10-Q 1 ps10q123109.txt PORTSMOUTH 10-Q 12-31-09 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-Q [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended December 31, 2009 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______ to _____ Commission File Number: 0-4057 PORTSMOUTH SQUARE, INC. ----------------------- (Exact name of registrant as specified in its charter) CALIFORNIA 94-1674111 ------------------------------ ------------------ (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 10940 Wilshire Blvd., Suite 2150, Los Angeles, California 90024 --------------------------------------------------------- -------- (Address of principal executive offices) (Zip Code) (310) 889-2500 ----------------------------- (Registrant's telephone number) Indicate by check mark whether the registrant (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. [x] Yes [ ] No Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [ ] Smaller reporting company [x] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.) [ ] Yes [x] No INDEX PORTSMOUTH SQUARE, INC. PART I. FINANCIAL INFORMATION PAGE Item 1. Condensed Consolidated Financial Statements Condensed Consolidated Balance Sheets As of December 31, 2009 and June 30, 2009 (Unaudited) 3 Condensed Consolidated Statements of Operations (Unaudited) For the Three Months ended December 31, 2009 and 2008 4 Condensed Consolidated Statements of Operations (Unaudited) For the Six Months ended December 31, 2009 and 2008 5 Condensed Consolidated Statements of Cash Flows (Unaudited) For the Six Months ended December 31, 2009 and 2008 6 Notes to Condensed Consolidated Financial Statements (Unaudited) 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 18 Item 4T. Controls and Procedures 28 PART II. OTHER INFORMATION Item 6. Exhibits 28 SIGNATURES 29 -2- PART 1 FINANCIAL INFORMATION Item 1 - Condensed Consolidated Financial Statements PORTSMOUTH SQUARE, INC. CONDENSED CONSOLIDATED BALANCE SHEETS December 31, 2009 June 30, 2009 ----------------- ------------- Assets Investment in hotel, net $ 35,637,000 $ 36,342,000 Investment in real estate 973,000 973,000 Investment in marketable securities 2,704,000 5,987,000 Other investments, net 2,460,000 2,409,000 Cash and cash equivalents 1,337,000 209,000 Accounts receivable, net 1,338,000 1,271,000 Other assets, net 2,070,000 1,684,000 Deferred tax asset 4,320,000 3,709,000 ------------ ------------ Total assets $ 50,839,000 $ 52,584,000 ============ ============ Liabilities and Shareholders' Equity (Deficit) Liabilities Accounts payable and other liabilities $ 9,372,000 $ 8,531,000 Due to securities broker - 1,514,000 Obligations for securities sold 441,000 699,000 Line of Credit 2,500,000 1,811,000 Mortgage notes payable 46,379,000 46,757,000 ------------ ------------ Total liabilities 58,692,000 59,312,000 ------------ ------------ Commitments and contingencies Shareholders' equity (deficit): Common stock, no par value; 750,000 authorized shares; 734,183 shares issued and outstanding 2,092,000 2,092,000 Additional paid-in capital 916,000 916,000 Accumulated deficit (2,040,000) (1,140,000) ------------ ------------ Total Portsmouth shareholders' equity 968,000 1,868,000 Noncontrolling interest (8,821,000) (8,596,000) ------------ ------------ Total shareholders' deficit (7,853,000) (6,728,000) ------------ ------------ Total liabilities and shareholders' equity (deficit) $ 50,839,000 $ 52,584,000 ============ ============
The accompanying notes are an integral part of these condensed consolidated financial statements. -3- PORTSMOUTH SQUARE, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) For the three months ended December 31, 2009 2008 ---------- ---------- Revenue - hotel $ 8,368,000 $ 8,644,000 ---------- ---------- Costs and operating expenses Hotel operating expenses (6,543,000) (7,277,000) Depreciation and amortization expense (1,199,000) (1,120,000) Loss on termination of garage lease - (684,000) General and administrative expense (150,000) (162,000) ---------- ---------- Total costs and operating expenses (7,892,000) (9,243,000) ---------- ---------- Income(loss) from operations 476,000 (599,000) ---------- ---------- Other income(expense) Interest expense (729,000) (724,000) Net gain(loss) on marketable securities (18,000) 336,000 Net unrealized gain on other investments 85,000 - Impairment loss on other investments (334,000) - Dividend and interest income 20,000 18,000 Trading and margin interest expense (85,000) (52,000) ---------- ---------- Net other expense (1,061,000) (422,000) ---------- ---------- Loss before income taxes (585,000) (1,021,000) Income tax benefit 202,000 170,000 ---------- ---------- Net loss (383,000) (851,000) Less: Net loss attributable to the noncontrolling interest 87,000 - ---------- ---------- Net loss attributable to Portsmouth (296,000) (851,000) ========== ========== Basic and diluted loss per share attributable to Portsmouth $ (0.40) $ (1.16) ========== ========== Weighted average number of common shares Outstanding 734,183 734,183 ========== ========== The accompanying notes are an integral part of these condensed consolidated financial statements. -4- PORTSMOUTH SQUARE, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) For the six months ended December 31, 2009 2008 ---------- ---------- Revenue - hotel $ 16,898,000 $ 17,943,000 ---------- ---------- Costs and operating expenses Hotel operating expenses (13,419,000) (14,519,000) Depreciation and amortization expense (2,331,000) (2,217,000) Loss on termination of garage lease - (684,000) General and administrative expense (274,000) (272,000) ---------- ---------- Total costs and operating expenses (16,024,000) (17,692,000) ---------- ---------- Income from operations 874,000 251,000 ---------- ---------- Other income(expense) Interest expense (1,442,000) (1,443,000) Net gain(loss) on marketable securities (796,000) 120,000 Net unrealized gain on other investments 85,000 - Impairment loss on other investments (334,000) (358,000) Dividend and interest income 51,000 45,000 Trading and margin interest expense (173,000) (107,000) ---------- ---------- Net other expense (2,609,000) (1,743,000) ---------- ---------- Loss before income taxes (1,735,000) (1,492,000) Income tax benefit 611,000 397,000 ---------- ---------- Net loss (1,124,000) (1,095,000) Less: Net loss attributable to the noncontrolling interest 224,000 - ---------- ---------- Net loss attributable to Portsmouth (900,000) (1,095,000) ========== ========== Basic and diluted loss per share attributable to Portsmouth $ (1.23) $ (1.49) ========== ========== Weighted average number of common shares Outstanding 734,183 734,183 ========== ========== The accompanying notes are an integral part of these condensed consolidated financial statements. -5- PORTSMOUTH SQUARE, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) For the six months ended December 31, 2009 2008 ---------- ---------- Cash flows from operating activities: Net loss $(1,124,000) $(1,095,000) Adjustments to reconcile net loss to net cash provided by operating activities: Net unrealized loss(gain) on marketable securities 2,826,000 (481,000) Net unrealized (gain) on other investments (85,000) - Impairment loss on other investments 334,000 358,000 Depreciation and amortization 2,331,000 2,217,000 Loss on termination of garage lease - 684,000 Changes in assets and liabilities: Investment in marketable securities 457,000 630,000 Accounts receivable (67,000) (160,000) Other assets (386,000) (222,000) Deferred tax asset (611,000) (397,000) Accounts payable and other liabilities 341,000 (1,000) Due to securities broker (1,514,000) (271,000) Obligations for securities sold (258,000) - ---------- ---------- Net cash provided by operating activities 2,244,000 1,262,000 ---------- ---------- Cash flows from investing activities: Capital expenditures for furniture, equipment and building improvements (926,000) (657,000) Other investments (300,000) (435,000) ---------- ---------- Net cash used in investing activities (1,226,000) (1,092,000) ---------- ---------- Cash flows from financing activities: Draw on line of credit 689,000 243,000 Principal payments on mortgage note payable (378,000) (358,000) Payment on other notes payable (201,000) - Distributions to noncontrolling interest - (425,000) ---------- ---------- Net cash provided by (used in) financing activities 110,000 (540,000) ---------- ---------- Net increase(decrease) in cash and cash equivalents 1,128,000 (370,000) Cash and cash equivalents at the beginning of the period 209,000 485,000 ---------- ---------- Cash and cash equivalents at the end of the period $ 1,337,000 $ 115,000 ========== ========== Supplemental information: Interest paid $ 1,529,000 $ 1,452,000 ========== ========== Non cash investing and financing activities: Note payable on termination of garage lease $ - $ (727,000) ========== ========== Fixed assets acquired, net of liabilities, upon termination of garage lease $ - $ 43,000 ========== ========== Assets acquired through capital lease $ 700,000 $ - ========== ==========
