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, 2006
[ ] Transition Report Under Section 13 Or 15 (d) of the
Securities Exchange Act of 1934
For the transition period from ______ to _____
Commission file number 1-10324
THE INTERGROUP CORPORATION
--------------------------
(Exact Name of Small Business Issuer as Specified in Its Charter)
DELAWARE 13-3293645
------------------------------ ------------------
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification No.)
820 Moraga Drive Los Angeles, CA 90049
--------------------------------------
(Address of Principal Executive Offices)
(310) 889-2500
-------------------------
(Issuer's Telephone Number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
YES [X] NO [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). YES [ ] NO [X]
The number of shares outstanding of the issuer's Common Stock, $.01 par value,
as of May 10, 2006 were 2,364,141 shares.
Transitional Small Business Disclosure Format: YES [ ] NO [X]
THE INTERGROUP CORPORATION
INDEX TO FORM 10-QSB
PART I. FINANCIAL INFORMATION PAGE
Item 1. Consolidated Financial Statements:
Consolidated Balance Sheet (unaudited)
As Of March 31, 2006 3
Consolidated Statements of Operations (unaudited)
For the Three Months Ended March 31, 2006 and 2005 4
Consolidated Statements of Operations (unaudited)
For the Nine Months Ended March 31, 2006 and 2005 5
Consolidated Statements of Cash Flows (unaudited)
For the Nine Months Ended March 31, 2006 and 2005 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 17
Item 3. Controls and Procedures 25
Part II. OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use
of Proceeds 26
Item 4. Submission of Matters to a Vote of Shareholders 26
Item 6. Exhibits and Reports on Form 8-K 27
Signatures 28
-2-
THE INTERGROUP CORPORATION
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
As of March 31, 2006
-----------
ASSETS
Investment in real estate, at cost:
Land $ 25,487,000
Buildings, improvements and equipment 68,309,000
Less: accumulated depreciation (19,270,000)
-----------
74,526,000
Property held for sale or development 4,350,000
-----------
78,876,000
Cash and cash equivalents 638,000
Restricted cash 2,289,000
Investment in marketable securities 40,028,000
Prepaid expenses and other assets 5,736,000
Investment in Justice Investors 6,518,000
-----------
Total assets $134,085,000
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Mortgage notes payable $ 78,008,000
Due to securities broker 15,570,000
Obligation for securities sold 8,585,000
Line of credit 5,658,000
Accounts payable and other liabilities 2,898,000
Deferred income taxes 6,300,000
-----------
Total liabilities 117,019,000
-----------
Minority interest 6,065,000
-----------
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, 2,364,141 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 11,040,000
Treasury stock, at cost, 829,604 shares (8,746,000)
-----------
Total shareholders' equity 11,001,000
-----------
Total liabilities and shareholders' equity $134,085,000
===========
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, 2006 2005
----------- -----------
Real estate operations:
Rental income $ 3,042,000 $ 3,052,000
Rental expenses:
Property operating expense (1,620,000) (1,269,000)
Mortgage interest expense (914,000) (935,000)
Real estate taxes (482,000) (425,000)
Depreciation (560,000) (599,000)
Amortization - intangible asset - (167,000)
----------- -----------
Loss from real estate operations (534,000) (343,000)
----------- -----------
Equity in net loss of Justice Investors (1,624,000) (509,000)
----------- -----------
Investment transactions:
Net investment gains(losses) 4,439,000 (8,203,000)
Dividend and interest income 170,000 166,000
Margin interest and trading expenses (698,000) (719,000)
----------- -----------
Income(loss) from investment transactions 3,911,000 (8,756,000)
----------- -----------
Other income(expense):
General and administrative expense (338,000) (320,000)
Other, net 232,000 18,000
----------- -----------
Other expense (106,000) (302,000)
----------- -----------
Income(loss) before provision for income taxes and
minority interest 1,647,000 (9,910,000)
Provision for income tax benefit(expense) (613,000) 3,965,000
----------- -----------
Income(loss) before minority interest 1,034,000 (5,945,000)
Minority interest benefit(expense), net of tax (135,000) 1,081,000
----------- -----------
Net income(loss) from continuing operations $ 899,000 $ (4,864,000)
----------- -----------
Discontinued operations:
Net loss on discontinued operations $ (22,000) $ (85,000)
Gain(loss) on sale of real estate 160,000 -
Provision for income tax benefit(expense) (55,000) 34,000
----------- -----------
Income(loss) from discontinued operations $ 83,000 $ (51,000)
----------- -----------
Net income(loss) $ 982,000 $ (4,915,000)
=========== ===========
Income(loss) per share from continuing operations
Basic $ 0.38 $ (2.00)
Diluted $ 0.33 $ (2.00)
=========== ===========
Income(loss) per share from discontinued operations
Basic $ 0.03 $ (0.02)
Diluted $ 0.03 $ (0.02)
=========== ===========
Income(loss) per share
Basic $ 0.41 $ (2.02)
Diluted $ 0.36 $ (2.02)
=========== ===========
Weighted average number of shares outstanding 2,378,643 2,428,136
=========== ===========
Diluted weighted average number of shares
outstanding 2,747,643 2,428,136
=========== ===========
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, 2006 2005
----------- -----------
Real estate operations:
Rental income $ 9,054,000 $ 8,955,000
Rental expenses:
Property operating expense (4,777,000) (3,812,000)
Mortgage interest expense (2,801,000) (2,662,000)
Real estate taxes (1,355,000) (1,449,000)
Depreciation (1,768,000) (1,818,000)
Amortization - intangible asset - (500,000)
Loss on early termination of debt - (133,000)
----------- -----------
Loss from real estate operations (1,647,000) (1,419,000)
----------- -----------
Equity in net loss of Justice Investors (3,482,000) (789,000)
----------- -----------
Investment transactions:
Net investment gains 5,735,000 (6,125,000)
Impairment loss on other investments (299,000) (258,000)
Dividend and interest income 594,000 657,000
Margin interest and trading expenses (1,848,000) (2,119,000)
----------- -----------
Income from investment transactions 4,182,000 (7,845,000)
----------- -----------
Other income(expense):
General and administrative expense (1,145,000) (1,022,000)
Other, net 62,000 112,000
----------- -----------
Other expense (1,083,000) (910,000)
----------- -----------
Loss before provision for income taxes and
minority interest (2,030,000) (10,963,000)
Provision for income tax benefit 801,000 4,386,000
----------- -----------
Loss before minority interest (1,229,000) (6,577,000)
Minority interest benefit, net of tax 379,000 1,130,000
----------- -----------
Net loss from continuing operations $ (850,000) $ (5,447,000)
----------- -----------
Discontinued operations:
