10QSB 1 sf10q93006.txt SANTA FE 10-QSB 9-30-06 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------------- FORM 10-QSB [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 2006 [ ] Transition Report Under Section 13 or 15 (d) of the Securities Exchange Act of 1934 For the transition period from ________ to _________. Commission file number 0-6877 SANTA FE FINANCIAL CORPORATION ------------------------------ (Exact Name of Small Business Issuer as Specified in Its Charter) Nevada 95-2452529 ------------------------------- ------------------ (State or Other Jurisdiction of (IRS Employer Incorporation or Organization) Identification No.) 820 Moraga Drive Los Angeles, CA 90049 --------------------------------------- ------------------ (Address of Principal Executive Offices) (Zip Code) (310) 889-2500 --------------------------------------------------- (Registrant's Telephone Number, Including Area Code) 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, and (2) has been subject to such filing requirements for the past 90 days. Yes (x) No ( ) Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ( ) No (X) State the number of shares outstanding of each of the issuer's classes of Common equity, as of the latest practicable date: 1,241,810 shares of issuer's $.10 Par Value Common Stock were outstanding as of November 10, 2006. Transitional Small Business Disclosure Format (check one): Yes ( ) No (X) INDEX SANTA FE FINANCIAL CORPORATION PART I FINANCIAL INFORMATION PAGE Item 1. Consolidated Financial Statements Consolidated Balance Sheet - As of September 30, 2006 (Unaudited) 3 Consolidated Statements of Operations (Unaudited) - For the Three Months ended September 30, 2006 and September 30, 2005 4 Consolidated Statements of Cash Flows (Unaudited) - For the Three Months ended September 30, 2006 and September 30, 2005 5 Notes to Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 Item 3. Controls and Procedures 18 PART II. OTHER INFORMATION Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 19 Item 6. Exhibits and Reports on Form 8-K. 20 SIGNATURES 20 -2- PART I FINANCIAL INFORMATION Item 1. Consolidated Financial Statements Santa Fe Financial Corporation Consolidated Balance Sheet (Unaudited) As of September 30, 2006 ----------- ASSETS Investment in hotel, at cost: Land $ 1,124,000 Furniture and equipment 15,095,000 Building and improvements 42,204,000 Accumulated depreciation (15,837,000) ----------- 42,586,000 ---------- Investment in real estate, at cost: Land 2,430,000 Building and improvements 2,575,000 Accumulated depreciation (468,000) ----------- 4,537,000 ----------- Cash and cash equivalents 2,609,000 Investment in marketable securities 15,199,000 Other investments 3,000,000 Other assets 7,431,000 Deferred tax asset 2,018,000 ----------- Total assets $ 77,380,000 =========== LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities Accounts payable and other liabilities 7,444,000 Due to securities broker 6,239,000 Obligations for securities sold 2,664,000 Mortgage notes payable - real estate 2,239,000 Mortgage notes payable - hotel 45,617,000 ----------- Total liabilities 64,203,000 ----------- Minority interest 1,747,000 ----------- Commitments and contingencies Shareholders' equity 6% Cumulative, convertible, voting preferred stock par value $.10 per share Authorized shares - 1,000,000 - Common stock - par value $.10 per share Authorized - 2,000,000 Issued 1,339,638 and outstanding 1,241,810 134,000 Additional paid-in capital 8,808,000 Retained earnings 3,439,000 Treasury stock, at cost, 97,828 shares (951,000) ----------- Total shareholders' equity 11,430,000 ----------- Total liabilities & shareholders' equity $ 77,380,000 ===========
See accompanying notes to consolidated financial statements. -3- Santa Fe Financial Corporation Consolidated Statements of Operations (Unaudited) For the three months ended September 30, 2006 2005 ---------- ----------- Justice Investors operations: Hotel and garage revenue $ 7,592,000 $ - Operating expense (6,360,000) - Interest expense (749,000) - Real estate taxes (180,000) - Depreciation and amortization (1,034,000) - ---------- ---------- Loss from Justice Investors operations (731,000) - ---------- ---------- Real estate operations: Rental income 115,000 114,000 Property operating expense (70,000) (44,000) Mortgage interest expense (43,000) (44,000) Depreciation expense (19,000) (19,000) ---------- ---------- Income(loss) from real estate operations (17,000) 7,000 ---------- ---------- Equity in net loss of Justice Investors - (728,000) ---------- ---------- General and administrative expenses (221,000) (189,000) Amortization of excess purchase price - Justice (21,000) (21,000) ---------- --------- (242,000) (210,000) ---------- --------- Investment transactions: Net losses on marketable securities (509,000) (148,000) Dividend and interest income 43,000 161,000 Margin interest and trading expenses (180,000) (156,000) Other income, net - 13,000 ---------- ---------- Total other loss (646,000) (130,000) ---------- ---------- Loss before income taxes and minority interest (1,636,000) (1,061,000) Income tax benefit 642,000 413,000 ---------- ---------- Loss before minority interest (994,000) (648,000) Minority interest benefit, net of tax 520,000 189,000 ---------- ---------- Net loss $ (474,000) $ (459,000) Preferred stock dividend - (13,000) ---------- ---------- Loss available to common shareholders $ (474,000) $ (472,000) ========== ========== Basic loss per share $ (0.38) $ (0.40) ========== ========== Weighted average number of shares outstanding 1,241,810 1,178,210 ========== ==========