The accompanying notes are an integral part of these condensed consolidated financial statements. -6- PORTSMOUTH SQUARE, INC. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 1 - BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES The consolidated financial statements included herein have been prepared by Portsmouth Square, Inc. ("Portsmouth" or the "Company"), without audit, according to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes the disclosures that are made are adequate to make the information presented not misleading. Further, the consolidated financial statements reflect, in the opinion of management, all adjustments (which included only normal recurring adjustments) necessary for a fair statement of the financial position, cash flows and results of operations as of and for the periods indicated. As of December 31, 2009, Santa Fe Financial Corporation ("Santa Fe"), a public company, owns approximately 68.8% of the outstanding common shares of Portsmouth Square, Inc. ("Portsmouth" or the "Company"). Santa Fe is a 76%- owned subsidiary of The InterGroup Corporation ("InterGroup"), a public company. InterGroup also directly owns approximately 11.7% of the common stock of Portsmouth. Portsmouth's primary business is conducted through its general and limited partnership interest in Justice Investors, a California limited partnership ("Justice" or the "Partnership"). Portsmouth has a 50.0% limited partnership interest in Justice and serves as one of the two general partners. The other general partner, Evon Corporation ("Evon") served as the managing general partner until December 1, 2008. The Limited Partnership Agreement was amended, effective December 1, 2008, to provide for a change in the respective roles of the general partners. Pursuant to that amendment, Portsmouth became the Managing General Partner of Justice while Evon assumed the role of Co-General Partner of Justice. The financial statements of Justice are consolidated with those of the Company. Justice owns a 544-room hotel property located at 750 Kearny Street, San Francisco California, now known as the Hilton San Francisco Financial District (the Hotel) and related facilities including a five level underground parking garage. The Hotel is operated by the partnership as a full service Hilton brand hotel pursuant to a Franchise License Agreement with Hilton Hotels Corporation. Justice also has a Management Agreement with Prism Hospitality L.P. (Prism) to perform the day-to-day management functions of the Hotel. Justice leased the parking garage to Evon through September 30, 2008. Effective October 1, 2008, Justice and Evon entered into an Installment Sale Agreement whereby Justice purchased all of Evon's right, title, and interest in the remaining term of its lease of the parking garage, which was to expire on November 30, 2010, and other related assets. Justice also agreed to assume Evon's contract with Ace Parking Management, Inc. ("Ace Parking") for the -7- management of the garage and any other liabilities related to the operation of the garage commencing October 1, 2008. The Partnership also leases a day spa on the lobby level to Tru Spa. Portsmouth also receives management fees as a general partner of Justice for its services in overseeing and managing the Partnership's assets. Those fees are eliminated in consolidation. Certain prior period balances have been reclassified to conform with the current period presentation. Basic loss per share is calculated based upon the weighted average number of common shares outstanding during each fiscal year. During the three and six months ended December 31, 2009 and 2008, the Company did not have any potentially dilutive securities outstanding. It is suggested that these financial statements be read in conjunction with the audited financial statements and the notes therein included in the Company's Form 10-K for the year ended June 30, 2009. The results of operations for the three and six months ended December 31, 2009 are not necessarily indicative of results to be expected for the full fiscal year ending June 30, 2010. In June 2009, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles, which was primarily codified into Accounting Standards Codification (ASC) Topic 105. This standard will become the single source of authoritative nongovernmental U.S. generally accepted accounting principles (GAAP). The Codification was effective for interim or annual financial periods ended after September 15, 2009. The Company adopted ASC 105 beginning the quarter ended September 30, 2009. The adoption of ASC 105 did not have a material impact on our consolidated financial position, results of operations and cash flows. Additionally, the FASB now uses Accounting Standards Updates (ASU) to amend ASC. In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R) (SFAS 167), which has not yet been codified in the ASC. This guidance is a revision to pre-existing guidance pertaining to the consolidation and disclosures of variable interest entities. Specifically, it changes how a reporting entity determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a reporting entity is required to consolidate another entity is based on, among other things, the other entity's purpose and design and the reporting entity's ability to direct the activities of the other entity that most significantly impact the other entity's economic performance. This guidance will require a reporting entity to provide additional disclosures about its involvement with variable interest entities and any significant changes in risk exposure due to that involvement. A reporting entity will be required to disclose how its involvement with a variable interest entity affects the reporting entity's financial statements. This guidance will be effective at the start of a reporting entity's first fiscal year beginning after November 15, 2009. Early application is not permitted. The Company is currently evaluating the impact on our financial statements, if any, upon adoption. -8- In May 2009, the FASB issued SFAS No. 165, Subsequent Events, which was primarily codified into ASC Topic 855. The Company adopted ASC Topic 855 which requires an entity to recognize in the financial statements the effects of all subsequent events that provide additional evidence about conditions that existed at the date of the balance sheet. For non-recognized subsequent events that must be disclosed to keep the financial statements from being misleading, an entity will be required to disclose the nature of the event as well as an estimate of its financial effect, or a statement that such an estimate cannot be made. In addition, ASC Topic 855 requires an entity to disclose the date through which subsequent events have been evaluated. ASC Topic 855 is consistent with current practice and did not have any impact on the Company's consolidated financial statements. Subsequent events were evaluated through the date the condensed and consolidated financial statements were issued, which was February 12, 2010. In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interest in Consolidated Financial Statements-an amendment of ARB No. 51" which was primarily codified into ASC Topic 810, "Consolidation." ASC Topic 810 states that accounting and reporting for minority interests will be recharacterized as noncontrolling interests and classified as a component of equity. This standard also establishes reporting requirements that provide disclosures that identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. ASC Topic 810 required retrospective adoption of the presentation and disclosure requirements for previously existing minority interests. All other requirements are to be applied prospectively. This standard is effective for fiscal years beginning after December 15, 2008. The Company adopted the provisions beginning July 1, 2009. Prior to adopting this standard, the Company absorbed 100% of the net loss and accumulated deficit of Justice Investors as of June 30, 2009. Effective July 1, 2009 under ASC Topic 810, losses attributable to the parent and the noncontrolling interest in a subsidiary shall be attributed to those respective interests. That is, the noncontrolling interest shall continue to be attributed its share of losses even if that attribution results in a deficit noncontrolling interest balance. As a result, upon adoption, the Company recalculated the accumulated deficit pertaining to noncontrolling interest totaling $8,596,000 as of June 30, 2009 and reclassified