Net loss on discontinued operations $ (296,000) $ (577,000)
Gain(loss) on sale of real estate 1,321,000 6,006,000
Provision for income tax benefit(expense) (408,000) (2,172,000)
----------- -----------
Income from discontinued operations $ 617,000 $ 3,257,000
----------- -----------
Net income(loss) $ (233,000) $ (2,190,000)
=========== ===========
Loss per share from continuing operations
Basic $ (0.36) $ (2.21)
Diluted $ (0.36) $ (2.21)
=========== ===========
Income per share from discontinued operations
Basic $ 0.26 $ 1.32
Diluted $ 0.22 $ 1.15
=========== ===========
Income(loss) per share
Basic $ (0.10) $ (0.89)
Diluted $ (0.10) $ (0.89)
=========== ===========
Weighted average number of shares outstanding 2,393,130 2,465,410
=========== ===========
Diluted weighted average number of shares
outstanding 2,762,130 2,832,910
=========== ===========
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, 2006 2005
----------- -----------
Cash flows from operating activities:
Net loss $ (233,000) $ (2,190,000)
Adjustments to reconcile net loss to
cash provided by(cash used) in operating
activities:
Depreciation of real estate 1,768,000 1,818,000
Depreciation - discontinued operations 149,000 394,000
Amortization of intangible asset - 500,000
Loss on early termination of debt - 133,000
Impairment loss on other investments 299,000 258,000
Gain on sale of real estate (1,321,000) (6,006,000)
Net unrealized gains on investments (6,042,000) 9,368,000
Equity in net loss from Justice Investors 3,482,000 789,000
Minority interest benefit (379,000) (1,130,000)
Changes in assets and liabilities:
Restricted cash 692,000 790,000
Investment in marketable securities (9,952,000) 41,953,000
Prepaid expenses and other assets (2,000,000) (1,088,000)
Accounts payable and other liabilities (614,000) (1,687,000)
Due to broker 8,844,000 (22,445,000)
Obligation for securities sold 3,328,000 (18,822,000)
Deferred income taxes - (363,000)
----------- -----------
Net cash provided by(used in)
operating activities (1,979,000) 2,272,000
----------- -----------
Cash flows from investing activities:
Net proceeds from sale of real estate 8,677,000 11,850,000
Investment in real estate - (1,467,000)
Additions to buildings, improvements
and equipment (2,283,000) (2,016,000)
Purchase of Santa Fe stock (399,000) (197,000)
Purchase of Portsmouth stock (260,000) -
----------- -----------
Net cash provided by investing activities 5,735,000 8,170,000
----------- -----------
Cash flows from financing activities:
Borrowings from mortgage notes payable - 2,303,000
Principal payments on mortgage notes payable (2,424,000) (11,824,000)
Borrowings from (paydown of) line of credit (655,000) 1,413,000
Purchase of treasury stock (907,000) (1,046,000)
----------- -----------
Net cash used in financing activities (3,986,000) (9,154,000)
----------- -----------
Net increase(decrease) in cash and cash
equivalents (230,000) 1,288,000
Cash and cash equivalents at beginning of
period 868,000 777,000
----------- -----------
Cash and cash equivalents at end of period $ 638,000 $ 2,065,000
=========== ===========
The accompanying notes are an integral part of the consolidated
financial statements.
-6-
THE INTERGROUP CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. General
The consolidated financial statements included herein are unaudited; however,
in the opinion of The InterGroup Corporation ("InterGroup" or the "Company"),
the interim financial information contains all adjustments, including normal
recurring adjustments, necessary to present fairly the results for the interim
period. These consolidated financial statements include the accounts of the
Company and its subsidiaries and should be read in conjunction with the
Company's June 30, 2005 audited consolidated financial statements and notes
thereto.
As of March 31, 2006, the Company had the power to vote 78%, of the voting
shares of Santa Fe Financial Corporation ("Santa Fe"), a public company (OTCBB:
SFEF). Santa Fe's revenue is primarily generated through the management of its
68.8% owned subsidiary, Portsmouth Square, Inc. ("Portsmouth"), a public
company (OTCBB: PRSI), which derives its revenue primarily as a general partner
and a 49.8% limited partner in Justice Investors, a California limited
partnership ("Justice" or the "Partnership"). Justice owns the land,
improvements and leaseholds now known as the Hilton San Francisco Financial
District, a 549-room hotel in San Francisco, California (the "Hotel"). Both
Santa Fe and Portsmouth are consolidated into the Company's financial
statements.
Certain prior year balances have been reclassified to conform with the current
year presentation.
The results of operations for the three and nine months ended March 31, 2006
are not necessarily indicative of results to be expected for the full fiscal
year ending June 30, 2006.
Earnings Per Share
Basic earnings per share is computed by dividing net income available to common
stockholders by the weighted average number of common shares outstanding. The
computation of diluted earnings per share is similar to the computation of
basic earnings per share except that the weighted-average number of common
shares is increased to include the number of additional common shares that
would have been outstanding if potential dilutive common shares had been
issued. The Company's only potentially dilutive common shares are stock
options. Stock options are included in diluted earnings per share by
application of the treasury stock method. As of March 31, 2006, the Company
had 369,000 stock options that were considered potentially dilutive common
shares and 36,000 stock options that were considered anti-dilutive. As of
March 31, 2005, the Company had 367,500 stock options that were considered
potentially dilutive common shares and 25,500 stock options that were
considered anti-dilutive. These amounts were included in the calculation for
diluted earnings per share.
Stock-Based Compensation Plans
Effective December 15, 2005, the FASB revised FAS No. 123, Share-Based Payment
("SFAS 123R"). FAS 123R requires companies to recognize compensation expense
equal to the fair value of stock options or other share-based payments.
During the nine months ended March 31, 2006 and March 31, 2005, the Company
granted 12,000 and 15,000 stock options, respectively.
-7-
For the options granted during the nine months ended March 31, 2006 and March
31 2005, the pro forma net income and earnings per share are as follows:
For the nine months ended March 31, 2006 2005
------------ -----------
Net loss $ (233,000) $(2,190,000)
Stock based employee
Compensation expense* (48,000) (87,000)
------------ -----------
Pro forma net loss $ (281,000) $(2,277,000)
============ ===========
Loss per share
Basic as reported $ (0.10) $ (0.89)
Basic pro forma $ (0.12) $ (0.92)
Diluted as reported $ (0.10) $ (0.89)
Diluted pro forma $ (0.12) $ (0.92)
*Determined based on the fair value method for awards net of related tax
effects (40%).