See accompanying notes to consolidated financial statements. -4- Santa Fe Financial Corporation Consolidated Statements of Cash Flows (Unaudited) For the three months ended September 30, 2006 2005 ---------- ---------- Cash flows from operating activities: Net loss $ (474,000) $ (459,000) Adjustments to reconcile net loss to net cash provided by operating activities: Equity in net loss of Justice Investors - 749,000 Net unrealized losses on marketable securities 372,000 228,000 Minority interest benefit (520,000) (189,000) Depreciation and amortization 1,052,000 19,000 Changes in operating assets and liabilities: Investment in marketable securities 3,045,000 (1,361,000) Other investments and other assets (1,486,000) (1,631,000) Accounts payable and accrued expenses 393,000 138,000 Due to securities broker (1,390,000) 2,801,000 Obligations for securities sold (528,000) (200,000) ---------- ---------- Net cash provided by operating activities 464,000 95,000 ---------- ---------- Cash flows from financing activities: Principal payments on mortgage note payable (111,000) (8,000) Dividends paid to preferred shareholders - (13,000) ---------- ---------- Net cash used in financing activities (111,000) (21,000) ---------- ---------- Cash flows from investing activities: Additions to furniture, equipment and building improvements (358,000) - ---------- ---------- Net cash used in investing activities (358,000) - ---------- ---------- Net (decrease)increase in cash and cash equivalents (5,000) 74,000 Cash and cash equivalents at beginning of period 2,614,000 72,000 ---------- ---------- Cash and cash equivalents at end of period $ 2,609,000 $ 146,000 ========== ========== Supplemental disclosure of non-cash activities: Consolidation of Justice Investors Gross components: Assets(including cash of $2,352,000) $(42,975,000) - Liabilities 52,366,000 - Investment in Justice (7,321,000) - Minority interest (2,343,000) -
See accompanying notes to consolidated financial statements. -5- SANTA FE FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Basis of Presentation and Significant Accounting Policies --------------------------------------------------------- The consolidated financial statements included herein have been prepared by Santa Fe Financial Corporation ("Santa Fe" 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. The Company's operations primarily consist of owning and managing a hotel property through its 68.8%-owned consolidated subsidiary, Portsmouth Square, Inc. ("Portsmouth"), in Justice Investors, a California limited partnership ("Justice" or the "Partnership"). Portsmouth has a 50.0% interest in Justice. Portsmouth also serves as one of the two general partners of the Partnership. The other general partner, Evon Corporation ("Evon"), serves as the managing general partner. As discussed below, the financial statements of Justice have been consolidated with those of the Company, effective as of the first reporting period of its fiscal year beginning July 1, 2006. The Company also derives income from its rental properties and the investment of its cash and securities assets. On December 31, 1997, the Company acquired a controlling 55.4% interest in Intergroup Woodland Village, Inc. ("Woodland Village") from a related party, The InterGroup Corporation ("InterGroup"), which controls approximately 78.1% of the voting stock of the Company. Woodland Village's major asset is a 27-unit apartment complex located in Los Angeles, California. The Company also owns a two-unit apartment building in Los Angeles, California. Woodland Village is consolidated in the Company's financial statements. Certain prior quarter balances have been reclassified to conform with the current quarter presentation. It is suggested that these financial statements be read in conjunction with the audited financial statements and the notes therein included in the Company's Form 10-KSB for the year ended June 30, 2006. The results of operations for the three months ended September 30, 2006 are not necessarily indicative of results to be expected for the full fiscal year ending June 30, 2007. -6- 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 the 6% cumulative, convertible, voting preferred stock. As of September 30, 2006, there were no preferred stock outstanding. As of September 30, 2005, the conversion price of the preferred stock was above the market value of the Company's common stock, consequently, the preferred stock was not considered dilutive. 