such amount as a separate component of the shareholders' equity (deficit). However, the losses attributed to the noncontrolling interest were not adjusted in the consolidated statement of operations the three and six months ended December 31, 2008. See Note 10. In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" which was primarily codified into ASC Topic 825, "Financial Instruments." ASC Topic 825 provides entities with an irrevocable option to report selected financial assets and financial liabilities at fair value. It also establishes presentation and disclosure requirements that are designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. The Company adopted ASC Topic 825 on July 1, 2008 and chose not to elect the fair value option for its financial assets and liabilities that had not been previously carried at fair value. Therefore, material financial assets and liabilities not carried at fair value, such as other assets, accounts payable, line of credit, and mortgage payables are reported at their carrying values. -9- In December 2007, the FASB issued SFAS No. 141(R), "Business Combinations", which was primarily codified into ASC Topic 805, "Business Combinations". It establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any controlling interest; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. This standard is to be applied prospectively to business combinations for which the acquisition date is on or after an entity's fiscal year that begins after December 15, 2008. The Company adopted this standard beginning July 1, 2009 and adoption of this standard had no material impact on the Company's consolidated financial statements. NOTE 2 - INVESTMENT IN HOTEL, NET Property and equipment consisted of the following: Accumulated Net Book As of December 31, 2009 Cost Depreciation Value ------------ ------------ ------------ Land $ 1,124,000 $ - $ 1,124,000 Furniture and equipment 18,071,000 (12,915,000) 5,156,000 Building and improvements 46,278,000 (16,921,000) 29,357,000 ------------ ------------ ------------ $ 65,473,000 $(29,836,000) $ 35,637,000 ============ ============ ============ Accumulated Net Book As of June 30, 2009 Cost Depreciation Value ------------ ------------ ------------ Land $ 1,124,000 $ - $ 1,124,000 Furniture and equipment 16,939,000 (11,262,000) 5,677,000 Building and improvements 45,693,000 (16,152,000) 29,541,000 ------------ ------------ ------------ $ 63,756,000 $(27,414,000) $ 36,342,000 ============ ============ ============ NOTE 3 - INVESTMENT IN MARKETABLE SECURITIES The Company's investment in marketable securities consists primarily of corporate equities. The Company has also invested in corporate bonds and income producing securities, which may include interests in real estate based companies and REITs, where financial benefit could insure to its shareholders through income and/or capital gain. At December 31, 2009, all of the Company's marketable securities are classified as trading securities. The change in the unrealized gains and losses on these investments are included in earnings. -10- Trading securities are summarized as follows: Gross Gross Net Fair Investment Cost Unrealized Gain Unrealized Loss Unrealized Gain Value ---------- ----------- --------------- --------------- --------------- ------------ As of December 31, 2009 Corporate Equities $ 2,377,000 $ 584,000 ($ 257,000) $ 327,000 $ 2,704,000 As of June 30, 2009 Corporate Equities $ 2,896,000 $ 3,442,000 ($ 351,000) $ 3,091,000 $ 5,987,000
As of December 31, 2009 and June 30, 2009, the Company had unrealized losses of $251,000 and $137,000, respectively, related to securities held for over one year. Net gain(loss) on marketable securities on the statement of operations is comprised of realized and unrealized gains(losses). Below is the composition of the net gain(loss) for the three and six months ended December 31, 2009 and 2008, respectively. For the three months ended December 31, 2009 2008 ----------- ----------- Realized gain(loss) on marketable securities $ 2,107,000 $ (78,000) Unrealized gain(loss) on marketable securities (2,125,000) 414,000 ----------- ----------- Net gain(loss) on marketable securities $ (18,000) $ 336,000 =========== =========== For the six months ended December 31, 2009 2008 ----------- ----------- Realized gain(loss) on marketable securities $ 2,114,000 $ (361,000) Unrealized gain(loss) on marketable securities (2,910,000) 481,000 ----------- ----------- Net gain(loss) on marketable securities $ (796,000) $ 120,000 =========== ===========
NOTE 4 - OTHER INVESTMENTS, NET The Company may also invest, with the approval of the Securities Investment Committee, in private investment equity funds and other unlisted securities, such as convertible notes through private placements. Those investments in non- marketable securities are carried at cost on the Company's balance sheet as part of other investments, net of other than temporary impairment losses. -11- As of December 31, 2009 and June 30, 2009, the Company had net other investments of $2,460,000 and $2,409,000, respectively, which consist of the following: Type December 31, 2009 June 30, 2009 --------------------------- ------------------ ---------------- Private equity hedge fund $ 1,675,000 $ 2,009,000 Corporate debt instruments 634,000 400,000 Warrants 151,000 - ----------------- ---------------- $ 2,460,000 $ 2,409,000 ================= ================ During the three months ended December 31, 2009 and 2008, the Company recorded impairment losses on other investments of $334,000 and $0, respectively. During the six months ended December 31, 2009 and 2008, the Company recorded impairment losses on other investments of $334,000 and $358,000, respectively. As of December 31, 2009, the Company had investments in corporate debt and equity instruments which had attached warrants that were considered derivative instruments. These warrants have an allocated cost basis of $66,000 and a fair market value of $151,000. The unrealized gain of $85,000 related to these warrants was included in the Company's consolidated statement of operations. Derivative financial instruments, as defined in ASC 815-10-15-83 Derivatives and Hedging (pre-Codification FAS No. 133 Accounting for Derivative Financial Instruments and Hedging Activities ), consist of financial instruments or other contracts that contain a notional amount and one or more underlying (e.g. interest rate, security price or other variable), require no initial net investment and permit net settlement. Derivative financial instruments may be free-standing or embedded in other financial instruments. Further, derivative financial instruments are initially, and subsequently, measured at fair value on the Company's consolidated balance sheet with the related unrealized gain or loss recorded in the Company's consolidated statement of operations. The Company used the Black-Scholes option valuation model to estimate the fair value these instruments which requires management to make significant assumptions including trading volatility, estimated terms, and risk free rates. Estimating fair values of derivative financial instruments requires the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors. In addition, option-based models are highly volatile and sensitive to changes in the trading market price of the underlying common stock, which has a high-historical volatility. Since derivative financial instruments are initially and subsequently carried at fair values, the Company's consolidated statement of operations will reflect the volatility in these estimate and assumption changes. NOTE 5 - FAIR VALUE MEASUREMENTS In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" ("SFAS No. 157"), which was primarily codified into ASC Topic 820, which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. ASC Topic 820 is effective as of the beginning of the Company's 2009 fiscal year. In February 2008, the FASB deferred the effective date of ASC Topic 820 for non-financial assets and liabilities that are recognized or disclosed at fair value on a nonrecurring -12- basis until the beginning of fiscal year 2010. The Company adopted ASC Topic 820 with respect to financial assets and liabilities on July 1, 2008. There was no material effect on the financial statements upon adoption of this new accounting pronouncement. ASC Topic 820 discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow), and the cost approach (cost to replace the service capacity of an asset or replacement cost). The statement utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels: Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. Level 2: Inputs, other than quoted prices, that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active. Level 3: Unobservable inputs that reflect the reporting entity's own assumptions The assets measured at fair value on a recurring basis as of December 31, 2009 are as follows: Assets: Level 1 Level 2 Level 3 December 31, 2009 ----------- --------- --------- --------- ------------------ Cash $1,337,000 $ - - $ 1,337,000 Investment in marketable securities 2,704,000 - - 2,704,000 Other investments - warrants 151,000 - 151,000 --------- --------- --------- --------- $4,041,000 $ 151,000 - $ 4,192,000 ========= ========= ========= =========