The Black-Scholes option pricing model was used with the following weighted-
average assumptions for the nine months ended March 31, 2006 and March 31,
2005:
For the
Nine months ended March 31,
----------------------------
2006 2005
----------- ------------
Risk free interest rate 5.01% 3.42%
Dividend yield 0.00% 0.00%
Price volatility factor 23.27 24.54
Weighted average expected life 10 10
Fair value of each option granted $6.65 $8.78
Aggregate fair value of options granted $80,000 $145,000
2. Investment in Real Estate
In February 2006, the Company sold 5.4 acres of unimproved land in Pasadena,
Texas for $467,000 and recognized a gain on the sale of $160,000.
In December 2005, the Company sold its 54-unit apartment complex located in
Irving, Texas for $3,100,000 and realized a gain on the sale of real estate of
$598,000. The Company received net proceeds of $2,931,000 after selling costs
and attorney's fees.
In November 2005, the Company sold its 5-unit apartment complex located in Los
Angeles, California for $1,620,000 and realized a gain on the sale of real
estate of $587,000. The Company received net proceeds of $870,000 after
selling costs and attorney's fees and the repayment of the mortgage note in the
amount of $660,000.
In August 2005, the Company sold its 112-unit apartment complex located in
Austin, Texas for $4,400,000 and realized a net loss on the sale real estate of
$24,000. The Company received net proceeds of $1,664,000 after selling costs
and attorney's fees and the repayment of the mortgage note in the amount of
$2,186,000.
-8-
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 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, 2006 and
March 31, 2005 and reported as income from discontinued operations in the
consolidated statements of operations.
The revenues and expenses from the operation of the properties that were sold
during three months and nine ended March 31, 2006 and March 31, 2005, are
summarized as follows:
For the three months ended March 31, 2006 2005
---------- ----------
Revenues $ 364,000 $ 563,000
Expenses (386,000) (648,000)
---------- ----------
Net loss (22,000) (85,000)
========== ==========
Depreciation expense for the three months ended March 31, 2006 and March 31,
2005, was $32,000 and $103,000, respectively.
For the nine months ended March 31, 2006 2005
---------- ----------
Revenues $ 1,159,000 $ 2,033,000
Expenses (1,455,000) (2,610,000)
---------- ----------
Net loss (296,000) (577,000)
========== ==========
Depreciation expense for the nine months ended March 31, 2006 and March 31,
2005, was $149,000 and $394,000, respectively.
3. Marketable Securities:
The Company's investment portfolio 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, 2006, all of the Company's marketable securities are classified as
trading securities. In accordance with SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities," the change in the unrealized gains
and losses on these investments are included earnings. Trading securities are
summarized as follows:
As of March 31, 2006
Gross Gross Net Market
Investment Cost Unrealized Gain Unrealized Loss Unrealized Gain Value
---------- ----------- --------------- --------------- --------------- ------------
Corporate
Equities $31,349,000 $9,516,000 ($837,000) $8,679,000 $40,028,000
As of March 31, 2006, the Company had $583,000 of unrealized losses related to
securities held for over one year.
-9-
Marketable securities are stated at market value as determined by the most
recently traded price of each security at the balance sheet date. Marketable
securities are classified as trading with net change in unrealized gains or
losses included in earnings.
As part of the investment strategies, the Company may assume short positions in
marketable securities. Short sales are used by the Company to potentially
offset normal market risks undertaken in the course of its investing activities
or to provide additional return opportunities. The Company has no naked short
positions. As of March 31, 2006, the Company had obligations for securities
sold (equities short) of $8,585,000.
The Company may utilize margin for its marketable securities purchases through
the use of standard margin agreements with national brokerage firms. The use
of available leverage is guided by the business judgment of management.
Net gains on marketable securities on the statement of operations are comprised
of realized and unrealized gains. Below is the composition of the two
components for the three and nine months ended March 31, 2006 and March 31,
2005, respectively.
For the three months ended March 31, 2006 2005
----------- -----------
Realized gains(losses) on marketable securities $ (184,000) $ 2,738,000
Unrealized gains(losses) on marketable securities 4,623,000 (10,941,000)
----------- -----------
Net gains(losses) on marketable securities 4,439,000 $(8,203,000)
=========== ===========
For the nine months ended March 31, 2006 2005
----------- -----------
Realized gains(losses) on marketable securities $ (307,000) $ 3,243,000
Unrealized gains(losses) on marketable securities 6,042,000 (9,368,000)
----------- -----------
Net gains(losses) on marketable securities $ 5,735,000 $ 6,125,000
=========== ===========
4. Investment in Justice Investors:
The consolidated accounts include a 49.8% interest in Justice Investors, a
California limited partnership ("Justice" or the "Partnership"), in which
Portsmouth serves as one of the two general partners. The other general
partner, Evon Corporation ("Evon"), serves as the managing general partner.
Justice owns the land, improvements and leaseholds now known as the Hilton San
Francisco Financial District, a 549-room hotel in San Francisco, California
(the "Hotel"). The Company's investment in Justice is recorded on the equity
basis.
The Company amortizes 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 over 40 years, which
approximates the remaining life of the primary asset, the hotel building.
As a general and limited partner, Portsmouth has significant control over the
management and operation of the assets of Justice. 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.
-10-
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.
Historically, Justice's most significant income source was a lease between the
Partnership and Felcor Lodging Trust, Inc. ("Felcor") for the Hotel portion of
the property. Pursuant to a Settlement Agreement entered into on May 3, 2004,
Felcor agreed to terminate its lease and surrender possession of the Hotel to
Justice, on June 30, 2004. Effective July 1, 2004, Justice became the owner-
operator of the Hotel, with the assistance of a Management Agreement with Dow
Hotel Company, LLC. ("Dow") 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 and from a lease on the lobby level of the
Hotel to Tru Spa. The Company also derives revenue from management fees from
Justice for actively managing the hotel as a general partner.
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 Agreement required that
those renovations be complete and the Hotel commence operations as a Hilton
hotel no later than June 1, 2006. 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.
On March 15, 2005, the Partnership announced its decision to close down its
Hotel operations on or about June 1, 2005 to complete renovations of the Hotel
as required by the Hilton Agreement. 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. The Hotel renovation
work was substantially completed on January 12, 2006 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. All of the guest rooms, suites and amenities were completed by the
end of February 2006.
The total cost of the renovation project of the Hotel is currently expected to
be approximately $43 million. That amount includes approximately $35 million
for the actual cost of the renovations and approximately $8 million for
estimated carrying costs of operations during the renovation period and for the
first four months of operations after the hotel opens. As of March 31, 2006,
the Partnership has expended approximately $31,864,000 in construction costs
related to the renovation and approximately $7,700,000 in carrying costs, which
includes approximately $636,000 in interest costs incurred during the
construction phase that was capitalized. For the nine months ended March 31,
2006, the Partnership had an operating loss of approximately $6,632,000.