2. Investment in Justice Investors ------------------------------- Justice Investors owns the land, improvements and leaseholds now known as the Hilton San Francisco Financial District, a 549-room hotel located at 750 Kearny Street, San Francisco, California (the "Hotel"). All significant partnership decisions require the active participation and approval of both general partners. The Company and Evon jointly consult and determine the amount of partnership reserves and the amount of cash to be distributed to the limited partners. Pursuant to the terms of the partnership agreement, voting rights of the partners are determined according to the partners' entitlement to share in the net profit and loss of the partnership. The Company is not entitled to any additional voting rights by virtue of its position as a general partner. The partnership agreement also provides that no portion of the partnership real property can be sold without the written consent of the general and limited partners entitled to more than 72% of the net profit. On July 14, 2005, the Financial Accounting Standards Board directed Staff Position (FSP) SOP 78-9-1, "Interaction of AICPA Statement of Position 78-9 and EITF Issue No. 04-5" to amend the guidance in AICPA Statement of Position 78-9, "Accounting for Investments in Real Estate Ventures" (SOP 78-9) to be consistent with the consensus in Emerging Issues Task Force Issue No. 04-5 "Determining Whether a General Partner, or General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights" (Issue 04-5). FSP SOP 78-9-1 eliminated the concept of "important rights" in paragraph .09 of SOP 78-9 and replaces it with the concepts of "kick out rights" and "substantive participating rights" as defined in Issue 04-5. Under the amendment to paragraph .09 of SOP 78-9 the general partners of a limited partnership should be deemed to control a limited partnership; however, the rights of the limited partners may overcome that presumption of control. The guidance in EITF Issue No. 04-5 should be used to determine whether the rights of the limited partners overcome the presumption of control by the general partners. The presumption of control is not overcome by the rights of the limited partners and if a single general partner controls the limited partnership, that general partner should consolidate the limited partnership -7- and apply the principles of accounting applicable for investments in subsidiaries. For existing partnership agreements such as Justice Investors, the guidance should be applied in financial statements issued for the first reporting period in the fiscal years beginning after December 15, 2005. During the fiscal quarter ended March 31, 2006, Portsmouth conducted an assessment of its general and limited interest in Justice Investors under the new guidance provided by SOP 78-9-1. The Company determined that, under the limited partnership agreement, the limited partners of Justice do not have either "kick out rights" to remove Portsmouth as a general partner or "substantive participating rights" to direct the business of the Partnership. Significant in that assessment is the fact that the limited partners of Justice do not have the ability to dissolve (liquidate) the Partnership and effectively remove the general partners without the participation and consent of Portsmouth's 50.0% limited partnership interest since any action to sell the Partnership real property and dissolve the Partnership requires the approval of partners entitled to more than 72% of the net profit of the Partnership. Based on its assessment, Portsmouth concluded that rights of the limited partners under the Partnership agreement do not overcome the presumption that Portsmouth, as a general partner and a significant limited partner, controls the Partnership in accordance with guidance set forth in FSP SOP 78-9-1. Thus, effective with the first reporting period of its fiscal year beginning July 1, 2006, Portsmouth has applied the principles of accounting applicable for investments in subsidiaries due to its substantial limited partnership interest and general partnership rights and has consolidated the financial statements of Justice with those of the Company. For the three months ended September 30, 2006, the results of operations for Justice were consolidated with those of Portsmouth. However, for the three months ended September 30, 2005, Portsmouth's investment in Justice was accounted for under the equity method. For comparative purposes, the statement of operations for Justice for the three months ended September 30, 2006 and September 30, 2005 are disclosed below. The Company amortizes on a straight line basis the step up in the asset values which represents the excess purchase price over the underlying book value and is allocable to the depreciable assets of its investment in Justice Investors over 40 years, which approximates the remaining life of the primary asset, the hotel building. Significant to note is the operations of the Hotel were temporarily closed down effective May 31, 2005, to complete the substantial renovations of the Hotel required by the Hilton Franchise Agreement. Thus, the Hotel did not generate any room or food and beverage revenues during the first quarter of fiscal 2005. The below ground parking garage and Tru Spa located on the lobby level of the Hotel, both of which are lessees of the Partnership, remained open during the renovation work. As of January 12, 2006 the Hotel renovation work was substantially completed, at which time Justice obtained approval from Hilton to open the Hotel as the "Hilton San Francisco Financial District". The Hotel opened with a limited number of rooms available to rent, which increased as the Hotel transitioned into full operations by the end of February 2006. -8- JUSTICE