization schedule. The
Prudential 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 Prudential Loan is
without recourse to the limited and general partners of Justice. As of December
31, 2007, the Prudential Loan balance was approximately $28,972,000.
On March 27, 2007, Justice entered into a second mortgage loan with Prudential
(the "Second Prudential Loan") in the 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 Prudential Loan. 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 30-year amortization schedule. The Second Prudential 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 Second Prudential Loan is without
recourse to the limited and general partners of Justice. As of December 31,
2007, the Second Prudential Loan balance was approximately $18,858,000.
From the proceeds of the Second Prudential Loan, Justice retired its existing
line of credit facility with United Commercial Bank ("UCB") and paid 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
-22-
of business due to labor issues, natural causes affecting tourism or 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 December 31, 2007, there were no amounts borrowed by Justice
under the new line of credit; however, $1,750,000 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 $1,750,000,
which fee is to be paid in quarterly installments for the periods in which the
letter of credit is in effect.
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.
In August 2007, the Company sold its 224-unit apartment complex located in
Irving, Texas for $8,050,000 and recognized a gain on the sale of real estate
of $4,074,000. The Company received net proceeds after selling costs of
$7,739,000 and paid off the related outstanding mortgage note payable of
$4,007,000 and made a $3,000,000 payment to reduce its outstanding line of
credit to $1,258,000 from $4,258,000. In October 2007, the Company utilized
$2,700,000 of its line of credit for investments, increasing the outstanding
balance to $3,958,000 as of December 31, 2007.
In August 2007, the Company refinanced its $7,203,000 construction loan on its
30-unit apartment complex located in Los Angeles, California and obtained a
mortgage note payable in the amount of $6,850,000. The term of the note is 15
years, with interest only for the first two years. The interest is fixed at
5.97%.
During the six months ended December 31, 2007, the Company made property
improvements in the aggregate amount of $3,089,000. 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.
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 consolidated statements of operations.
Management believes that its cash, marketable securities, and the cash flows
generated from those assets and from its real estate operations, partnership
distributions and management fees, will be adequate to meet the Company's
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.
-23-
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. Since Prism has the power and ability under the
terms of its management agreement to adjust hotel room rates on an ongoing
basis, 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
Critical accounting policies are those that are most significant to the
portrayal of our financial position and results of operations and require
judgments by management in order to make estimates about the effect of matters
that are inherently uncertain. The preparation of these financial statements
requires us to make estimates and judgments that affect the reported amounts in
our consolidated financial statements. We evaluate our estimates on an on-going
basis, including those related to the consolidation of our subsidiaries, to our
revenues, allowances for bad debts, accruals, asset impairments, other
investments, income taxes and commitments and contingencies. We base our
estimates on historical experience and on various other assumptions that we
believe to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities.
The actual results may differ from these estimates or our estimates may be
affected by different assumptions or conditions.
Item 3. Controls and Procedures
Evaluation of Disclosure Controls and Procedures.
The Company's management, with the participation of the Company's Chief
Executive Officer and the Principal 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. In connection
with the restatement described in Note 9, to our Condensed Consolidated
Financial Statements, management determined that there were material weaknesses
in our internal control over financial reporting in the areas of accounting for
minority interest and tax provisions related to the consolidation of a
partnership entity in prior comparative periods. In light of these material
weaknesses, the Company performed additional analyses and other review
procedures to ensure the Company's Condensed Consolidated Financial Statements
are prepared in accordance with generally accepted accounting principles.
Accordingly, management believes that the financial statements included in this
report fairly represent in all material respects the Company's financial
condition, results of operations and cash flows for the periods presented.
-24-
Material Weakness in Internal Control Over Financial Reporting
A material weakness is a control deficiency, or combination of control
deficiencies, that result in a more than remote likelihood that a material
misstatement of the annual or interim financial statements will not be
prevented or detected. As of December 31, 2007, we did not maintain effective
controls over the accuracy for our accounting for the minority interest and tax
provisions related to our consolidated partnership entity. These control
deficiencies resulted in the restatement of our consolidated financial
statements for the comparative quarterly periods ended December 31, 2006. In
addition, due to these control deficiencies, restatements of our consolidated
financial statements for our quarterly periods ended September 30, 2006 and
March 31, 2007 will also be necessary.