On July 14, 2005, the Financial Accounting Standards Board directed Staff
Position (FSP) SOP 78-9-1, "Interaction of AICPA Statement of Position 78-9 and
EITF Issue No. 04-5" to amend the guidance in AICPA Statement of Position 78-9,
"Accounting for Investments in Real Estate Ventures" (SOP 78-9) to be
-11-
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.
Under the amendment to paragraph .09 of SOP 78-9 the general partners of a
limited partnership should be deemed to control a limited partnership; however,
the rights of the limited partners may overcome that presumption of control.
The guidance in EITF Issue No. 04-5 should be used to determine whether the
rights of the limited partners overcome the presumption of control by the
general partners. The presumption of control is not overcome by the rights of
the limited partners and if a single general partner controls the limited
partnership, that general partner should consolidate the limited partnership
and apply the principles of accounting applicable for investments in
subsidiaries. For existing partnership agreements such as Justice Investors,
the guidance should be applied in financial statements issued for the first
reporting period in the fiscal years beginning after December 15, 2005 and
early application is encouraged.
During the fiscal quarter ended March 31, 2006, Portsmouth conducted an
assessment of its general and limited interest in Justice Investors under the
new guidance provided by SOP 78-9-1. The Company determined that, under the
limited partnership agreement, the limited partners of Justice do not have
either "kick out rights" to remove Portsmouth as a general partner or
"substantive participating rights" to direct the business of the Partnership.
Significant in that assessment is the fact that the limited partners of Justice
do not have the ability to dissolve (liquidate) the Partnership and effectively
remove the general partners without the participation and consent of
Portsmouth's 49.8% limited partnership interest since any action to sell the
Partnership real property and dissolve the Partnership requires the approval of
partners entitled to more than 72% of the net profit of the Partnership. Based
on its assessment, Portsmouth has concluded that rights of the limited partners
under the Partnership agreement do not overcome the presumption that
Portsmouth, as a general partner and a significant limited partner, controls
the Partnership in accordance with guidance set forth in FSP SOP 78-9-1. Thus,
Portsmouth should consolidate Justice and apply the principles of accounting
applicable for investments in subsidiaries due to its substantial limited
partnership interest and general partnership rights.
Portsmouth will apply the guidance of FSP SOP 78-9-1 no later than in its
financial statements issued for the first reporting period of its fiscal year
beginning July 1, 2006.
-12-
Condensed financial statements for Justice Investors are as follows:
JUSTICE INVESTORS
CONDENSED BALANCE SHEET
(Unaudited)
As of March 31, 2006
----------
Assets
Cash $ 1,674,000
Other assets 2,065,000
Property, plant and equipment, net of
accumulated depreciation of $13,306,000 40,920,000
Land 1,124,000
----------
Total assets $ 45,783,000
==========
Liabilities and partners' capital
Total current liabilities $ 8,392,000
Long-term debt 40,109,000
Partners' capital (2,718,000)
----------
Total liabilities and partners' capital $ 45,783,000
==========
JUSTICE INVESTORS
CONDENSED STATEMENTS OF OPERATIONS
For the three months ended March 31, 2006 2005
---------- ----------
Hotel revenue $ 3,158,000 $ 2,903,000
Garage rent 279,000 245,000
Other income(loss) (1,070,000) 60,000
Operating expenses (5,508,000) (4,067,000)
---------- ----------
Net loss $ (3,141,000) $ (859,000)
========== ==========
JUSTICE INVESTORS
CONDENSED STATEMENTS OF OPERATIONS
For the nine months ended March 31, 2006 2005
---------- ----------
Hotel revenue $ 3,158,000 $ 10,709,000
Garage rent 604,000 794,000
Other income(loss) (1,535,000) 189,000
Operating expenses (8,859,000) (12,916,000)
---------- ----------
Net loss $ (6,632,000) $ (1,224,000)
========== ==========
-13-
5. Mortgage Note Payable
In May 2004, the Company obtained a construction loan in the amount of
$6,268,000 as part of a major renovation of its 30-unit apartment complex
located in Los Angeles, California. In December 2005, the Company entered into
a loan modification agreement with the bank and increased the loan amount to
$7,286,000. As of March 31, 2006, the balance on the construction loan was
$6,360,000.
In November 2005, the Company paid off a mortgage in the amount of $660,000
related to the sale of its 5-unit family apartment located Los Angeles,
California.
In August 2005, the Company paid off a mortgage in the amount of $2,186,000
related to the sale of its 112-unit multi-family apartment located Austin,
Texas.
6. 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.
7. 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, 2006 and 2005. Operating income(loss) for rental properties
consists of rental income. Operating income(loss) from Justice Investors
consists of the operations of the hotel and garage included in the equity in
net income of Justice Investors. Operating income(loss) for investment
transactions consist of net investment gains(losses)and dividend and interest
income.
Real Estate
-------------------------
Three months ended Rental Justice Investment Discontinued
March 31, 2006 Properties Investors Transactions Other Subtotal Operations Total
----------- ----------- ------------ ----------- ------------ ------------ ------------
Operating income(loss) $ 3,042,000 $(1,624,000) $ 4,609,000 $ - $ 6,027,000 $ 364,000 $ 6,391,000
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 (1,624,000) 3,911,000 - 3,227,000 86,000 3,313,000
Gain on sale of RE - - - - - 160,000 160,000
Mortgage interest expense (914,000) - - - (914,000) (76,000) (990,000)
Depreciation (560,000) - - - (560,000) (32,000) (592,000)
General and administrative
Expense - - - (338,000) (338,000) - (338,000)
Other income - - - 232,000 232,000 - 232,000
Income tax expense - - - (613,000) (613,000) (55,000) (668,000)
Minority interest - - - (135,000) (135,000) - (135,000)
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net income(loss) $ (534,000) (1,624,000) $ 3,911,000 $ (854,000) $ 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
=========== =========== =========== =========== ============ ============ ============
-14-
Real Estate
-------------------------
Three months ended Rental Justice Investment Discontinued
March 31, 2005 Properties Investors Transactions Other Subtotal Operations Total
----------- ----------- ------------ ----------- ------------ ------------ ------------
Operating income(loss) $ 3,052,000 $ (509,000) $(8,037,000) $ - $ (5,494,000) $ 563,000 $ (4,931,000)
Operating expenses (1,269,000) - (719,000) - (1,988,000) (308,000) (2,296,000)
Real estate taxes (425,000) - - - (425,000) (80,000) (505,000)
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net operating income(loss) 1,358,000 (509,000) (8,756,000) - (7,907,000) 175,000 (7,732,000)
Mortgage interest expense (935,000) - - - (935,000) (157,000) (1,092,000)
Depreciation (599,000) - - - (599,000) (103,000) (702,000)
Amort. of intangible asset (167,000) - - - (167,000) - (167,000)
General and administrative
Expense - - - (320,000) (320,000) - (320,000)
Other income - - - 18,000 18,000 - 18,000
