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 September 30, 2005
[ ] Transition Report Under Section 13 Or 15 (d) of the
Securities Exchange Act of 1934
For the transition period from ______ to _____
Commission file number 1-10324
THE INTERGROUP CORPORATION
--------------------------
(Exact Name of Small Business Issuer as Specified in Its Charter)
DELAWARE 13-3293645
------------------------------ ------------------
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification No.)
820 Moraga Drive Los Angeles, CA 90049
--------------------------------------
(Address of Principal Executive Offices)
(310) 889-2500
-------------------------
(Issuer's Telephone Number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
YES [X] NO [ ]
The number of shares outstanding of the issuer's Common Stock, $.01 par value,
as of November 9, 2005 were 2,397,241 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 September 30, 2005 3
Consolidated Statements of Operations (unaudited)
For the Three Months Ended September 30, 2005 and 2004 4
Consolidated Statements of Cash Flows (unaudited)
For the Three Months Ended September 30, 2005 and 2004 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 13
Item 3. Controls and Procedures 20
Part II. OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use
of Proceeds 20
Item 6. Exhibits and Reports on Form 8-K 21
Signatures 21
-2-
THE INTERGROUP CORPORATION
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
As of September 30, 2005
-----------
ASSETS
Investment in real estate, at cost:
Land $ 22,937,000
Buildings, improvements and equipment 67,335,000
Less: accumulated depreciation (19,912,000)
-----------
70,360,000
Property held for sale or development 11,351,000
-----------
81,711,000
Cash and cash equivalents 790,000
Restricted cash 2,983,000
Investment in marketable securities 23,357,000
Prepaid expenses and other assets 7,258,000
Investment in Justice Investors 8,778,000
-----------
Total assets $124,877,000
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Mortgage notes payable $ 78,055,000
Due to securities broker 10,205,000
Obligation for securities sold 3,377,000
Line of credit 6,058,000
Accounts payable and other liabilities 3,699,000
Deferred income taxes 6,300,000
-----------
Total liabilities 107,694,000
-----------
Minority interest 6,347,000
-----------
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, 2,397,241 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 10,343,000
Treasury stock, at cost, 796,504 shares (8,214,000)
-----------
Total shareholders' equity 10,836,000
-----------
Total liabilities and shareholders' equity $124,877,000
===========
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 September 30, 2005 2004
----------- -----------
Real estate operations:
Rental income $ 3,237,000 $ 3,163,000
Rental expenses:
Property operating expense (1,660,000) (1,369,000)
Mortgage interest expense (952,000) (954,000)
Real estate taxes (462,000) (363,000)
Depreciation (671,000) (627,000)
Amortization - intangible asset - (167,000)
----------- -----------
Loss from real estate operations (508,000) (317,000)
----------- -----------
Equity in net income(loss) of Justice Investors (787,000) 77,000
----------- -----------
Investment transactions:
Net investment losses (11,000) (4,627,000)
Impairment loss on other investments (58,000) -
Dividend and interest income 302,000 292,000
Margin interest and trading expenses (560,000) (576,000)
----------- -----------
Loss from investment transactions (327,000) (4,911,000)
----------- -----------
Other income(expense):
General and administrative expense (338,000) (381,000)
Other, net 13,000 86,000
----------- -----------
Other expense (325,000) (295,000)
----------- -----------
Loss before provision for income taxes and
minority interest (1,947,000) (5,446,000)
Provision for income tax benefit 747,000 2,178,000
----------- -----------
Loss before minority interest (1,200,000) (3,268,000)
Minority interest benefit, net of tax 321,000 645,000
----------- -----------
Net loss from continuing operations $ (879,000) $ (2,623,000)
----------- -----------
Discontinued operations:
Net loss on discontinued operations $ (58,000) $ (305,000)
Gain(loss) on sale of real estate (24,000) 6,006,000
Provision for income tax benefit(expense) 31,000 (2,280,000)
----------- -----------
Income(loss) from discontinued operations $ (51,000) $ 3,421,000
----------- -----------
Net income(loss) $ (930,000) $ 798,000
=========== ===========
Loss per share from continuing operations
Basic $ (0.37) $ (1.05)
Diluted $ (0.37) $ (1.05)
=========== ===========
Income(loss) per share from discontinued operations
Basic $ (0.02) $ 1.37
Diluted $ (0.02) $ 1.19
=========== ===========
Income(loss) per share
Basic $ (0.39) $ 0.32
Diluted $ (0.39) $ 0.28
=========== ===========
Weighted average number of shares outstanding 2,403,192 2,496,468
=========== ===========
Diluted weighted average number of shares
outstanding 2,770,692 2,862,468
=========== ===========
The accompanying notes are an integral part of the consolidated
financial statements.