INVESTORS STATEMENTS OF OPERATIONS For the three months ended September 30, 2006 2005 ---------- ---------- Revenues: Hotel rooms $ 5,881,000 $ - Food and beverage 1,015,000 - Rent - hotel garage 430,000 157,000 Other 266,000 121,000 Total revenues ---------- ---------- 7,592,000 278,000 Operating expenses: Hotel rooms (1,917,000) (6,000) Food and beverage (1,300,000) (103,000) Other operating expenses (2,334,000) (320,000) Interest expense (749,000) (141,000) Real estate taxes (180,000) (133,000) Depreciation and amortization (1,034,000) (140,000) General and administrative (822,000) (900,000) ---------- ---------- Total expenses (8,336,000) (1,743,000) ---------- ---------- (744,000) (1,465,000) Intercompany eliminations 13,000 11,000 ---------- ---------- Net loss $ (731,000) $(1,454,000) ========== ========== During the three months ended September 30, 2006, Portsmouth received monthly general partner management fees in the amount of $13,000 from Justice Investors. This amount was eliminated from Justice operating expenses during consolidation. Below are the comparative standalone statements of operations for the Hotel for the indicated periods. For the three months ended September 30, 2006 2005 ----------- ---------- Operating revenue: Room $ 5,881,000 $ - Food and beverage 1,015,000 - Other operating revenue 178,000 - ----------- ---------- Total operating revenue 7,074,000 - ----------- ---------- Operating expenses: Rooms (1,917,000) (6,000) Food and beverage (1,300,000) (103,000) Other operating expenses (3,214,000) (509,000) ----------- ---------- Total operating expenses (6,431,000) (618,000) ----------- ---------- Net income(loss) from Hotel operations 643,000 (618,000) Net expenses at Justice Investors (1,374,000) (836,000) ----------- ---------- Net loss from Justice Investors $ (731,000) $(1,454,000) =========== ========== -9- 3. Investment in Marketable Securities ----------------------------------- The Company's investment portfolio consists primarily of corporate equities. The Company has also invested in corporate bonds and in 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, 2006, all of the Company's marketable securities are classified as trading securities. In accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," the change in the unrealized gains and losses on these investments are included in earnings. Trading securities are summarized as follows: As of September 30, 2006: Gross Gross Net Market Investment Cost Unrealized Gain Unrealized Loss Unrealized Gain Value ---------- ----------- --------------- --------------- --------------- ------------ Corporate Equities $12,260,000 $ 3,677,000 ($738,000) $ 2,939,000 $ 15,199,000
As of September 30, 2006, the Company had $488,000 of unrealized losses related to securities held for over one year. As part of the investment strategies, the Company may assume short positions against its long positions in marketable securities. Short sales are used by the Company to potentially offset normal market risks undertaken in the course of its investing activities or to provide additional return opportunities. The Company has no naked short positions. As of September 30, 2006, the Company had obligations for securities sold (equities short) of $2,664,000. Net gains on marketable securities on the statement of operations are comprised of realized and unrealized gains. Below is the composition of the two components for the three months ended September 30, 2006 and September 30, 2005, respectively. For the three months ended September 30, 2006 2005 ----------- ----------- Realized (losses)gains on marketable securities $ (137,000) $ 80,000 Unrealized losses on marketable securities (372,000) (228,000) ----------- ----------- Net losses on marketable securities (509,000) $ (148,000) =========== =========== 4. Segment Information ------------------- The Company operates in three reportable segments, the operations of Justice Investors, its multi-family residential properties 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 same information. -10- Information below represents reporting segments for the three months ended September 30, 2006 and September 30, 2005, respectively. Operating income for rental properties consist of rental income. Operating income from Justice Investors consists of the operations of the hotel and garage. Operating income (loss) from investment transactions consist of net investment gains(losses) and dividend and interest income. REAL ESTATE ------------------------- Three months ended Justice Rental Investment September 30, 2006 Investors Properties Transactions Other Total ----------- ----------- ------------ ----------- ------------ Operating income(loss) $ 7,592,000 $ 115,000 $ (466,000) $ - $ 7,240,000 Operating expenses (6,540,000) (70,000) (180,000) - (6,790,000) ----------- ----------- ----------- ----------- ------------ 1,052,000 45,000 (646,000) - 450,000 Mortgage interest expense (749,000) (43,000) - - (792,000) Depreciation and amort. (1,034,000) (19,000) - - (1,052,000) General and administrative Expense - - - (221,000) (221,000) Amortization of excess purchase price (21,000) - - - (21,000) Income tax benefit - - - 642,000 642,000 Minority interest 373,000 - - 147,000 520,000 ----------- ----------- ----------- ----------- ------------ Net income (loss) $ (379,000) $ (17,000) $ (646,000) $ 568,000 $ (474,000) =========== =========== =========== =========== ============ Total Assets $42,586,000 $ 4,537,000 $18,199,000 $12,058,000 $ 77,380,000 =========== =========== =========== =========== ============