Income tax expense - - - 3,965,000 3,965,000 34,000 3,999,000
Minority interest - - - 1,081,000 1,081,000 - 1,081,000
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net income(loss) $ (343,000) $ (509,000) $(8,756,000) $ 4,744,000 $ (4,864,000) $ (51,000) $ (4,915,000)
=========== =========== =========== =========== ============ ============ ============
Total Assets $85,417,000 $10,514,000 $17,571,000 $ 6,880,000 $ 120,382,000 - $120,382,000
=========== =========== =========== =========== ============ ============ ============
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 $(3,482,000) $ 6,030,000 $ - $ 11,602,000 $ 1,159,000 $ 12,761,000
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 (3,482,000) 4,182,000 - 3,622,000 157,000 3,779,000
Gain on sale of RE - - - - - 1,321,000 1,321,000
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)
General and administrative
Expense - - - (1,145,000) (1,145,000) - (1,145,000)
Other income - - - 62,000 62,000 - 62,000
Income tax benefit - - - 801,000 801,000 (408,000) 393,000
Minority interest benefit - - - 379,000 379,000 - 379,000
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net income(loss) $(1,647,000) $(3,482,000) $ 4,182,000 $ 97,000 $ (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
=========== =========== =========== =========== ============ ============ ============
Real Estate
-------------------------
Nine months ended Rental Justice Investment Discontinued
March 31, 2005 Properties Investors Transactions Other Subtotal Operations Total
----------- ----------- ------------ ----------- ------------ ------------ ------------
Operating income(loss) $ 8,955,000 $ (789,000) $(5,726,000) $ - $ 2,440,000 $ 2,033,000 $ 4,473,000
Operating expenses (3,812,000) - (2,119,000) - (5,931,000) (1,214,000) (7,145,000)
Real estate taxes (1,449,000) - - - (1,449,000) (282,000) (1,731,000)
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net operating income(loss) 3,694,000 (789,000) (7,845,000) - (4,940,000) 537,000 (4,403,000)
Gain on sale of RE - - - - - 6,006,000 6,006,000
Loss on early term. of debt (133,000) - - - (133,000) - (133,000)
Mortgage interest expense (2,662,000) - - - (2,662,000) (720,000) (3,382,000)
Depreciation (1,818,000) - - - (1,818,000) (394,000) (2,212,000)
Amort. of intangible asset (500,000) - - - (500,000) - (500,000)
General and administrative
Expense - - - (1,022,000) (1,022,000) - (1,022,000)
Other income - - - 112,000 112,000 - 112,000
Income tax expense - - - 4,386,000 4,386,000 (2,172,000) 2,214,000
Minority interest - - - 1,130,000 1,130,000 - 1,130,000
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net income(loss) $(1,419,000) $ (789,000) $(7,845,000) $ 4,606,000 $ (5,447,000) $ 3,257,000 $ (2,190,000)
=========== =========== =========== =========== ============ ============ ============
Total Assets $85,417,000 $10,514,000 $17,571,000 $ 6,880,000 $ 120,382,000 - $120,382,000
=========== =========== =========== =========== ============ ============ ============
-15-
8. Subsequent event
In April 2006, Portsmouth purchased a 0.20% limited partnership interest in
Justice Investors from another limited partner for $180,000. That purchase
brings Portsmouth's limited partnership interest in Justice to exactly 50.00%.
In April 2006, the Company entered into third party management agreements (the
"Agreements") with JPI Management Services, L.P. ("JPI") for property
management services for five of its properties located in: Irving, Texas; San
Antonio, Texas; Parsippany, New Jersey; Florissant, Missouri; and Florence,
Kentucky. The Agreements provide for a management fee equal to three and one-
half percent of the gross monthly receipts of each property and are for a term
of one year, but can be terminated by either party upon thirty days written
notice.
-16-
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS AND PROJECTIONS
The discussion below and elsewhere in the Report includes forward-looking
statements about the future business results and activities of the Company,
which, by their very nature, involve a number of risks and uncertainties. When
used in this discussion, the words "estimate", "project", "anticipate" and
similar expressions, are subject to certain risks and uncertainties, such as
the impact of terrorism and war on the national and international economies,
including tourism and the securities markets, changes in general economic
conditions, interest rates, local real estate markets, and competition, as well
as uncertainties relating to uninsured losses, securities markets, and
litigation, including those discussed below and in the Company's Form 10-KSB
for the fiscal year ended June 30, 2005 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.
RECENT DEVELOPMENTS
In February 2006, the Company sold 5.4 acres of unimproved land in Pasadena,
Texas for $467,000 and recognized a gain on the sale of $160,000.
In December 2005, the Company sold its 54-unit apartment complex located in
Irving, Texas for $3,100,000 and realized a gain on the sale of real estate of
$598,000. The Company received net proceeds of $2,931,000 after selling costs
and attorney's fees.
In November 2005, the Company sold its 5-unit apartment complex located in Los
Angeles, California for $1,620,000 and realized a gain on the sale of real
estate of $587,000. The Company received net proceeds of $870,000 after
selling costs and attorney's fees and the repayment of the mortgage note in the
amount of $660,000.
In August 2005, the Company sold its 112-unit apartment complex located in
Austin, Texas for $4,400,000 and realized a net loss on the sale real estate of
$24,000. The Company received net proceeds of $1,664,000 after selling costs
and attorney's fees and the repayment of the mortgage note in the amount of
$2,186,000.
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.
The newly opened Hilton hotel has 549 well appointed guestrooms and luxury
suites with bay or city views, featuring large working desks, ergonomic chairs,
wired and wireless high-speed Internet access, and "The Suite Dreams" beds by
Hilton, complete with duvet, down comforter and jumbo size pillows. The newly
redesigned meeting rooms and ballroom will accommodate meetings and events for
up to 500 people with video conferencing and premium audio/visual equipment. A
new business center and fitness center are additional amenities. The new Hilton
hotel also has the only hotel day spa (Tru Spa) in the Financial District. A
-17-
redesigned entry way is integrated into the lobby and management expects the
new restaurant "Seven Fifty" and lounge, with a dramatic fireplace treatment,
will bring a new level of excitement and service to the guests of the hotel.
Management believes that the new Hilton hotel will now be able to directly
compete with all hotels in the Financial District.
On January 20, 2006, the Partnership obtained a $4,500,000 increase in its
existing line of credit capacity with United Commercial Bank, raising the total
amount available to the Partnership pursuant to that line of credit to
$14,500,000. The increase in the credit line is on the same terms as the
existing line of credit with additional loan and documentation fees of $4,000.
As of March 31, 2006, the balance on this line was $10,109,000.
Effective February 23, 2006, Justice Investors entered into an amended and
restated compensation agreement with its general partners, Evon and Portsmouth.