-4-
THE INTEGROUP CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the three months ended September 30, 2005 2004
----------- -----------
Cash flows from operating activities:
Net income(loss) $ (930,000) $ 798,000
Adjustments to reconcile net income(loss) to
cash provided by(cash used) in operating
activities:
Depreciation of real estate 671,000 626,000
Depreciation (discontinued operations) 17,000 173,000
Amortization of intangible asset - 167,000
Loss on early termination of debt - 133,000
Impairment loss on other investments 58,000 -
Loss(gain) on sale of real estate 24,000 (6,006,000)
Net unrealized losses(gains) on investments (170,000) 4,751,000
Equity in net loss(income) from Justice
Investors 787,000 (77,000)
Minority interest benefit (321,000) (645,000)
Changes in assets and liabilities:
Restricted cash (2,000) (1,027,000)
Investment in marketable securities 847,000 19,027,000
Prepaid expenses and other assets (3,459,000) 1,665,000
Accounts payable and other liabilities 187,000 (690,000)
Due to broker 3,479,000 (2,816,000)
Obligation for securities sold (1,880,000) (15,100,000)
Deferred income taxes - 674,000
----------- -----------
Net cash provided by(used in)
operating activities (692,000) 1,653,000
----------- -----------
Cash flows from investing activities:
Net proceeds from sale of real estate 3,785,000 11,850,000
Investment in real estate - (1,467,000)
Additions to buildings, improvements
and equipment (164,000) (875,000)
----------- -----------
Net cash provided by investing activities 3,621,000 9,508,000
----------- -----------
Cash flows from financing activities:
Borrowings from mortgage notes payable - 1,675,000
Principal payments on mortgage notes payable (2,377,000) (11,396,000)
Pay down of line of credit (255,000) -
Purchase of treasury stock (375,000) (268,000)
----------- -----------
Net cash used in financing activities (3,007,000) (9,989,000)
----------- -----------
Net increase(decrease) in cash and cash
equivalents (78,000) 1,172,000
Cash and cash equivalents at beginning of
period 868,000 777,000
----------- -----------
Cash and cash equivalents at end of period $ 790,000 $ 1,949,000
=========== ===========
The accompanying notes are an integral part of the consolidated
financial statements.
-5-
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 September 30, 2005, the Company had the power to vote 76.9%, 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 formerly known as the Holiday Inn Select Downtown &
Spa, a 565-room hotel in San Francisco, California (the "Hotel").
The results of operations for the three months ended September 30, 2005 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 September 30, 2005, the
Company had 367,500 stock options that were considered potentially dilutive
common shares and 37,500 stock options that were considered anti-dilutive. As
of September 30, 2004, the Company had 366,000 stock options that were
considered potentially dilutive common shares and 27,000 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, 2002, the Company adopted Statement of Financial
Accounting Standards No. 148, "Accounting for Stock-Based Compensation-
Transition and Disclosure", which amends Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS 148). In
accounting for its plans, the Company, as allowable under the provisions of
SFAS 148, applies Accounting Principles Board Opinions No. 25, "Accounting for
Stock issued to Employees." As a result of this election, the Company does not
recognize compensation expense for its stock option plans. During the three
-6-
months ended September 30, 2005 and September 30, 2004, the Company granted
12,000 and 15,000 stock options, respectively. Had the Company determined
compensation cost based on the fair value for its stock options at grant date,
net income(loss) and earnings(loss) per share would have been reduced to the
pro forma amounts as follows:
For the three months ended September 30, 2005 2004
------------ -----------
Net income(loss) $ (930,000) $ 798,000
Stock based employee
Compensation expense* (44,000) (62,000)
------------ -----------
Pro forma net income(loss) $ (974,000) $ 736,000
============ ===========
Earnings(loss) per share
Basic as reported $ (0.39) $ 0.32
Basic pro forma $ (0.41) $ 0.29
Diluted as reported $ (0.39) $ 0.28
Diluted pro forma $ (0.41) $ 0.26
*Determined based on the fair value method for awards net of related tax
effects (38%).
