-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, NpAK2WZxtLvjHV3WOYeZnK6/ly2N+eaq0hGqa0TekFmMmRpCK5GCSTl3+lRSpzEp mzzNU8btcq4aEIUJtA2W7g== 0000086759-07-000016.txt : 20071001 0000086759-07-000016.hdr.sgml : 20071001 20070928185144 ACCESSION NUMBER: 0000086759-07-000016 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20070630 FILED AS OF DATE: 20071001 DATE AS OF CHANGE: 20070928 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SANTA FE FINANCIAL CORP CENTRAL INDEX KEY: 0000086759 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE [6500] IRS NUMBER: 952452529 STATE OF INCORPORATION: NV FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10KSB SEC ACT: 1934 Act SEC FILE NUMBER: 000-06877 FILM NUMBER: 071143855 BUSINESS ADDRESS: STREET 1: 820 MORAGA DRIVE CITY: LOS ANGELES STATE: CA ZIP: 90049 BUSINESS PHONE: (310) 889-2500 MAIL ADDRESS: STREET 1: 820 MORAGA DRIVE CITY: LOS ANGELES STATE: CA ZIP: 90049 10KSB 1 sf10ksb63007.txt SANTA FE FORM 10-KSB UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------------- FORM 10-KSB [x] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended June 30, 2007 [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Commission file number 0-6877 SANTA FE FINANCIAL CORPORATION ------------------------------ (Name of Small Business Issuer in Its Charter) Nevada 95-2452529 ------------------------------ ------------------ (State or Other Jurisdiction of (IRS Employer Incorporation or Organization) Identification No.) 820 Moraga Drive, Los Angeles, California 90049 ----------------------------------------- ---------- (Address of Principal Executive Offices) (Zip Code) (310) 889-2500 ---------------------------------------------------- (Issuer's Telephone Number) Securities registered pursuant to Section 12(b) of the Exchange Act: None Securities registered pursuant to Section 12(g) of the Exchange Act: $.10 Par Value Common Stock --------------------------- (Title of Class) Check whether the issuer is not required to file reports pursuant to section 13 or 15(d) of the Exchange Act. [ ] Check whether the issuer: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No Check if there is no disclosure of delinquent filers pursuant to Item 405 of Regulation S-B contained in this form, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendments to this Form 10-KSB. [X] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] The issuer's revenues for the year ended June 30, 2007 were $32,216,000. The aggregate market value of the common equity held by non-affiliates of issuer computed by reference to the price of $20.00 at which the stock last sold on August 29, 2007 is $5,199,020. The number of shares outstanding of issuer's $.10 Par Value Common Stock, as of September 21, 2007, was 1,241,810. Transitional Small Business Disclosure Format: Yes [ ] No [X] DOCUMENTS INCORPORATED BY REFERENCE: None TABLE OF CONTENTS PART I PAGE Item 1. Description of Business. 4 Item 2. Description of Property. 10 Item 3. Legal Proceedings. 14 Item 4. Submission of Matters to a Vote of Security Holders. 14 PART II Item 5. Market For Common Equity and Related 15 Stockholder Matters. Item 6. Management's Discussion and Analysis of Financial 17 Condition and Results of Operations. Item 7. Financial Statements and Supplementary Data. 25 Item 8. Changes in and Disagreements with Accountants on 43 Accounting and Financial Disclosure. Item 8A. Controls and Procedures. 44 Item 8B. Other Information. 44 PART III Item 9. Directors, Executive Officers, Promoters and 45 Control Persons; Compliance with Section 16(a) of The Exchange Act. Item 10. Executive Compensation. 47 Item 11. Security Ownership of Certain Beneficial Owners and 50 Management. Item 12. Certain Relationships and Related Transactions. 52 Item 13. Exhibits. 54 Item 14. Principal Accountant Fees and Services. 