REAL ESTATE ------------------------- Three months ended Justice Rental Investment September 30, 2005 Investors Properties Transactions Other Total ----------- ----------- ------------ ----------- ------------ Operating income(loss) $ (728,000) $ 114,000 $ 13,000 $ - $ (601,000) Operating expenses - (44,000) (156,000) - (200,000) ----------- ----------- ----------- ----------- ------------ (728,000) 70,000 (143,000) - (801,000) Mortgage interest expense - (44,000) - - (44,000) Depreciation - (19,000) - - (19,000) General and administrative Expense - - - (189,000) (189,000) Amortization of excess purchase price (21,000) - - - (21,000) Other income - - - 13,000 13,000 Income tax benefit - - - 413,000 413,000 Minority interest - - - 189,000 189,000 ----------- ----------- ----------- ----------- ------------ Net income (loss) $ (749,000) $ 7,000 $ (143,000) $ 426,000 $ (459,000) =========== =========== =========== =========== ============ Total Assets $ 4,604,000 $ 5,049,000 $16,137,000 $ 1,759,000 $ 27,549,000 =========== =========== =========== =========== ============
-11- 5. Related Party Transactions -------------------------- Certain shared costs and expenses primarily administrative expenses including rent and insurance, are allocated among the Company and its subsidiary, Portsmouth, and the Company's parent, InterGroup, based on management's estimate of the pro rata utilization of resources. For the three months ended September 30, 2006 and September 30, 2005, the Company and Portsmouth made payments to InterGroup of $36,000 and $40,000, respectively. John V. Winfield serves as Chief Executive Officer and Chairman of the Company, Portsmouth, and InterGroup. Depending on certain market conditions and various risk factors, the Chief Executive Officer, his family, Portsmouth 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 Portsmouth and InterGroup, at risk in connection with investment decisions made on behalf of the Company. During the three months ended September 30, 2006, Portsmouth received monthly general partner management fees in the total amount of $13,000 and $50,000 in repositioning fees from Justice Investors. Portsmouth also has a receivable from Justice in the amount of $50,000 for the balance of repositioning fees earned during the prior fiscal year. All of those amounts were eliminated in the consolidation of Justice. Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS AND PROJECTIONS The Company may from time to time make forward-looking statements and projections concerning future expectations. When used in this discussion, the words "anticipate," "estimate," "expect," "project," "intend," "plan," "believe," "may," "could," "might" and similar expressions, are intended to identify forward-looking statements. These statements are subject to certain risks and uncertainties, such as the impact of terrorism and war on the national and international economies, including tourism and securities markets, natural disasters, general economic conditions and competition in the hotel industry in the San Francisco area, labor relations and labor disruptions, partnership distributions, the ability to obtain financing at favorable interest rates and terms, securities markets, regulatory factors, litigation and other factors discussed below in this Report and in the Company's Form 10- KSB Report for the fiscal year ended June 30, 2006, that could cause actual results to differ materially from those projected. Readers are cautioned not to place undue reliance on these forward-looking statements, 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. -12- RESULTS OF OPERATIONS The Company's 68.8% owned subsidiary, Portsmouth, has a 50.0% interest in the Justice Investors limited partnership ("Justice" or the "Partnership"). Portsmouth serves as one of the general partners. Justice owns the land, improvements and leaseholds at 750 Kearny Street, San Francisco, California, now known as the Hilton San Francisco Financial District hotel (the "Hotel"). The financial statements of Justice have been consolidated with those of the Company, effective as of July 1, 2006. See Note 2 to the Consolidated Financial Statements. The Hotel is operated by the Partnership, with the assistance of a Management Agreement with Dow Hotel Company, LLC. ("Dow") to perform the day-to-day management functions. The Partnership also derives income from the lease of the garage portion of the property to Evon Corporation ("Evon"), the managing general partner of Justice, and from a lease with Tru Spa for a portion of the lobby level of the Hotel. The Company also receives management fees as a general partner of Justice for its services in overseeing and managing the Partnership's assets. On December 10, 2004, Justice entered into a Franchise License Agreement for the right to operate the Hotel property as a Hilton brand hotel. Prior to operating the hotel as a Hilton, the Partnership was required to make substantial renovations to the hotel to meet Hilton standards in accordance