The Black-Scholes option pricing model was used with the following weighted-
average assumptions for the three months ended September 30, 2005; risk-free
interest rate of 4.38%; dividend yield of 0%; expected Common Stock market
price volatility factor of 21.21; and a weighted-average expected life of the
options of 10 years. The weighted-average fair value of options granted during
the three months ended September 30, 2005 was $6.18 per option. The aggregate
fair value of the options granted in during the three months ended September
30, 2005 was $74,000. For the three months ended September 30, 2004, the
following weighted-average assumptions for September 30, 2004; risk-free
interest rate of 2.60%; dividend yield of 0%; expected Common Stock market
price volatility factor of 31.37; and a expected life of the options of 10
years. The fair value of options granted in during the three months ended
September 30, 2004 were $6.95 per option. The aggregate fair value of the
options granted during the three months ended September 30, 2004, was $104,000.
The Company is currently evaluating the impact of Financial Accounting Standard
123R, "Share-Based Payments"(FAS 123R). FAS 123R requires companies to
recognize compensation expense equal to the fair value of stock options or
other share-based payments.
2. Investment in Real Estate
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.
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 or for properties for which the Company actively
markets for sale at a price that is reasonable in relation to its market value,
the properties are required to be classified as held for sale on the balance
sheet and 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 months ended
September 30, 2005 and 2004 and reported as income from discontinued operations
in the consolidated statements of operations.
-7-
As of September 30, 2005, the Company had five properties that were classified
as held for sale, one of the properties is located in Texas and the remaining
four are located in California. The revenues and expenses from the operation
of these five properties and the property that was sold in August 2005 have
been reclassified from continuing operations for the three months ended
September 30, 2005 and 2004 and reported as income from discontinued operations
in the consolidated statements of operations.
Revenues and expenses from the operation of these properties for the three
months ended September 30, 2005 and 2004 are summarized as follows:
2005 2004
---------- ----------
Revenues $ 245,000 $ 702,000
Expenses (303,000) (1,007,000)
---------- ----------
Net loss (58,000) (305,000)
========== ==========
Depreciation expense for the three months ended September 30, 2005 and 2004,
was $17,000 and $173,000, 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 September 30, 2005, 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 September 30, 2005
Gross Gross Net Market
Investment Cost Unrealized Gain Unrealized Loss Unrealized Gain Value
---------- ----------- --------------- --------------- --------------- ------------
Corporate
Equities $21,052,000 $3,989,000 ($1,684,000) $2,305,000 $23,357,000
Of the cumulative gross unrealized loss of $1,684,000, $540,000 of the loss is
related to securities held for over one year.
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 September 30, 2005, the Company had obligations for
securities sold (equities short) of $3,377,000.
-8-
The Company may utilize margin for its marketable securities purchases through
the use of standard margin agreements with national brokerage firms. The use
of available leverage is guided by the business judgment of management.
Included in the net losses on marketable securities of $11,000 for the three
months ended September 30, 2005 are net unrealized gains of $170,000 and net
realized losses of $181,000. Included in the net losses on marketable
securities of $4,627,000 for the three months ended September 30, 2004 are net
unrealized losses of $4,751,000 and net realized gains of $124,000.
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 at 750 Kearny Street, San
Francisco, California, formerly known as the Holiday Inn Select Downtown & Spa
(the "Hotel"). Portsmouth records its investment in Justice on the equity
basis. 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
access purchase price over the underlying book value and is allocable to the
depreciable assets of its investment in Justice Investors over 40 years, which
approximates the remaining life of the primary asset, the hotel building.
As a general and limited partner, Portsmouth has significant control over the
management and operation of the assets of Justice Investors. All significant
partnership decisions require the active participation and approval of both
general partners. The Company and Evon jointly consult and determine the
amount of partnership reserves and the amount of cash to be distributed to the
limited partners.
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 is 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
-9-
estimates that the cost of the renovation project will be approximately $34
million. That amount includes approximately $29 million for the actual cost of
the renovations and approximately $5 million for construction interest and
estimated carrying costs of operations during the renovation period. As of
September 30, 2005, the Partnership has incurred approximately $15,093,000 in
construction costs related to the renovation. Of this amount, $132,000 is
related to capitalized interest. Additionally, the Partnership incurred
approximately $3,593,000 in carrying costs related to operations. The
Agreement requires that those renovations be complete and the Hotel commence
operations as a Hilton hotel no later than June 1, 2006. Hilton is presently
accepting reservations for Hotel guest arrivals on January 29, 2006 and beyond.