The fair values of investments in marketable securities are determined by the most recently traded price of each security at the balance sheet date. The fair value of the warrants was determined based upon a Black-Scholes option valuation model. Financial assets that are measured at fair value on a non-recurring basis and are not included in the tables above include "Other investments in non- marketable securities," that were initially measured at cost and have been written down to fair value as a result of impairment. The following table shows the fair value hierarchy for these assets measured at fair value on a non- recurring basis as of December 31, 2009: Gain(loss) for the six months ended Assets: Level 1 Level 2 Level 3 December 31, 2009 December 31, 2009 ----------- --------- --------- --------- ------------------ ------------------ Other non-marketable investments - - $2,460,000 $2,460,000 $(334,000)
-13- Other investments in non-marketable securities are carried at cost net of any impairment loss. The Company has no significant influence or control over the entities that issue these investments. These investments are reviewed on a periodic basis for other-than-temporary impairment. The Company reviews several factors to determine whether a loss is other-than-temporary. These factors include but are not limited to: (i) the length of time an investment is in an unrealized loss position, (ii) the extent to which fair value is less than cost, (iii) the financial condition and near term prospects of the issuer and (iv) our ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in fair value. NOTE 6 - TERMINATION OF GARAGE LEASE Effective October 1, 2008, Justice and Evon entered into an Installment Sale Agreement whereby Justice purchased all of Evon's right title and interest in the remaining term of its lease of the parking garage, which was to expire on November 30, 2010, and other related assets. Justice also agreed to assume Evon's contract with Ace Parking for the management of the garage and any other liabilities related to the operation of the garage commencing October 1, 2008. The purchase price for the garage lease and related assets was approximately $755,000, payable in one down payment of approximately $28,000 and 26 equal monthly installments of approximately $29,000, which includes interest at the rate of 2.4% per annum. Future installment payments as of December 31, 2009 are as follows: For the year ending June 30, 2010 174,000 2011 144,000 -------- Total $318,000 ======== As of December 31, 2009, the present value of the liability of $318,000 was included in the accounts payable and other liabilities balance of $9,372,000 on the Company's condensed consolidated balance sheet. NOTE 7 - LINE OF CREDIT The Partnership has a $2,500,000 unsecured revolving line of credit facility with a bank that was to mature on February 2, 2010. On January 13, 2010, the Partnership received an extension of the maturity date from the bank to April 30, 2010. Borrowings under the line of credit bear interest at Prime plus 3.0% per annum or based on the Wall Street Journal Prime Rate (3.25%) plus 3.0% per annum, floating, (but subject to a minimum floor rate at 5.0% per annum). The interest rate at December 31, 2009 was 6.25%. The outstanding balance on the line of credit was $2,500,000 and $1,811,000 as of December 31, 2009 and June 30, 2009, respectively. Borrowings under the line of credit are subject to certain financial covenants, which are measured annually at June 30th and December 31st based on the credit arrangement. The Partnership was not in compliance with the financial covenants as of December 31, 2009, but is working with the bank on a waiver of such non-compliance as well as a longer term extension. -14- NOTE 8 - SEGMENT INFORMATION The Company operates in two reportable segments, the operation of the hotel ("Hotel Operations") and the investment of its cash in marketable securities and other investments ("Investment Transactions"). These two operating segments, as presented in the consolidated financial statements, reflect how management internally reviews each segment's performance. Management also makes operational and strategic decisions based on this same information. Information below represents reporting segments for the three and six months ended December 31, 2009 and 2008, respectively. Operating income(loss) from Hotel operations consists of the operation of the hotel and operation of the garage. Operating income(loss) for investment transactions consist of net investment gain (loss) and dividend and interest income. As of and for the Three months ended Hotel Investment December 31, 2009 Operations Transactions Other Total ----------- ------------ ----------- ------------ Revenues $ 8,368,000 $ - $ - $ 8,368,000 Expenses (7,742,000) - (150,000) (7,892,000) ----------- ----------- ----------- ------------ Income(loss)from operations 626,000 - (150,000) 476,000 Interest expense (729,000) - - (729,000) Net loss from investments - (332,000) - (332,000) Income tax benefit - - 202,000 202,000 ----------- ----------- ----------- ------------ Net income(loss) $ (103,000) $ (332,000) $ 52,000 $ (383,000) =========== =========== =========== ============ Total Assets $35,637,000 $ 5,164,000 $10,038,000 $ 50,839,000 =========== =========== =========== ============ As of and for the Three months ended Hotel Investment December 31, 2008 Operations Transactions Other Total ----------- ------------ ----------- ------------ Revenues $ 8,644,000 $ - $ - $ 8,644,000 Expenses (9,081,000) - (162,000) (9,243,000) ----------- ----------- ----------- ------------ Loss from operations (437,000) - (162,000) (599,000) Interest expense (724,000) - - (724,000) Net income from investments - 302,000 - 302,000 Income tax benefit - - 170,000 170,000 ----------- ----------- ----------- ------------ Net income(loss) $(1,161,000) $ 302,000 $ 8,000 $ (851,000) =========== =========== =========== ============ Total Assets $41,349,000 $ 5,375,000 $12,179,000 $ 58,903,000 =========== =========== =========== ============
-15- As of and for the six months ended Hotel Investment December 31, 2009 Operations Transactions Other Total ----------- ------------ ----------- ------------ Revenues $16,898,000 $ - $ - $ 16,898,000 Expenses (15,750,000) - (274,000) (16,024,000) ----------- ----------- ----------- ------------ Income(loss)from operations 1,148,000 - (274,000) 874,000 Interest expense (1,442,000) - - (1,442,000) Net loss from investments - (1,167,000) - (1,167,000) Income tax benefit - - 611,000 611,000 ----------- ----------- ----------- ------------ Net income(loss) $ (294,000) $(1,167,000) $ 337,000 $ (1,124,000) =========== =========== =========== ============ Total Assets $35,637,000 $ 5,164,000 $ 10,038,000 $50,839,000 =========== =========== =========== ============ As of and for the six months ended Hotel Investment December 31, 2008 Operations Transactions Other Total ----------- ------------ ----------- ------------ Revenues $ 17,943,000 $ - $ - $17,943,000 Expenses (17,420,000) - (272,000) (17,692,000) ----------- ----------- ----------- ------------ Income(loss)from operations 523,000 - (272,000) 251,000 Interest expense (1,443,000) - - (1,443,000) Net loss from investments - (300,000) - (300,000) Income tax benefit - - 397,000 397,000 ----------- ----------- ----------- ------------ Net income(loss) $ (920,000) $ (300,000) $ 125,000 $ (1,095,000) =========== =========== =========== ============ Total Assets $41,349,000 $ 5,375,000 $12,179,000 $ 58,903,000 =========== =========== =========== ============