Pursuant to that agreement, Evon and Portsmouth are each to receive a total of
$377,500 in repositioning fees as compensation for their services rendered to
Justice with respect to repositioning the Hotel and restructuring its business
and management subject to certain performance criteria. As of March 31, 2006, a
total of $187,500 in repositioning fees had been paid to Portsmouth, with
$118,750 having been received in current quarter. An additional $100,000 in
repositioning fees has been earned by Portsmouth and accrued by Justice but not
yet paid.
RESULTS OF OPERATIONS
For the Three Months Ended March 31, 2006 Compared to the
Three Months Ended March 31, 2005
The Company had net income of $982,000 for the three months ended March 31,
2006 compared to a net loss of $4,915,000 for the three months ended March 31,
2005. As discussed below, the substantial change was primarily due to the
significant improvement in the performance of the Company's investment
portfolio partially offset by the significantly higher loss related to the
Company's equity investment in Justice Investors.
The loss from real estate operations increased to $534,000 for the three months
ended March 31, 2006 from $343,000 for the three months March 31, 2005
primarily as the result of higher property operating expenses. Property
operating expenses increased to $1,620,000 from $1,269,000 as the result of
management's continual effort to improve the real operations and provide a
higher quality product and service to our tenants and to improve economic
occupancy of our properties. As the result, the Company incurred higher
repairs and maintenance, salary, cleaning and decorating, and leasing expenses.
These increases were partially offset by lower property insurance expenses.
During quarter ended March 31, 2006, the Company sold 5.4 acres of unimproved
land in Pasadena, Texas for $467,000 and recognized a gain on the sale of
$160,000. This gain is presented under discontinued operations. Additionally,
in March 2006, the Company listed its 224 unit apartment complex located in
Irving, Texas for sale. The revenues and expenses for this property are
excluded from real estate operations and are presented under discontinued
operations. The amortization expense of $167,000 during the three months ended
March 31, 2005 was related to the amortization of the intangible asset acquired
along with the purchase of the Las Colinas, Texas property purchased in April
2004.
The loss from the Company's equity investment in Justice Investors increased to
$1,624,000 for the three months ended March 31, 2006 from $509,000 for the
three months ended March 31, 2005. The increased Partnership loss was primarily
-18-
attributable to approximately $794,000 in one time start up costs for the
reopening of the hotel in January 2006 as well as higher interest expenses,
depreciation and amortization, property taxes, insurance costs and general and
administrative expenses related to the renovation and repositioning of the
Hotel. Partnership operating revenues for the three months ended March 31, 2006
were approximately $3,471,000 compared to approximately $3,001,000 for the
three months ended March 31, 2005. Of that amount, $3,158,000 was attributable
to the operations of the Hotel, which commenced operations on a limited basis
on January 12, 2006, compared to $2,903,000 in hotel revenues for the same
three month period in fiscal 2005. Average Hotel occupancy rates for the three
months ended March 31, 2006 were approximately 37% (based on 549 rooms) with an
average daily room rate of approximately $146, compared to an average occupancy
rate of approximately 60% and an average daily room rate of approximately $85
for the three months ended March 31, 2005. Garage rental income increased to
approximately $279,000 from approximately $245,000 for the same period in the
prior fiscal year.
While the Partnership believes that the Hotel is now positioned to compete with
the other hotels in the Financial District, it is expected that it will be
several months before the Hotel operations begin to reach its stabilization
level after being closed for more than 7 months. Management understands that
such a ramp up period is typical in the industry for hotels that shut down
operations for major renovations, especially for those hotels that reopen as a
different brand. As a general partner of Justice, Portsmouth will continue to
work diligently with Evon, Dow and Hilton to improve the operations of the
Hotel.
Included in other income are monthly management fees and repositioning fees
from Justice earned by the Company for its services as a general partner
related to the repositioning of the hotel. The increase in other income to
$232,000 for the three months ended March 31, 2006 from $18,000 for the three
months ended March 31, 2005 was primarily the result of $218,000 in
repositioning fees earned by the Company during the current period.
The Company had net gains on marketable securities of $4,439,000 for the three
months ended March 31, 2006 compared to net losses on marketable securities of
$8,203,000 for the three months ended March 31, 2005 as the result of the
significant improvement in the performance of the Company's investment
portfolio. For the three months ended March 31, 2006, the Company had net
unrealized gains of $4,623,000 and net realized losses of $184,000. For the
three months ended March 31, 2005, the Company had net unrealized losses of
$10,941,000 and net realized gains of $2,738,000. 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.
The provision for income tax benefit(expense) changed to a tax expense of
$668,000 for the three months ended March 31, 2006 from a tax benefit of
$3,999,000 for the three months ended March 31, 2005 primarily due to the pre-
tax income generated by the Company during current quarter as compared a
substantial to pre-tax loss of incurred during the quarter ended March 31,
2005.
Minority interest benefit(expense) changed to a minority expense of $135,000
from a minority expense of $1,081,000 as the result of the income generated by
the Company's subsidiary, Santa Fe, in the current quarter as compared a
significant loss incurred in the comparable quarter.
-19-
For the Nine Months Ended March 31, 2006 Compared to the
Nine Months Ended March 31, 2005
The Company had a net loss of $233,000 for the nine months ended March 31, 2006
compared to a net loss of $2,190,000 for the nine months ended March 31, 2005.
As discussed below, the substantial decrease in the net loss was primarily due
to the significant improvement in the performance of the Company's investment
portfolio partially offset by the significantly higher loss related to the
Company's equity investment in Justice Investors and the decrease in the gain
from sale of real estate.
The loss from real estate operations increased to $1,647,000 for the nine
months ended March 31, 2006 from $1,419,000 for the nine months March 31, 2005.
Property operating expenses increased to $4,777,000 from $3,812,000 partially
due to $250,000 in consulting fees for professional services provided during
the nine months ended March 31, 2006 to assist management with the improvement
of the Company's real estate operations and to help with the sale of certain
non-strategic real estate properties. Additionally, as the result of
management's continual effort to improve the real estate operations and provide
a higher quality product and service to our tenants and to improve the economic
occupancy of our properties, the Company incurred higher property related
operating expenses which include repairs and maintenance, salary, cleaning and
decorating, and leasing expenses. These increases were partially offset by
lower property insurance expenses. Utilities expense also increased as the
result of higher energy prices.