The Partnership believes that the renovations will be complete and the Hotel
opened by that date. 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. It is anticipated that the Hotel will be
closed for a period of approximately seven to nine months before a contemplated
reopening in the early part of 2006 as the "Hilton San Francisco Financial
District". The below ground parking garage and Tru Spa located on the lobby
level of the Hotel, both of which are lessees of the Partnership, will remain
open during the renovation work.
Condensed financial statements for Justice Investors are as follows:
JUSTICE INVESTORS
CONDENSED BALANCE SHEET
(Unaudited)
As of September 30, 2005
----------
Assets
Cash $ 13,382,000
Other current assets 1,416,000
Property, plant and equipment, net of
accumulated depreciation of $13,538,000 4,870,000
Construction in progress 15,093,000
Land 1,124,000
----------
Total assets $ 35,885,000
==========
Liabilities and partners' capital
Total current liabilities $ 2,471,000
Long-term debt 30,965,000
Partners' capital 2,449,000
----------
Total liabilities and partners' capital $ 35,885,000
==========
-10-
JUSTICE INVESTORS
CONDENSED STATEMENTS OF OPERATIONS
For the three months ended September 30, 2005 2004
---------- ----------
Hotel revenue $ - $ 4,354,000
Hotel rent - 45,000
Garage rent 157,000 306,000
Other income 23,000 14,000
Operating expenses (1,640,000) (4,443,000)
---------- ----------
Net income(loss) $ (1,460,000) $ 276,000
========== ==========
5. Mortgage Note Payable
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 months ended
September 30, 2005 and 2004. Operating income for rental properties consists
of rental income. Operating income from Justice Investors consists of the
operations of the hotel and garage included in the equity in net income of
Justice Investors. Operating income (loss) for investment transactions consist
of net investment gains (losses) and dividend and interest income.
-11-
Real Estate
-------------------------
Three months ended Rental Justice Investment Discontinued
September 30, 2005 Properties Investors Transactions Other Subtotal Operations Total
----------- ----------- ------------ ----------- ------------ ------------ ------------
Operating income(loss) $ 3,237,000 $ (787,000) $ 291,000 $ - $ 2,741,000 $ 245,000 $ 2,986,000
Operating expenses (1,660,000) - (618,000) - (2,278,000) (118,000) (2,396,000)
Real estate taxes (462,000) - - - (462,000) (47,000) (509,000)
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net operating income(loss) 1,115,000 (787,000) (327,000) - 1,000 80,000 81,000
Mortgage interest expense (952,000) - - - (952,000) (121,000) (1,073,000)
Depreciation (671,000) - - - (671,000) (17,000) (688,000)
Loss on sale of real estate - - - - - (24,000) (24,000)
General and administrative
Expense - - - (338,000) (338,000) - (338,000)
Other income - - - 13,000 13,000 - 13,000
Income tax benefit - - - 747,000 747,000 31,000 778,000
Minority interest benefit - - - 321,000 321,000 - 321,000
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net income(loss) $ (508,000) $ (787,000) $ (327,000) $ 743,000 $ (879,000) $ (51,000) $ (930,000)
=========== =========== =========== =========== ============ ============ ============
Total Assets $70,360,000 $ 8,778,000 $28,100,000 $ 6,288,000 $ 113,526,000 - $124,877,000
=========== =========== =========== =========== ============ ============ ============
Real Estate
-------------------------
Three months ended Rental Justice Investment Discontinued
September 30, 2004 Properties Investors Transactions Other Subtotal Operations Total
----------- ----------- ------------ ----------- ------------ ------------ ------------
Operating income $ 3,163,000 $ 77,000 $(4,335,000) $ - $ (1,095,000) $ 702,000 $ (393,000)
Operating expenses (1,369,000) - (576,000) - (1,945,000) (514,000) (2,459,000)
Real estate taxes (363,000) - - - (363,000) (96,000) (459,000)
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net operating income(loss) 1,431,000 77,000 (4,911,000) - (3,403,000) 92,000 (3,311,000)
Mortgage interest expenses (954,000) - - - (954,000) (225,000) (1,179,000)
Depreciation (627,000) - - - (627,000) (172,000) (799,000)
Amortization of intangible (167,000) - - - (167,000) - (167,000)
Gain on sale of real estate - - - - - 6,006,000 6,006,000
General and administrative
expenses - - - (381,000) (381,000) - (381,000)
Other income - - - 86,000 86,000 - 86,000
Income tax benefit(expense) - - - 2,178,000 2,178,000 (2,280,000) (102,000)
Minority interest benefit - - - 645,000 645,000 - 645,000
----------- ----------- ----------- ----------- ------------ ------------ ------------
Net income(loss) $ (317,000) $ 77,000 $(4,911,000) $ 2,528,000 $ (2,623,000) $ 3,421,000 $ 798,000
=========== =========== =========== =========== ============ ============ ============
Total Assets $71,945,000 $11,405,000 $43,254,000 $ 8,694,000 $ 135,298,000 $ 13,746,000 $149,044,000
=========== =========== =========== =========== ============ ============ ============
-12-
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 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.