NOTE 9 - RELATED PARTY TRANSACTIONS Certain shared costs and expenses, primarily administrative expenses, rent and insurance are allocated among the Company, the Company's parent, Santa Fe and InterGroup, the parent of Santa Fe, based on management's estimate of the pro rata utilization of resources. For the three months ended December 31, 2009 and 2008, these expenses were approximately $18,000 for each respective period. For the six months ended December 31, 2009 and 2008, these expenses were approximately $36,000 for each respective period. Four of the Company's Directors serve as directors of InterGroup and three of the Company's Directors serve as directors of Santa Fe. Evon, a general partner of Justice, was the lessee of the parking garage until September 30, 2008. Under the terms of the lease agreement, Evon paid the Partnership rent of $399,000 for the six months ended December 31, 2008. As discussed in Note 6, Justice and Evon entered into an installment sale agreement whereby Justice purchased the remaining term of the lease agreement and related assets for a total of approximately $755,000. During the three and six months ended December 31, 2009, the Company received management fees from Justice Investors totaling $72,000 and $151,000, respectively. These amounts were eliminated in consolidation. -16- John V. Winfield serves as Chief Executive Officer and Chairman of the Company, Santa Fe, and InterGroup. Depending on certain market conditions and various risk factors, the Chief Executive Officer, his family, Santa Fe and InterGroup 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 Santa Fe and InterGroup, at risk in connection with investment decisions made on behalf of the Company. NOTE 10 - PROFORMA DISCLOSURE UPON ADOPTION OF ASC 810-10 ("CONSOLIDATION") As discussed in Note 1, the Company adopted ASC Topic No. 810-10, "Consolidation," effective July 1, 2009, which requires a retrospective adoption of the presentation and disclosure of previously existing minority interest. Prior to the adoption of ASC Topic No. 810-10, the Company absorbed 100% of the net loss and accumulated deficit of Justice Investors as of June 30, 2009. Hence, the minority interest in Justice as of June 30, 2009 and for each of the three quarters ended June 30, 2009 were $0. For purposes of presentation, the deficit noncontrolling interest was reclassified in the consolidated balance sheet as of June 30, 2009. However, the losses attributed to the noncontrolling interest were not adjusted in the consolidated statement of operations for the three months ended September 30, 2008, and for the three and six months ended December 31, 2008. Below are the pro-forma consolidated net losses of the Company for the three months ended September 30, 2008, and for the three and six months ended December 31, 2008, assuming ASC Topic 810-10 had been adopted in those periods. Proforma Proforma Proforma Three Months Ended Three Months Ended Six Months Ended September 30, 2008 December 31, 2008 December 31, 2008 ------------------ ----------------- ----------------- Net loss $ (244,000) $ (851,000) $ (1,095,000) Less: net loss (income) attributable to the noncontrolling interest (96,000) 608,000 512,000 -------------- -------------- -------------- Net Loss attributable to Portsmouth $ (340,000) $ (243,000) $ (583,000) ============== ============== ============== Basic and diluted loss per share attributable to Portsmouth $ (0.46) $ (0.33) $ (0.79) ============== ============== ==============
Below are the consolidated net losses as reported in the consolidated financial statements for the three months ended September 30, 2008, and for the three and six months ended December 31, 2008: Three Months Ended Three Months Ended Six Months Ended September 30, 2008 December 31, 2008 December 31, 2008 ------------------ ----------------- ----------------- Net loss $ (244,000) $ (851,000) $ (1,095,000) Less: net loss attributable to the noncontrolling interest - - - -------------- -------------- -------------- Net Loss attributable to Portsmouth $ (244,000) $ (851,000) $ (1,095,000) ============== ============== ============== Basic and diluted loss per share attributable to Portsmouth $ (0.33) $ (1.16) $ (1.49) ============== ============== ==============
-17- Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS AND PROJECTIONS The Company may from time to time make forward-looking statements and projections concerning future expectations. When used in this discussion, the words "anticipate," "estimate," "expect," "project," "intend," "plan," "believe," "may," "could," "might" and similar expressions, are intended to identify forward-looking statements. These statements are subject to certain risks and uncertainties, such as national and worldwide economic conditions, including the impact of recessionary conditions on tourism, travel and the lodging industry, the impact of terrorism and war on the national and international economies, including tourism and securities markets, energy and fuel costs, natural disasters, general economic conditions and competition in the hotel industry in the San Francisco area, seasonality, labor relations and labor disruptions, actual and threatened pandemics such as swine flu, partnership distributions, the ability to obtain financing at favorable interest rates and terms, securities markets, regulatory factors, litigation and other factors discussed below in this Report and in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2009, that could cause actual results to differ materially from those projected. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as to the date hereof. The Company undertakes no obligation to publicly release the results of any revisions to those forward-looking statements, which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. RESULTS OF OPERATIONS The Company's principal business is conducted through its general and limited partnership interest in the Justice Investors limited partnership ("Justice" or the "Partnership"). The Company has a 50.0% limited partnership interest in Justice and serves as the managing general partner of Justice. Evon Corporation ("Evon") serves as the other general partner. Justice owns the land, improvements and leaseholds at 750 Kearny Street, San Francisco, California, known as the Hilton San Francisco Financial District (the "Hotel"). The financial statements of Justice are consolidated with those of the Company. The Hotel is operated by the Partnership as a full service Hilton brand hotel pursuant to a Franchise License Agreement with Hilton Hotels Corporation. The term of the Agreement is for a period of 15 years commencing on January 12, 2006, with an option to extend the license term for another five years, subject to certain conditions. Justice also has a Management Agreement with Prism Hospitality L.P. ("Prism") to perform the day-to-day management functions of the Hotel. Until September 30, 2008, the Partnership also derived income from the lease of the parking garage to Evon. Effective October 1, 2008, Justice entered into an installment sale agreement with Evon to purchase the remaining term of the garage lease and related garage assets, and assumed the contract with Ace Parking for the operations of the garage. Justice also leases a portion of the lobby level of the Hotel to a day spa operator. Portsmouth also receives management fees as a general partner of Justice for its services in overseeing and managing the Partnership's assets. Those fees are eliminated in consolidation. -18- Three Months Ended December 31, 2009 Compared to Three Months Ended December 31, 2008 The Company had a net loss of $383,000 for the three months ended December 31, 2009 compared to a net loss of $851,000 for the three months ended December 31, 2008. The decrease in the net loss is primarily attributable to the decrease in the net loss from hotel operations partially offset by the loss from investing activities. During the three months ended December 31, 2009, the Company had a loss on hotel operations of $103,000 compared to a loss of $1,161,000 for the three months ended December 31, 2008. The significant reduction in that loss was primarily attributable to a reduction in hotel operating expenses as a percentage of hotel revenues in the current period and a one-time loss related to the termination of the hotel garage lease in the amount of $684,000 which was incurred in the three months ended December 31, 2008. The following table sets forth a more detailed presentation of Hotel operations for the three months ended December 31, 2009 and 2008. For the three months ended December 31, 2009 2008 ---------- ---------- Hotel revenues: Hotel rooms $ 6,474,000 $ 6,612,000 Food and beverage 1,118,000 1,268,000 Garage 598,000 571,000 Other 178,000 193,000 ---------- ---------- Total hotel revenues 8,368,000 8,644,000 Operating expenses, excluding loss on termination of garage lease, interest, depreciation and amortization (6,543,000) (7,277,000) ---------- ---------- Operating income before loss on termination of garage lease, interest, depreciation and amortization 1,825,000 1,367,000 Loss on termination of garage lease - (684,000) Interest expense (729,000) (724,000) Depreciation and amortization expense (1,199,000) (1,120,000) ---------- ---------- Loss from hotel operations $ (103,000) $(1,161,000) ========== ==========