with a product improvement plan agreed upon by Hilton and the Partnership, as well as complying with other brand standards. The term of the Agreement is for a period of 15 years commencing on the opening date, with an option to extend the license term for another five years, subject to certain conditions. Effective May 31, 2005, the Partnership temporarily closed down its Hotel operations to complete the renovations of the Hotel as required by the Hilton Agreement. The below ground parking garage and Tru Spa located on the lobby remained open during the renovation work, although the operations of both were impacted during that period of time. As of January 12, 2006 the Hotel renovation work was substantially completed, at which time the Partnership obtained approval from Hilton to open the Hotel as the "Hilton San Francisco Financial District". The Hotel opened with a limited number of rooms available to rent, which increased as the Hotel transitioned into full operations by the end of February 2006. Three Months Ended September 30, 2006 Compared to Three Months Ended September 30, 2005 The Company had a net loss of $474,000 for the three months ended September 30, 2006 compared to a net loss of $459,000 for the three months ended September 30, 2005. As discussed below, although the net loss remained relatively consistent, the Company had a significantly smaller loss related to the operations of Justice Investors, partially offset by the significant increase in the net loss from marketable securities, the reduction of dividend and interest income, the increase in general and administrative expenses and the loss from real estate operations. -13- The net loss from the operations of Justice Investors decreased to $744,000 for the three months ended September 30, 2006 from a net loss of $1,465,000(before minority interest of $727,000) for the three months ended September 30, 2005. That decrease was primarily attributable to net income generated from the operations of the Hotel during the current quarter compared to the prior quarter when the Hotel was temporarily closed for major renovations and from higher garage rental income in the current quarter. Those results were partially offset by higher interest costs, insurance costs, property taxes and greater depreciation and amortization expenses resulting from the renovation of the Hotel. For the three months ended September 30, 2006, the Hotel operations generated net income of $643,000 on total operating revenues of approximately $7,074,000, while there were no revenues from the operations of the Hotel during the three months ended September 30, 2005. Garage rent increased to $430,000 from $157,000 primarily due to the Hotel being open during the current quarter. The average daily room rate for the Hotel was approximately $151 and the average occupancy rate was approximately 77% for the three months ended September 30, 2006. Occupancy and average daily room rates have continued to improve since the Hotel's reopening in January 2006 as the Hotel ramped up its operations and new programs were implemented to increase revenues. However, the Hotel's food and beverage operations remain problematic as they continue to generate losses, primarily attributable to brand requirements of maintaining a three-meal, full service restaurant, the associated costs of union labor, and the intense competition in the San Francisco market for restaurants. Management will continue to work closely with Dow and Hilton to address these issues and to improve the operations of the Hotel. From its real estate operations, the Company had a loss of $17,000 for the three months ended September 30, 2006 as compared to income of $7,000 for the three months ended September 30, 2006. Rental income remained consistent, however, operating expenses increased to $70,000 from $44,000 as the result of the higher replacement and repair expenses related to the Company's 27-unit apartment building. Corporate general and administrative expenses increased to $221,000 for the three months ended September 30, 2006 from $189,000 for the three months ended September 30, 2005 primarily as the result of the increase in audit related fees. Net losses on marketable securities increased to $509,000 for the three months ended September 30, 2006 from $148,000 for the three months ended September 30, 2005. For the three months ended September 30, 2006, the Company had net unrealized losses of $372,000 and net realized losses of $137,000. For the three months ended September 30, 2005, the Company had net unrealized losses of $228,000 and net realized gains of $80,000. 