On July 27, 2005, Justice Investors 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 $165,100, 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.
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.
From the proceeds of the Prudential Loan, the Partnership retired its existing
line of credit in the approximate amount of $7,436,000, including accrued
interest, and paid off a short term uncollateralized line of credit from United
Commercial Bank in the amount of $2,007,000, including accrued interest.
-13-
RESULTS OF OPERATIONS
For the Three Months Ended September 30, 2005 Compared to the
Three Months Ended September 30, 2004
The Company had a net loss of $930,000 for the three months ended September 30,
2005 compared to net income of $798,000 for the three months ended September
30, 2004. As discussed below, the change was primarily due to the gain on the
sale of real estate of $6,006,000 that was recorded during the quarter ended
September 30, 2004, the change in the equity in net income(loss) of Justice
Investors to a significant loss, the increase in the loss from real estate
operations and the decrease in other income. These changes were partially
offset by the significant reduction in the net investment losses from the
Company's marketable securities portfolio and the decrease in general and
administrative expenses.
Loss from real estate operations increased to $508,000 for the three months
ended September 30, 2005 from $317,000 for the three months September 30, 2004.
The increase was primarily due to the increase in property operating expenses
to $1,660,000 from $1,369,000 and the increase in real estate taxes to $462,000
from $363,000. The increase in property operating expenses was partially due
to $100,000 in consulting fees for professional services provided during the
quarter to assist with the improvement of the Company's real estate operations
and to help with the sale of certain non-strategic real estate properties. In
an effort to improve the Company's real estate operations by providing better
service to our tenants and to increase the economic occupancy of our
properties, the Company also incurred additional leasing, salary, cleaning and
decorating and repairs and maintenance expenses. These increases were partially
offset by lower property insurance bills. Real estate taxes increased to
$462,000 from $363,000 primarily as the result the $90,000 increase in property
tax expense on the Company's largest property located in Las Colinas, Texas
that was acquired in April 2004. In August 2005, the Company sold it's 112-
unit apartment complex located in Austin, Texas for $4,400,000 and realized a
loss on sale of real estate of $24,000. The loss on the sale of this property
and the related revenues and expenses are excluded from the real estate
operations and are presented under discontinued operations. Also included in
the discontinued operations are the revenues and expenses of the five
properties that the Company intends to sell, four of which are located in
California and the fifth located in Texas. These five properties are
classified on the balance sheet as held-for-sale.
The Company had a loss in equity in net income (loss) of Justice Investors of
$787,000 for the three months ended September 30, 2005, compared to net income
of $77,000 for the three months ended September 30, 2004. 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.
Thus, Partnership net income for the three months ended September 30, 2005 did
not have any operating income from the Hotel, while the three months ended
September 30, 2004 included the direct operating results of the Hotel. Net
operating income from the Hotel for the three months ended September 30, 2004,
was approximately $305,000. The overall decrease in Partnership net income was
also attributable to a decrease in garage rent to approximately $167,000 from
approximately $306,000 related to the closing of the Hotel, and to increased
costs in the current quarter related to higher interest expenses, insurance
costs, professional fees and other costs for the repositioning of the Hotel.
While the Hotel had traditionally enjoyed a favorable year-round occupancy
rate, but both occupancy and average daily room rates have suffered since
fiscal year ended June 30, 2001. Newer and more upscale properties have opened
-14-
in or near the Financial District, which provide greater amenities to their
guests, making it difficult for the Hotel to compete. These competitors are
now better positioned to attract both the business traveler and tourists and to
achieve higher occupancy and room rates.