For the three months ended December 31, 2009, the Hotel generated operating income of approximately $1,825,000, before interest, depreciation and amortization, on operating revenues of approximately $8,368,000 compared to operating income of approximately $1,367,000 before the loss on termination of garage lease, interest, depreciation and amortization, on operating revenues of approximately $8,644,000 for the three months ended December 31, 2008. The increase in Hotel operating income is primarily attributable to a significant decline in operating expenses and an increase in garage revenues, partially offset by a decrease in room and food and beverage revenues. Room revenues decreased by approximately $138,000 for the three months ended December 31, 2009 when compared to the three months ended December 31, 2008 and food and beverage revenues decreased by approximately $150,000 for the same period. The decrease in room revenues was primarily attributable to a decline in average daily room rates as hotels in the San Francisco market continue to -19- reduce room rates in an effort to maintain occupancy levels in a very competitive market as economic conditions continue to be very challenging. Many hotels have been forced to adopt this strategy due to a severe reduction in higher rated corporate and group business travel, which has been replaced by discounted business from Internet channels. The decrease in food and beverage revenues is primarily attributable to decline in banquet and catering business as companies continue with cuts in business travel, corporate meetings and events. The following table sets forth the average daily room rate, average occupancy percentage and room revenue per available room ("RevPar") of the Hotel for the three months ended December 31, 2009 and 2008. Three Months Ended Average Average December 31, Daily Rate Occupancy% RevPar ----------------- ---------- --------- -------- 2009 $149 87% $129 2008 $167 79% $132 The operations of the Hotel continued to be impacted by the significant downturn in the domestic and international economies and markets. The Hotel's average daily room rate was approximately $18 lower for the three months ended December 31, 2009 compared to the three months ended December 31, 2008. However, due to increased sales and marketing efforts in the face of difficult economic conditions and greater competition, the Hotel was able to boost occupancy rates by approximately 10% over the comparable period. As a result, the Hotel was able to achieve a RevPar number that was near the top of its competitive set. Management has also continued to focus on ways to improve efficiencies and reduce operating costs and other expenses in its efforts to stabilize and maintain operating income of the Hotel. As a result, operating expenses excluding loss on termination of garage lease, interest, depreciation and amortization for the three months ended December 31, 2009 decreased by approximately $734,000 from the three months ended December 31, 2008, despite the Hotel maintaining higher occupancy levels. Management will continue to explore new and innovative ways to improve operations and enhance the guest experience. The Company had a net loss on marketable securities of $18,000 for the three months ended December 31, 2009 compared to a net gain on marketable securities of $336,000 for the three months ended December 31, 2008. For the three months ended December 31, 2009, the Company had a net realized gain of $2,107,000 and a net unrealized loss of $2,125,000. For the three months ended December 31, 2008, the Company had a net realized loss of $78,000 and a net unrealized gain of $414,000. Gains and losses on marketable securities may fluctuate significantly from period to period in the future and could have a significant impact on the Company's results of operations. However, the amount of gain or loss on marketable securities for any given period may have no predictive value and variations in amount from period to period may have no analytical value. For a more detailed description of the composition of the Company's marketable securities see the Marketable Securities section below. -20- The Company may also invest, with the approval of the Securities Investment Committee, in private investment equity funds and other unlisted securities, such as convertible notes through private placements. Those investments in non- marketable securities are carried at cost on the Company's balance sheet as part of other investments, net of other than temporary impairment losses. As of December 31, 2009, the Company had net other investments of $2,460,000. Included in other investments are investments in corporate debt and equity instruments which had attached warrants that were considered derivative instruments. The Company recorded an unrealized gain of $85,000 related to these warrants during the three months ended December 31, 2009. During the three months ended December 31, 2009 and 2008, the Company performed an impairment analysis of its other investments and determined that its investments had other than temporary impairments and recorded impairment losses of $334,000 and $0, respectively. Margin interest and trading expenses increased to $85,000 for the three months ended December 31, 2009 from $52,000 for the three months ended December 31, 2008 primarily as the result of the increase in margin interest expense related to the increase in the use of margin. The provision for income tax benefit as a percentage of the loss before taxes was significantly lower for the three months ended December 31, 2008 as compared to the three months ended December 31, 2009 primarily as the result of the Company having to recognize 100% of the net loss from the hotel operations for financial statement purposes for the three months ended December 31, 2008, however, for tax purposes, the Company is only allowed to record an income tax benefit related to 50%(the Company's ownership percentage) of the net loss from hotel operations. Six Months Ended December 31, 2009 Compared to Six Months Ended December 31, 2008 The Company had a net loss of $1,124,000 for the six months ended December 31, 2009 compared to a net loss of $1,095,000 for the six months ended December 31, 2008. The increase in the net loss is primarily attributable to the increase the loss from investing activities partially offset by the significant decrease in the net loss from hotel operations. During the six months ended December 31, 2009, the Company had a loss on hotel operations of $294,000 compared to a loss of $920,000 for the six months ended December 31, 2008. The reduction in that loss was primarily attributable to a one-time loss related to the termination of the hotel garage lease in the amount of $684,000 was incurred in the three months ended December 31, 2008. The following table sets forth a more detailed presentation of Hotel operations for the six months ended December 31, 2009 and 2008. -21- For the six months ended December 31, 2009 2008 ---------- ---------- Hotel revenues: Hotel rooms $ 13,206,000 $ 14,200,000 Food and beverage 2,069,000 2,527,000 Garage 1,266,000 970,000 Other 357,000 246,000 ---------- ---------- Total hotel revenues 16,898,000 17,943,000 Operating expenses, excluding loss on termination of garage lease, interest, depreciation and amortization (13,419,000) (14,519,000) ---------- ---------- Operating income before loss on termination of garage lease, interest, depreciation and amortization 3,479,000 3,424,000 Loss on termination of garage lease - (684,000) Interest expense (1,442,000) (1,443,000) Depreciation and amortization expense (2,331,000) (2,217,000) ---------- ---------- Loss from hotel operations $ (294,000) $ (920,000) ========== ==========