(b) Changes In 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.
Remediation of Material Weakness
As noted above, management determined that there were material weaknesses in
our internal controls over financial reporting in the areas of accounting for
the minority interest and tax provisions related to the consolidation of a
partnership entity. In connection with the material weaknesses in internal
controls over financial reporting the Company intends to take the following
steps to alleviate the material weaknesses in these areas:
* An additional layer of review of the Company's tax provisions and
consolidation processes will be performed at the corporate level;
* The Company will engage tax consultants to review the Company's tax
provisions on a quarterly and annual basis; and
* The Company will review staffing levels, job assignments, and
processes to identify other process weaknesses, if any, in order
to mitigate the risk of reporting errors within the tax process for
future periods.
Management will continue to monitor internal control over financial reporting
and will modify or implement if necessary, any additional controls or
procedures that may be required to ensure the continued integrity of our
financial statements.
-25-
PART II.
OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
Bacon Plumbing Co., Inc. and Golden Electric Company v. Allied Construction, et
al., San Francisco County Superior Court, Case No. 06-455401 (the "Allied
Litigation").
This is to update matters previously reported in the Company's Form 10-KSB for
its fiscal year ended June 30, 2007 and its Form 10-QSB for the quarter ended
September 30, 2007, regarding the litigation and lien claims filed by Allied
Construction Management, Inc. ("Allied") and eight subcontractors arising out
of the renovation work performed on the San Francisco hotel property. All of
those claims were consolidated into the above entitled action. On October 23,
2007, the Superior Court entered an order approving settlements reached by
Justice Investor with all of the subcontractors that filed liens against the
hotel property. The aggregate amount of those settlements was approximately
$1,580,000 and the total amount of the liens filed by the subcontractors was
approximately $1,756,000. The settlement amounts were paid by Justice on
November 2, 2007 and the subcontractor liens were released. The Court also
reduced the lien claim of Allied from $2,061,544 to $1,166,649.
In December 2007, Justice entered into a settlement agreement in the amount of
$65,000 with another subcontractor engaged by Allied, which amount was paid by
Justice on January 31, 2008. Although that subcontractor did not file an
independent lien, the $236,000 allegedly due that subcontractor was part of
Allied claim and will serve as a further reduction in the amount allegedly due
Allied. With the settlement of all claims relating to the subcontractors
complete, a motion brought by Allied to stay the lawsuit and have the remaining
dispute between Allied and Justice determined by arbitration was granted by the
court. No date for has been selected for the arbitration. Justice, Evon and
Portsmouth dispute the amounts alleged to be owed to Allied and intend to
vigorously defend the balance of this action.
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.
-26-
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
2008 Shares Price Paid Announced Plans Under the Plans
Period Purchased Per Share or Programs or Programs
--------------------------------------------------------------------------------------
Month #1
(Oct. 1- - - - 23,328
Oct. 31)
--------------------------------------------------------------------------------------
Month #2
(Nov. 1- - - - 22,328
Nov. 30)
--------------------------------------------------------------------------------------
Month #3
(Dec. 1- 105 $18.13 105 22,223
Dec. 31)
--------------------------------------------------------------------------------------
Total 105 $18.13 105 22,223
--------------------------------------------------------------------------------------
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 6. Exhibits.
(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 Principal 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 Principal Financial Officer Pursuant to 18
U.S.C. Section 1350.
-27-
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 19, 2008 by /s/ John V. Winfield
----------------------------
John V. Winfield, President,
Chairman of the Board and
Chief Executive Officer
Date: February 19, 2008 by /s/ David Nguyen
------------------------------
David Nguyen, Treasurer
and Controller
(Principal Financial Officer)
-28-