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. -14- Dividend and interest income decreased to $43,000 for the three months ended September 30, 2006 from $161,000 for the three months ended September 30, 2005 as a result of the decreased investment in income yielding securities during the quarter ended September 30, 2006. The provision for income tax benefit increased to $642,000 for the three months ended September 30, 2006 from $413,000 for the three months ended September 30, 2005 as the result of the higher pre-tax loss incurred by the Company during the current quarter. Minority interest benefit increased to $520,000 from $189,000 primarily as the result of the $373,000 minority interest benefit recognized during the quarter ended September 30, 2006 related to the consolidation of Justice Investors. This was the first quarter Portsmouth consolidated Justice Investors. MARKETABLE SECURITIES The Company's investment portfolio is diversified with 41 different equity positions. The portfolio contains five equity securities that are more than 5% of the equity value of the portfolio, with the largest being 10.7% 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, 2006, the Company had investments in marketable equity securities of $15,199,000. The following table shows the composition of the Company's marketable securities portfolio by selected industry groups as of September 30, 2006. % of Total Investment Industry Group Market Value Securities -------------- ------------ ---------- REITs and building materials $ 2,548,000 16.8% Telecommunications and media 2,076,000 13.7% Technology and internet 1,998,000 13.1% Retail and consumer goods 1,816,000 11.9% Services 1,623,000 10.7% Newspapers and paper mills 1,103,000 7.3% Dairy products 1,050,000 6.9% Insurance, banks and brokers 829,000 5.5% Pharmaceuticals and healthcare 771,000 5.1% Other 1,385,000 9.0% ------------ ---------- $15,199,000 100.0% ============ ========== -15- The following table shows the net gain or loss on the Company's marketable securities and the associated margin interest and trading expenses for the respective period. For the three months ended September 30, 2006 2005 ------------- ------------- Net losses on marketable securities $ (509,000) $ (148,000) Dividend and interest income 43,000 161,000 Margin interest expense (97,000) (75,000) Trading and management expenses (83,000) (81,000) ---------- ---------- $ (646,000) $ (143,000) ========== ========== FINANCIAL CONDITION AND LIQUIDITY The Company's cash flows are primarily generated from the operations of Justice Investors. The Company also receives revenues generated from its real estate operations and from the investment of its cash and securities assets. Since the operations of the Hotel operations of the Hotel were temporarily closed down on May 31, 2005, and significant amounts of money were expended to renovate and reposition the Hotel as a Hilton, the partnership is not expected to pay any limited partnership distributions until some time after operations of the Hotel stabilize under the Hilton brand and net income and capital requirements warrant such distributions. As a result, the Company has had to depend more on the revenues generated from the investment of its cash and securities assets during that transition period. Prior to operating the hotel as a Hilton, the Partnership was required to make substantial renovations to the hotel to meet Hilton standards in accordance with a product improvement plan agreed upon by Hilton and the Partnership, as well as complying with other brand standards. The total cost of the construction-renovation project of the Hotel was approximately $36.4 million, which excludes approximately $630,000 in interest costs incurred during for the construction phase that were capitalized. To meet its substantial financial commitments for the renovation project and transition of the Hotel to a Hilton, Justice had to rely on borrowings to meet its obligations. On July 27, 2005, Justice entered into a first mortgage loan (the "Prudential Loan") with The Prudential Insurance Company of America in a principal amount of $30,000,000. The term of the Loan is for 120 months at a fixed interest rate of 5.22% per annum. The Loan calls for monthly installments of principal and interest in the amount of approximately $165,000, calculated on a 360 month amortization schedule. The Loan is collateralized by a first deed of trust on the Partnership's Hotel property, including all improvements and personal property thereon and an assignment of all present and future leases and rents. The Loan is without recourse to the limited and general partners of Justice. On July 27, 2005, Justice also obtained a $10,000,000 Revolving Line of Credit ("LOC") from United Commercial Bank ("UCB"). The term of the LOC is for 60 months at an annual interest rate, based on an index selected by Justice at the time of the advance, equal to the Wall Street Journal Prime Rate or the Libor -16- 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 a maturity. On January 20, 2006, the Partnership obtained a $4,500,000 increase in its LOC, raising the total amount available to the Partnership pursuant to $14,500,000. The increase in the credit line is on the same terms as the existing line of credit with additional loan and documentation fees of $4,000. On May 23, 2006, Justice obtained a short term increase of its LOC of an additional $2,000,000, raising the total amount available to the Partnership to $16,500,000. If the short term increase of is not paid off by December 31, 2006, UCB has the right to record a lien on the Hotel property for the additional $2,000,000. That increase is also on the same terms as the existing LOC, with additional documentation fees of $1,000. As of September 30, 2006, approximately $16,079,000 of the LOC was utilized. The Prudential Loan and the LOC have provided Justice with sufficient financial resources for the Partnership to complete the substantial