During nine months ended March 31, 2006, the Company sold three apartment
properties and a parcel of land and realized gains on the sale of real estate
of totaling $1,321,000. In February 2006, the Company sold 5.4 acres of
unimproved land in Pasadena, Texas for $467,000 and recognized a gain on the
sale of $160,000. In December 2005, the Company sold its 54-unit apartment
complex located in Irving, Texas for $3,100,000 and realized a gain on the sale
of real estate of $598,000. In November 2005, the Company sold its 5-unit
apartment complex located in Los Angeles, California for $1,620,000 and
realized a gain on the sale of real estate of $587,000. In August 2005, the
Company sold its 112-unit apartment complex located in Austin, Texas for
$4,400,000 and realized a net loss on the sale real estate of $24,000. During
the nine months ended March 31, 2005, the Company sold a 442-unit apartment
complex located in Houston, Texas and realized a gain of $6,006,000 from the
sale of real estate. The gain on the sale of these properties and the related
revenues and expenses are excluded from the real estate operations and are
presented under discontinued operations. During the nine months ended March
31, 2005, the Company incurred a loss on early termination of debt of $133,000
as the result of the repayment of $1,180,000 mortgage on 54-unit apartment
complex located in Irving, Texas that was eventually sold in December 2005.
The amortization expense of $500,000 during the nine months ended March 31,
2005 was related to the amortization of the intangible asset acquired along
with the purchase of the Las Colinas, Texas property purchased in April 2004.
The loss from the Company's equity investment in Justice Investors increased to
$3,482,000 for the nine months ended March 31, 2006 from $789,000 for the nine
months ended March 31, 2005. Effective, May 31, 2005, the Partnership elected
to close down its Hotel operations to complete the renovations of the Hotel as
required by the Hilton Franchise Agreement. Since the Hotel did not reopen
until January 12, 2006, less than three months of operating results from the
Hotel are included in the nine months ended March 31, 2006 while the nine
months ended March 31, 2005 include the full operations of the Hotel for that
period. For the nine months ended March 31, 2006 the Partnership sustained a
net loss of $6,632,000 compared to a net loss of $1,224,000 for the same period
-20-
in fiscal 2005. The increase in the net loss was primarily attributable to
hotel revenue of only $3,158,000 for the nine months ended March 31, 2006
compared to $10,709,000 for the nine months ended March 31, 2005 and increased
costs in the current period related to the reopening of the hotel, higher
interest expenses, property taxes, insurance costs, general and administrative
expenses, professional fees, security personnel and other costs for the
repositioning of the Hotel. The Partnership also had a decrease in garage rent
to $604,000 from $794,000 for the comparable period in fiscal 2005, primarily
due to the closing of the Hotel.
The Company had net gains on marketable securities of $5,735,000 for the nine
months ended March 31, 2006 compared to net losses of $6,125,000 for the nine
months ended March 31, 2005 as the result of the significant improvement in the
performance of the Company's investment portfolio. For the nine months ended
March 31, 2006, the Company had net unrealized gains of $6,042,000 and net
realized losses of $307,000. For the nine months ended March 31, 2005, the
Company had net unrealized losses of $9,368,000 and net realized gains of
$3,243,000. 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.
Margin interest and trading expenses decreased to $1,848,000 from $2,119,000
primarily as the result of the decrease in margin interest to $524,000 from
$774,000 due to the maintenance of lower margin balances during the nine months
ended March 31, 2006.
General and administrative expenses increased to $1,145,000 from $1,022,000 as
the result of the increase in accounting related expenses, tax consulting and
preparation fees and the expense of improving the Company's corporate computer
and communications systems.
The provision for income tax benefit decreased to $393,000 from $2,214,000 as
the result of the significantly smaller pre-tax loss incurred by the Company
during the nine months ended March 31, 2006 as compared to the nine months
ended March 31, 2005.
Minority interest benefit decrease to $379,000 from $1,130,000 is as the result
of the smaller losses incurred by the Company's subsidiary, Santa Fe, during
the nine months ended March 31, 2006 as compared to the nine months ended March
31, 2005.
MARKETABLE SECURITIES
The Company's investment portfolio is diversified with 99 different equity
positions. The portfolio contains five individual equity securities that are
more than 5% of the equity value of the portfolio with the largest security
being 9.9% 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.
-21-
As of March 31, 2006, the Company had investments in marketable equity
securities of $40,028,000. The following table shows the composition of the
Company's marketable securities portfolio by selected industry groups as of
March 31, 2006.
% of Total
Investment
Industry Group Market Value Securities
-------------- ------------ ----------
Telecommunications and media 10,476,000 26.2%
Internet and technology 4,780,000 11.9%
Insurance, banks and brokers 4,191,000 10.5%
Services 3,725,000 9.3%
REITs and building materials 3,683,000 9.2%
Pharmaceuticals and healthcare 3,400,000 8.5%
Consumer goods and retail 3,079,000 7.7%
Utilities and energy 2,402,000 6.0%
Automobiles and motor vehicle parts 1,757,000 4.4%
Other 2,535,000 6.3%
---------- ------
$ 40,028,000 100.0%
========== ======
As of March 31, 2006, the Company had approximately 26.2% of its marketable
securities portfolio invested in the telecommunications and media industry
group. While such concentration could be considered a risk factor, that
industry grouping includes telecommunications and media companies that operate
in different sectors of telecommunications and media industries, which the
Company believes is consistent with its diversification policies.
The following table shows the investment gain(loss) on the Company's marketable
securities and the associated margin interest and trading expenses for the
three and nine months ended March 31, 2006 and 2005, respectively.
For the three months ended March 31, 2006 March 31, 2005
-------------- --------------
Net gains(losses) on marketable securities $ 4,439,000 $ (8,203,000)
Dividend & interest income 170,000 166,000
Margin interest expense (203,000) (313,000)
Trading and management expenses (495,000) (406,000)
------------ ------------
Investment income(loss) $ 3,911,000 $ (8,756,000)
============ ============
For the nine months ended March 31, 2006 March 31, 2005
-------------- --------------
Net gains(losses) on marketable securities $ 5,735,000 $ (6,125,000)
Impairment loss on other investments (299,000) (258,000)
Dividend & interest income 594,000 657,000
Margin interest expense (524,000) (774,000)
Trading and management expenses (1,324,000) (1,345,000)
------------ ------------
Investment income(loss) $ 4,182,000 $ (7,845,000)
============ ============
-22-
FINANCIAL CONDITION AND LIQUIDITY
The Company's cash flows are generated primarily from its real estate
activities, sales of investment securities and borrowings related to both.
During the nine months ended March 31, 2006, operating activities used cash of
$1,979,000, investing activities provided cash of $5,735,000 and financing
activities used cash of $3,986,000.
During the nine months ended March 31, 2006, the Company made property
improvements in the aggregate amount of $2,283,000. Management believes the
improvements to its properties will enhance market values, maintain the
competitiveness of the Company's properties and potentially enable the Company
to obtain a higher yield through higher rents.
In February 2006, the Company sold 5.4 acres of unimproved land in Pasadena,
Texas for $467,000 and recognized a gain on the sale of $160,000. The Company
received net proceeds of $434,000 after selling costs and attorney's fees.