For the six months ended December 31, 2009, the Hotel generated operating income of approximately $3,479,000 before interest, depreciation and amortization, on operating revenues of approximately $16,898,000 compared to operating income of approximately $3,424,000 before the loss on termination of garage lease, interest, depreciation and amortization, on operating revenues of approximately $17,943,000 for the six months ended December 31, 2008. The increase in Hotel operating income is primarily attributable to a significant decline in operating expenses and an increase in garage revenues resulting from the termination of the garage lease in October 2008 and integration of those operations into those of the Hotel, partially offset by a decrease in room and food and beverage revenues. Room revenues decreased by approximately $994,000 for the six months ended December 31, 2009 when compared to the six months ended December 31, 2008 and food and beverage revenues decreased by approximately $458,000 for the same period. The decrease in room revenues was primarily attributable to a decline in average daily room rates as hotels in the San Francisco market continue to reduce room rates in an effort to maintain occupancy levels in a very competitive market as economic conditions continue to be very challenging. Many hotels have been forced to adopt this strategy due to a severe reduction in higher rated corporate and group business travel, which has been replaced by discounted business from Internet channels. The decrease in food and beverage revenues is primarily attributable to decline in banquet and catering business as companies continue with cuts in business travel, corporate meetings and events. The following table sets forth the average daily room rate, average occupancy percentage and room revenue per available room ("RevPar") of the Hotel for the six months ended December 31, 2009 and 2008. Six Months Ended Average Average December 31, Daily Rate Occupancy% RevPar ----------------- ---------- --------- -------- 2009 $148 89% $132 2008 $177 80% $142 -22- The operations of the Hotel continued to be impacted by the significant downturn in the domestic and international economies and markets. Room rates continue to be the toughest challenge as the Hotel's average daily room rate was approximately $29 lower for the six months ended December 31, 2009 compared to the six months ended December 31, 2008. However, due to increased sales and marketing efforts in the face of difficult economic conditions and greater competition, the Hotel was able to boost occupancy rates by approximately 10% over the comparable period. As a result, the Hotel was able to achieve a RevPar number that was near the top of its competitive set. Management has continued to focus on ways to improve efficiencies and reduce operating costs and other expenses in its efforts to stabilize and maintain operating income of the Hotel. As a result, operating expenses excluding loss on termination of garage lease, interest, depreciation and amortization for the six months ended December 31, 2009 decreased by approximately $1,100,000 from the six months ended December 31, 2008, despite the Hotel maintaining higher occupancy levels. Management will continue to explore new and innovative ways to improve operations and enhance the guest experience. The Company had a net loss on marketable securities of $796,000 for the six months ended December 31, 2009 compared to a net gain on marketable securities of $120,000 for the six months ended December 31, 2008. For the six months ended December 31, 2009, the Company had a net realized gain of $2,114,000 and a net unrealized loss of $2,910,000. For the six months ended December 31, 2008, the Company had a net realized loss of $361,000 and a net unrealized gain of $481,000. Gains and losses on marketable securities may fluctuate significantly from period to period in the future and could have a significant impact on the Company's results of operations. However, the amount of gain or loss on marketable securities for any given period may have no predictive value and variations in amount from period to period may have no analytical value. For a more detailed description of the composition of the Company's marketable securities see the Marketable Securities section below. The Company may also invest, with the approval of the Securities Investment Committee, in private investment equity funds and other unlisted securities, such as convertible notes through private placements. Those investments in non- marketable securities are carried at cost on the Company's balance sheet as part of other investments, net of other than temporary impairment losses. As of December 31, 2009, the Company had net other investments of $2,309,000. Included in other investments are investments in corporate debt and equity instruments which had attached warrants that were considered derivative instruments. The Company recorded an unrealized gain of $85,000 related to these warrants during the six months ended December 31, 2009. During the six months ended December 31, 2009 and 2008, the Company performed an impairment analysis of its other investments and determined that its investments had other than temporary impairments and recorded impairment losses of $334,000 and $358,000, respectively. Margin interest and trading expenses increased to $173,000 for the six months ended December 31, 2009 from $107,000 for the six months ended December 31, 2008 primarily as the result of the increase in margin interest expense related to the increase in the use of margin. -23- The provision for income tax benefit as a percentage of the loss before taxes was significantly lower for the six months ended December 31, 2008 as compared to the six months ended December 31, 2009 primarily as the result of the Company having to recognize 100% of the net loss from the hotel operations for financial statement purposes for the six months ended December 31, 2008, however, for tax purposes, the Company is only allowed to record an income tax benefit related to 50%(the Company's ownership percentage) of the net loss from hotel operations. MARKETABLE SECURITIES AND OTHER INVESTMENTS As of December 31, 2009 and June 30, 2008, the Company had investments in marketable equity securities of $2,704,000 and $5,987,000, respectively. The following table shows the composition of the Company's marketable securities portfolio by selected industry groups as December 31, 2009 and June 30, 2009. As of December 31, 2009: % of Total Investment Industry Group Fair Value Securities -------------- ------------ ---------- REITs 949,000 35.1% Investment funds 605,000 22.4% Financial services 435,000 16.1% Technology and telecom 136,000 5.0% Other 579,000 21.4% ------------ ---------- $ 2,704,000 100.0% ============ ========== As of June 30, 2009: % of Total Investment Industry Group Fair Value Securities -------------- ------------ ---------- Dairy products $ 2,935,000 49.0% REITs and financial 1,294,000 21.6% Basic materials and energy 563,000 9.4% Electronic traded funds(ETFs) 498,000 8.3% Services 241,000 4.0% Other 456,000 7.7% ---------- ------ $ 5,987,000 100.0% ========== ====== As of December 31, 2009, the Company's investment portfolio is diversified with 30 different equity positions. The portfolio contains four individual equity securities that are more than 5% of the equity value of the portfolio with the largest security being 19.6% 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. -24- The Company may also invest, with the approval of the Securities Investment Committee, in private investment equity funds and other unlisted securities, such as convertible notes through private placements. Those investments in non- marketable securities are carried at cost on the Company's balance sheet as part of other investments, net of other than temporary impairment losses. As of December 31, 2009 and June 30, 2009, the Company had net other investments of $2,460,000 and $2,409,000, respectively. As of December 31, 2009, the Company had a net other investment in a public company in a basic materials sector totaling $433,000. As of December 31, 2009, the Company holds notes and convertible notes of this company totaling approximately $3,673,000 which includes $2,618,000 of principal and $1,055,000 of accrued interest and penalties. LIQUIDITY AND SOURCES OF CAPITAL The Company's cash flows are primarily generated from its Hotel operations and general partner fees from Justice. The Company also receives revenues generated from the investment of its cash and marketable securities and other investments. Since the operations of the Hotel were temporarily suspended on May 31, 2005, and significant amounts of money were expended to renovate and reposition the Hotel as a Hilton, Justice did not pay any partnership distributions until the end of March 2007. As a result, the Company had to depend more on the revenues generated from the investment of its cash and marketable securities during that transition period. The Hotel started to generate cash flows from its operations in June 2006. For the six months ended September 30, 2008, Justice paid a total of $850,000 in limited partnership distributions, of which the Company received $425,000. Following the payment of those distributions, the San Francisco hotel market began to feel the full impact of the significant downturn in domestic and international economies that continued throughout fiscal 2009 and into fiscal 2010. As a result, no partnership distributions were paid for the six months ended December 31, 2009. Since no significant improvement in economic conditions is expected in the lodging industry until sometime during the second half of calendar 2010, no limited partnership distributions are anticipated in the foreseeable future. The general partners will continue to monitor and review the operations and financial results of the