Management believes that the Hotel could not continue to be competitive under
the conditions it operated under while a Holiday Inn Select brand hotel. By
terminating the Hotel Lease with Felcor, and taking over the operations of the
Hotel, the Partnership now has greater ability to direct the future of the
Hotel. The Hotel is now approximately 25 years old, with no major renovations
having been made to the property during that time. The Partnership is
committed to make substantial improvements to almost every area of the Hotel
before it reopens in the early part of 2006 as the Hilton San Francisco
Financial District. The newly renovated Hotel will feature among other
amenities: 552 totally remodeled guest rooms and suites; a new concierge lounge
and common areas; modern and expanded meeting rooms; a new ballroom; a new
restaurant and bar; a new fitness center; and the existing Tru Spa. The
Partnership believes that this renovation project, coupled with the strength of
the Hilton brand and reservation system, along with the hotel management
expertise of Dow, will allow the Hotel to directly compete with all hotels in
the Financial District.
Net losses on marketable securities decreased to $11,000 for the three months
ended September 30, 2005 from $4,627,000 for the three months ended September
30, 2004. For the three months ended September 30, 2005, the Company had net
realized losses of $181,000 and net unrealized gains of $170,000. For the
three months ended September 30, 2004, the Company had net unrealized losses of
$4,751,000 and net realized gains of $124,000. Gains and losses on marketable
securities may fluctuate significantly from period to period in the future and
could have a significant impact on the Company's net income. However, the
amount of gain or loss on marketable securities for any given period may have
no predictive value and variations in amount from period to period may have no
analytical value. For a more detailed description of the composition of the
Company's marketable securities please see the Marketable Securities section
below.
During the quarter ended September 30, 2005, the Company recorded an impairment
loss on other investments of $58,000. There were no such losses recorded in
the comparative quarter ended September 30, 2004.
Other income decreased to $13,000 from $86,000 primarily as the result of the
receipt of $69,000 in additional fees from Justice Investors for management's
work in the positioning of the hotel during the three months ended September
30, 2004.
General and administrative expenses decreased to $338,000 for three months
ended September 30, 2005 from $381,000 for the three months ended September 30,
2004. This decrease is the result of management's cost cutting efforts.
The provision for income tax benefit(expense) changed to a benefit of $778,000
for the three months ended September 30, 2005 from an expense of $102,000 for
the three months ended September 30, 2004 due to the significant pre-tax loss
incurred by the Company in the current quarter.
Minority interest benefit decreased to $321,000 from $645,000 as the result of
the lower losses incurred by the Company's subsidiary, Santa Fe, in the current
quarter.
-15-
MARKETABLE SECURITIES
The Company's investment portfolio is diversified with 57 different equity
positions. The portfolio contains six 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.
As of September 30, 2005, the Company had investments in marketable equity
securities of $23,357,000. The following table shows the composition of the
Company's marketable securities portfolio by selected industry groups as of
September 30, 2005.
% of Total
Investment
Industry Group Market Value Securities
-------------- ------------ ----------
Paper mills, steel mills and gold $ 5,944,000 25.4%
Telecommunications and media 5,822,000 24.9%
Insurance, banks and brokers 4,448,000 19.0%
Real estate invest trusts(REITs) 3,243,000 13.9%
Electric, pipelines, oil and gas 1,535,000 6.6%
Consumer goods and restaurants 973,000 4.2%
Motor vehicle parts 790,000 3.4%
Other 602,000 2.6%
---------- ------
$23,357,000 100.0%
========== ======
The following table shows the net loss on the Company's marketable securities
and the associated margin interest and trading expenses for the three ended
September 30, 2005 and 2004, respectively.
For the three months ended September 30, 2005 September 30, 2004
------------------ ------------------
Net losses on marketable securities $ (11,000) $ (4,627,000)
Impairment loss on other investments (58,000) -
Dividend & interest income 302,000 292,000
Margin interest expense (173,000) (252,000)
Trading and management expenses (387,000) (324,000)
------------ ------------
Investment loss $ (327,000) $ (4,911,000)
============ ============
-16-
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 three months ended September 30, 2005, operating activities used
cash of $692,000, investing activities provided cash of $3,621,000 and
financing activities used cash of $3,007,000.