In December 2005, the Company sold its 54-unit apartment complex located in
Irving, Texas for $3,100,000 and realized a gain on the sale of real estate of
$598,000. The Company received net proceeds of $2,931,000 after selling costs
and attorney's fees.
In November 2005, the Company sold its 5-unit apartment complex located in Los
Angeles, California for $1,620,000 and realized a gain on the sale of real
estate of $587,000. The Company received net proceeds of $870,000 after
selling costs and attorney's fees and the repayment of the mortgage note in the
amount of $660,000.
In August 2005, the Company sold its 112-unit apartment complex located in
Austin, Texas for $4,400,000 and realized a net loss on the sale real estate of
$24,000. The Company received net proceeds of $1,664,000 after selling costs
and attorney's fees and the repayment of the mortgage note in the amount of
$2,186,000. A portion of the net proceeds from the sale was used to pay down
the Company's line of credit by $255,000.
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 Partnership currently
estimates that the total cost of the renovation project will be approximately
$43 million. That amount includes approximately $35 million for the actual
cost of the renovations and approximately $8 million for estimated carrying
costs of operations during the renovation period and for the first four months
of operations after the hotel opens. That amount reflects an increase in the
Partnership's prior estimates primarily due to increased start up costs related
to the reopening of the Hotel and higher than anticipated operating costs in
relation to revenues due to opening the Hotel on a limited basis on January 12,
2006.
To meet its substantial financial commitments for the renovation project,
Justice has relied on additional 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.
-23-
On July 27, 2005, Justice also obtained a $10,000,000 Revolving Line of Credit
("LOC") from United Commercial Bank. The term of the LOC is for 60 months at an
annual interest rate based on the index selected by Justice at the time of the
request for each advance. The interest rate will either be a variable rate
equal to The Wall Street Journal Prime Rate or the Libor Rate plus 2%, fixed
for the period selected by the Partnership. The LOC is collateralized by a
second deed of trust on the Hotel property. Interest only is payable monthly
with principal and accrued interest due at maturity. On January 20, 2006, the
Partnership obtained a $4,500,000 increase in its existing line of credit
capacity with United Commercial Bank, raising the total amount available to the
Partnership pursuant to that line of credit to $14,500,000. The increase in the
credit line is on the same terms as the existing line of credit with additional
loan and documentation fees of $4,000. As of March 31, 2006, approximately
$10,109,000 of the $14,500,000 total LOC was utilized by the Partnership.
Prudential Loan and the LOC have provided Justice with sufficient financial
resources for the Partnership to complete the substantial renovations to the
Hotel required by its Franchise License Agreement with Hilton and to meet its
debt service requirements and operating capital needs through the reopening of
the Hotel and anticipates that those resources will be sufficient to sustain
its operating cash needs until the Hotel begins generating net income which the
Partnership expects to be in the late Spring of 2006. The Partnership also
believes that there is sufficient equity in the Hotel assets to support future
borrowings if necessary. The Partnership believes that the revenues expected to
be generated from the Hotel operations after stabilization will be sufficient
to meet all of its current and future obligations and financial requirements.
That additional amount of leverage related to the Prudential Loan and the
utilization of the LOC and the associated debt service will create additional
risk for the Partnership and its ability to generate cash flows in the future
since the Hotel asset has been virtually debt free for many years. The
Partnership does not anticipate paying any partnership distributions until some
time after operations commence under the Hilton brand and net income and
capital requirements warrant such distributions. As a result, the Company may
have to depend more on the revenues generated from the investment of its cash
and securities assets during that transition period.
The Company has invested in short-term, income-producing instruments and in
equity and debt securities when deemed appropriate. The Company's marketable
securities are classified as trading with unrealized gains and losses recorded
through the statement of operations.
Management believes that the net cash flow generated from future operating
activities and its capital resources will be adequate to meet its current and
future obligations.
OFF-BALANCE SHEET ARRANGEMENTS
The Company has no off balance sheet arrangements.
The Company also does not have any material contractual obligations or
commercial commitments.
IMPACT OF INFLATION
The Company's residential and commercial rental properties provide income from
short-term operating leases and no lease extends beyond one year. Rental
increases are expected to offset anticipated increased property operating
expenses.
-24-
Hotel room rates are typically impacted by supply and demand factors, not
inflation, since rental of a hotel room is usually for a limited number of
nights. Room rates can be, and usually are, adjusted to account for
inflationary cost increases. To the extent that the hotel lessee is able to
adjust room rates, there should be minimal impact on partnership revenues due
to inflation. Partnership revenues are also subject to interest rate risks,
which may be influenced by inflation. For the two most recent fiscal years,
the impact of inflation on the Company's income is not viewed by management as
material.
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.
-25-
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
2005 Shares Price Paid Announced Plans Under the Plans
Period Purchased Per Share or Programs or Programs
--------------------------------------------------------------------------------------
Month #1
(Jan. 1- - - - 73,496
Jan. 31)
--------------------------------------------------------------------------------------
Month #2
(Feb. 1- 32,100 $16.07 32,100 41,396
Feb. 28)
--------------------------------------------------------------------------------------
Month #3
(Mar. 1- 1,000 $16.21 1,000 40,396
Mar. 31)
--------------------------------------------------------------------------------------
Total 33,100 $16.07 33,100 40,396
--------------------------------------------------------------------------------------
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 Annual Meeting of the Shareholders of the Company was held on February 22,
2006 at the Hilton San Francisco Financial District, 750 Kearny Street, San
Francisco, California. At that meeting, John C. Love was elected as a Class C
Director to serve a three year term expiring at the Fiscal 2008 Annual Meeting.
John V. Winfield, Josef A. Grunwald, Gary N. Jacobs and William J. Nance
continue their terms as the Company's other directors. At the Annual Meeting,
the shareholders also voted in favor of the ratification of the Audit
-26-
Committee's selection of PricewaterhouseCoopers LLP as the Company's
independent registered public accounting firm for the fiscal year ending June
30, 2006. A tabulation of the vote follows:
Proposal (1) - Class C Director: Votes For Withheld
--------- --------
John C. Love 1,425,142 21,451
Proposal (2) - Accountants: Votes For Against Abstained
--------- ------- ---------
PricewaterhouseCoopers LLP 1,435,818 9,755 1,020
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 did not file any reports on Form 8-K during the last quarter of the
period covered by this Report.
-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: May 15, 2006 by /s/ John V. Winfield
----------------------------
John V. Winfield, President,
Chairman of the Board and
Chief Executive Officer
Date: May 15, 2006 by /s/ David T. Nguyen
------------------------------
David T. Nguyen, Treasurer
and Controller
(Principal Accounting Officer)
-28-