Hotel and to set the amount of any future distributions that may be appropriate based on operating results, cash flows and other factors, including establishment of reasonable reserves for debt payments and operating contingencies. The new Justice Compensation Agreement that became effective on December 1, 2008, when Portsmouth assumed the role of managing general partner of Justice, has provided additional cash flows to the Company. Under the new Compensation Agreement, Portsmouth is now entitled to 80% of the minimum base fee to be paid to the general partners of $285,000, while under the prior agreement, Portsmouth was entitled to receive only 20% of the minimum base fee. As a result, total general partner fees paid to Portsmouth for the three months ended December 31, 2009 increased to $151,000, compared to $97,000 for the three months ended December 31, 2008. To meet its substantial financial commitments for the renovation and transition of the Hotel to a Hilton, Justice had to rely on borrowings to meet its obligations. On July 27, 2005, Justice entered into a first mortgage loan with -25- The Prudential Insurance Company of America in a principal amount of $30,000,000 (the "Prudential Loan"). The term of the Prudential Loan is for 120 months at a fixed interest rate of 5.22% per annum. The Prudential Loan calls for monthly installments of principal and interest in the amount of approximately $165,000, calculated on a 30-year amortization schedule. The Loan is collateralized by a first deed of trust on the Partnership's Hotel property, including all improvements and personal property thereon and an assignment of all present and future leases and rents. The Prudential Loan is without recourse to the limited and general partners of Justice. The principal balance of the Prudential Loan was $27,986,000 as of December 31, 2009. On March 27, 2007, Justice entered into a second mortgage loan with Prudential (the "Second Prudential Loan") in a principal amount of $19,000,000. The term of the Second Prudential Loan is for approximately 100 months and matures on August 5, 2015, the same date as the first Prudential Loan. The Second Prudential Loan is at a fixed interest rate of 6.42% per annum and calls for monthly installments of principal and interest in the amount of approximately $119,000, calculated on a 30-year amortization schedule. The Second Prudential Loan is collateralized by a second deed of trust on the Partnership's Hotel property, including all improvements and personal property thereon and an assignment of all present and future leases and rents. The Second Prudential Loan is also without recourse to the limited and general partners of Justice. The principal balance of the Second Prudential Loan was $18,393,000 as of December 31, 2009. Justice also has a $2,500,000 unsecured revolving line of credit facility from EastWest Bank (formerly United Commercial Bank) that can be used for short term business requirements. The line of credit was to mature on February 2, 2010, but the Partnership received an extension of the maturity date to April 30, 2010. Borrowings bear interest at an annual interest rate based on the Wall Street Journal Prime Rate plus 3%, floating, with an interest rate floor of 5%. As of December 31, 2009, there was a balance of approximately $2,500,000 drawn by Justice under the line of credit facility, with an annual interest rate of 6.25% (Prime at 3.25% as of December 31, 2009, plus 3%). The Partnership was not in compliance with the financial covenants of its line of credit as of December 31, 2009, but is working with the bank on a waiver of such non- compliance as well as a longer term extension. Despite the downturns in the economy, the Hotel has continued to generate positive cash flows. While the debt service requirements related to the two Prudential loans, as well as the utilization of its line of credit, may create some additional risk for the Company and its ability to generate cash flows in the future since the Partnership's assets had been virtually debt free for an number of years, management believes that cash flows from the operations of the Hotel and the garage will continue to be sufficient to meet all of the Partnership's current and future obligations and financial requirements. Management also believes that there is sufficient equity in the Hotel assets to support future borrowings, if necessary, to fund any new capital improvements and other requirements. The Company has invested in short-term, income-producing instruments and in equity and debt securities when deemed appropriate. The Company's marketable securities are classified as trading with unrealized gains and losses recorded through the consolidated statements of operations. -26- MATERIAL CONTRACTUAL OBLIGATIONS The following table provides a summary of the Company's material financial obligations. Total Year 1 Year 2 Year 3 Year 4 Year 5 Thereafter ----------- ---------- ---------- ---------- ---------- ---------- ----------- Mortgage notes payable $46,379,000 $ 389,000 $ 811,000 $ 858,000 $ 907,000 $ 959,000 $42,455,000 Line of credit 2,500,000 2,500,000 - - - - - Other notes payable 383,000 204,000 179,000 - - - - Leases 999,000 216,000 430,000 201,000 126,000 26,000 - ---------- --------- --------- --------- --------- --------- ---------- Total $50,261,000 $3,309,000 $1,420,000 $1,059,000 $1,033,000 $ 985,000 $42,455,000 ---------- --------- --------- --------- --------- --------- ----------
OFF-BALANCE SHEET ARRANGEMENTS The Company has no off balance sheet arrangements. IMPACT OF INFLATION Hotel room rates are typically impacted by supply and demand factors, not inflation, since rental of a hotel room is usually for a limited number of nights. Room rates can be, and usually are, adjusted to account for inflationary cost increases. Since Prism has the power and ability under the terms of its management agreement to adjust hotel room rates on an ongoing basis, there should be minimal impact on partnership revenues due to inflation. Partnership revenues are also subject to interest rate risks, which may be influenced by inflation. For the two most recent fiscal years, the impact of inflation on the Company's income is not viewed by management as material. CRITICAL ACCOUNTING POLICIES Critical accounting policies are those that are most significant to the portrayal of our financial position and results of operations and require judgments by management in order to make estimates about the effect of matters that are inherently uncertain. The preparation of these condensed financial statements requires us to make estimates and judgments that affect the reported amounts in our consolidated financial statements. We evaluate our estimates on an on-going basis, including those related to the consolidation of our subsidiaries, to our revenues, allowances for bad debts, accruals, asset impairments, other investments, income taxes and commitments and contingencies. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. The actual results may differ from these estimates or our estimates may be affected by different assumptions or conditions. -27- Item 4T. Controls and Procedures EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES The Company's management, with the participation of the Company's Chief Executive Officer and Principal Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the quarterly period covered by this Quarterly Report on Form 10-Q. Based upon such evaluation, the Chief Executive Officer and Principal 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 within the time periods specified in the Securities and Exchange Commission rules and forms. CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING There have been no changes in the Company's internal control over financial reporting during the last quarterly period covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. PART II. OTHER INFORMATION Item 6. Exhibits. 31.1 Certification of Chief Executive Officer of Periodic Report Pursuant to Rule 13a-14(a) and Rule 15d-14(a). 31.2 Certification of Principal Financial Officer of Periodic Report Pursuant to Rule 13a-14(a) and Rule 15d-14(a). 32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350. 32.2 Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350. -28- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PORTSMOUTH SQUARE, INC. (Registrant) Date: February 12, 2010 by /s/ John V. Winfield --------------------------- John V. Winfield, President, Chairman of the Board and Chief Executive Officer Date: February 12, 2010 by /s/ Michael G. Zybala --------------------------- Michael G. Zybala, Vice President and Secretary Date: February 12, 2010 by /s/ David T. Nguyen -------------------------- David Nguyen, Treasurer (Principal Financial Officer) -29-