During the three months ended September 30, 2005, the Company made property
improvements in the aggregate amount of $164,000. 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 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.
On May 3, 2004, Justice entered into a settlement agreement with the hotel
lessee, Felcor, to resolve disputes regarding certain obligations of Felcor and
others under the terms of the hotel lease. Pursuant to the settlement, Felcor
paid the sum of $5,000,000 to Justice towards the costs of capital repairs,
replacements and maintenance necessary to place the hotel into the condition
required at the end of the lease. Felcor also agreed to terminate its
leasehold estate and surrendered possession of the hotel to the Partnership on
June 30, 2004, at which time Justice assumed the role as owner-operator of the
property.
To assist in the day-to-day operations of the hotel, Justice entered into a
third party management agreement with Dow Hotel Company, effective July 1,
2004. The termination of the hotel lease also made it possible for the
Partnership to seek a new franchise agreement for the hotel. Those efforts were
successful and culminated with Justice entering into a Franchise License
Agreement (the "Hilton Franchise Agreement"), on December 10, 2004, for the
right to operate the hotel property as a Hilton brand hotel.
Prior to operating the hotel as a Hilton, the Partnership is 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 cost of the renovation project will be approximately $34
million. That amount includes approximately $29 million for the actual cost of
the renovations and approximately $5 million for construction interest and
estimated carrying costs of operations during the renovation period. The Hilton
Franchise Agreement requires that those renovations be complete and the Hotel
commence operations as a Hilton hotel no later than June 1, 2006.
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. It is anticipated that the Hotel will be closed until the
first part of 2006 before it reopens as the "Hilton San Francisco Financial
District". The below ground parking garage and Tru Spa located on the lobby
level of the Hotel, both of which are lessees of the Partnership, will remain
open during the renovation work.
As the Partnership transitions from a lessor of the hotel to an owner-operator,
cash flows will be dependent on net income from the operations of the hotel and
-17-
not from a lease with a guaranteed rent. That uncertainty increases the amount
of risk for the Company, but also provides an opportunity for a greater share
of the profits in good economic times with the repositioning of the hotel.
Although the Partnership is not expected to see an improvement in cash flows
until the Hotel reopens in the first part of 2006, it believes that the
renovations to the Hotel, the new management structure and the new Hilton brand
will make the Hotel more competitive in the future. There will be a negative
impact on the revenues from the hotel garage during the transition period due
to the shut down of the Hotel operations. Evon has entered into a management
agreement with a new garage operator, effective September 1, 2005, and it is
expected that the new operator will take affirmative steps to help minimize the
loss of garage revenues during the transition period.
As discussed above, the Partnership will be expending significant amounts of
money to renovate and reposition the Hotel as Hilton. During that transition
period, the Hotel will be shut down and revenues to the Partnership will be
limited to rentals received from the parking garage and Tru Spa. Thus, it is
expected that the Partnership will continue to incur losses during that time.
To meet its substantial financial commitments for the renovation project,
Justice will have to rely 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 $165,100, 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.
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. As of September 30, 2005,
$1,000,000 of the LOC was utilized by the Partnership.
From the proceeds of the Prudential Loan, the Partnership retired its existing
line of credit in the approximate amount of $7,436,000, including accrued
interest, and paid off a short term uncollateralized line of credit from United
Commercial Bank in the amount of $2,007,000, including accrued interest.
Justice believes that the Prudential Loan and the LOC will provide 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 in the early part of 2006. The Partnership believes
that, after the reopening of the Hotel, the revenues expected to be generated
from the Hotel operations 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
-18-
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.
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.
-19-
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.
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
(Jul. 1- 20,645 $16.51 20,645 75,796
Jul. 31)
--------------------------------------------------------------------------------------
Month #2
(Aug. 1- 2,300 $15.01 2,300 73,496
Aug. 31)
--------------------------------------------------------------------------------------
Month #3
(Sep. 1- - - - 73,496
Sep. 30)
--------------------------------------------------------------------------------------
Total 22,945 $16.35 22,945 73,496
--------------------------------------------------------------------------------------
-20-
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 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.
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: November 10, 2005 by /s/ John V. Winfield
----------------------------
John V. Winfield, President,
Chairman of the Board and
Chief Executive Officer
Date: November 10, 2005 by /s/ David T. Nguyen
------------------------------
David T. Nguyen, Treasurer
and Controller
(Principal Accounting Officer)
-21-