renovations to the Hotel required by its Franchise License Agreement with Hilton and to meet its debt service requirements and operating capital needs through the reopening of the Hotel and the period of time necessary to ramp up operations. The Hotel started to generate net operating income from its operations in June 2006, which have continued to improve in the first quarter of the Company's current fiscal year. Management believes that the revenues expected to be generated from the Hotel operations and the garage lease will be sufficient to meet all of its 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. The 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 Company and its ability to generate cash flows in the future since the Hotel asset has been virtually debt free for many years. Justice also does not anticipate paying any partnership distributions until net income from the operations of the Hotel and capital requirements warrant such distributions. As a result, the Company may have to continue to rely on 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. Although the Company may be facing a period of time without partnership distributions, management believes that its cash, securities assets, and the cash flows generated from those assets, will be adequate to meet the Company's current and future obligations. MATERIAL CONTRACTUAL OBLIGATIONS The Company does not have any material contractual obligations or commercial commitments other than the mortgages of its rental properties and Justice Investors' first mortgage loan with Prudential and its LOC with United Commercial Bank. -17- 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. To the extent that the Dow 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. The Company's residential 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. 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. For the Company's investment in Justice, to the extent that projected future undiscounted cash flows from the operation of the Company's hotel property are less than the carrying value of the asset, the carrying value of the asset is reduced to its fair value. For other investments, the Company reviews the investment's operating results, financial position and other relevant factors to determine whether the estimated fair value of the asset is less than the carrying value of the asset. Marketable securities are stated at market value as determined by the most recently traded price of each security at the balance sheet date. Marketable securities are classified as trading with net unrealized gains or losses included in earnings. Item 3. Controls and Procedures (a) Disclosure Controls and Procedures. The Company's management, with the participation of the Company's Chief Executive Officer and the Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the fiscal period covered by this Quarterly Report on Form 10-QSB. Based upon such evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company's disclosure controls and procedures are effective in ensuring that information required to be disclosed in this filing is accumulated and communicated to management and is recorded, processed, summarized and reported in a timely manner and in accordance with Securities and Exchange Commission rules and regulations. -18- (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. Santa Fe did not repurchase any of its own securities during the first quarter of its fiscal year ending June 30, 2007 and does not have any publicly announced repurchase program. The following table reflects purchases of Santa Fe's common stock made by The InterGroup Corporation, for its own account, during the first quarter of fiscal 2007. InterGroup can be considered an affiliated purchaser. SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES (c)Total Number (d)Maximum Number (a)Total (b) of Shares Purchased of Shares that May Fiscal Number of Average as Part of Publicly Yet Be Purchased 2007 Shares Price Paid Announced Plans Under the Plans Period Purchased Per Share or Programs or Programs -------------------------------------------------------------------------------------- Month #1 (July 1- - - - N/A July 31) -------------------------------------------------------------------------------------- Month #2 (Aug. 1- - - - N/A Aug. 31) -------------------------------------------------------------------------------------- Month #3 (Sept. 1- 1,000 $17.55 - N/A Sept. 30) -------------------------------------------------------------------------------------- Total 1,000 $17.55 - N/A --------------------------------------------------------------------------------------
-19- 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) Registrant did not file any reports on Form 8-K during the quarter 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. SANTA FE FINANCIAL CORPORATION (Registrant) Date: November 14, 2006 by /s/ John V. Winfield --------------------------- John V. Winfield, President, Chairman of the Board and Chief Executive Officer Date: November 14, 2006 by /s/ Michael G. Zybala --------------------------- Michael G. Zybala, Vice President, and Secretary Date: November 14, 2006 by /s/ David T. Nguyen -------------------------- David T. Nguyen, Treasurer and Controller (Principal Accounting Officer -20-