55 SIGNATURES 56 -2- FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-KSB contains certain "forward-looking statements" within the meaning of the Private Securities Litigation reform Act of 1995. Forward-looking statements give our current expectations or forecasts of future events. You can identify these statements by the fact that they do not relate strictly to historical or current facts. They contain words such as "anticipate," "estimate," expect," "project," intend," "plan," "believe" "may," "could," "might" and other words or phrases of similar meaning in connection with any discussion of future operating or financial performance. From time to time we also provide forward-looking statements in our Forms 10-QSB and 8-K, Annual reports to Shareholders, press releases and other materials we may release to the public. Forward looking statements reflect our current views about future events and are subject to risks, uncertainties, assumptions and changes in circumstances that may cause actual results or outcomes to differ materially from those expressed in any forward looking statement. Consequently, no forward looking statement can be guaranteed and our actual future results may differ materially. Factors that may cause actual results to differ materially from current expectations include, but are not limited to: * risks associated with the hotel industry, including competition, increases in wages, labor relations, energy costs, actual and threatened terrorist attacks, and downturns in economic and market conditions, particularly in the San Francisco Bay area; * risks associated with the real estate industry, including changes in real estate and zoning laws or regulations, increases in real property taxes, rising insurance premiums, costs of compliance with environmental laws and other governmental regulations; * the availability and terms of financing and capital and the general volatility of securities markets; * changes in the competitive environment in the hotel industry and * risks related to natural disasters; * litigation; and * other risk factors discussed below in this Report. We caution you not to place undue reliance on these forward-looking statements, which speak only as to the date hereof. We undertake no obligation to publicly update any forward looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any further disclosures we make on related subjects on our Forms 10-KSB, 10-QSB, and 8-K reports to the Securities and Exchange Commission. -3- PART I Item 1. Description of Business. GENERAL Santa Fe Financial Corporation ("Santa Fe" or the "Company") was incorporated under the name of Tri Financial Corporation in the State of Nevada on July 25, 1967 as a wholly owned subsidiary of Crateo, Inc, a public company. On October 31, 1969, Crateo issued a one-for-one stock dividend of all of its shares of Tri Financial to its common shareholders. On September 17, 1970, the name of the Corporation was changed to Santa Fe Financial Corporation. One of the Company's principal sources of operating revenue has been, and continues to be, derived from the management of its 68.8% owned subsidiary, Portsmouth Square, Inc. ("Portsmouth"), a public company (OTCBB: PRSI). Portsmouth is limited partner, and one of two general partners in Justice Investors, a California limited partnership ("Justice" or the "Partnership"). In April 2006, Portsmouth purchased a 0.20% limited partnership interest in Justice from another limited partner, which brought Portsmouth's limited partnership interest in Justice to exactly 50.0%. The other general partner, Evon Corporation ("Evon"), acts as the managing general partner. All significant partnership decisions require the active participation and approval of both general 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. As of June 30, 2007, there were 85 limited partners in Justice (not including multiple family accounts). In accordance with guidance set forth in FSP SOP 78-9-1, Portsmouth has applied the principles of accounting applicable for investments in subsidiaries due to its "kick out rights" and "substantive participating rights" arising from its limited partnership and general partnership interest and has consolidated the financial statements of Justice with those of the Company, effective with the first reporting period of its fiscal year beginning July 1, 2006. In prior years, Portsmouth's interest in Justice was recorded on the equity basis. Please see Item 7. "Financial Statements." - Note 2 to the consolidated financial statements for a further discussion. The Company's principal business is conducted through its limited and general partnership interest in Justice. Justice owns a 544 room hotel property located at 750 Kearny Street, San Francisco, California 94108, now known as the "Hilton San Francisco Financial District" (the "Hotel") and related facilities, including a five level underground parking garage. Historically, the Partnership's most significant source of income was a lease between Justice and Holiday Inn for the Hotel portion of the property. That lease was amended in 1995, and ultimately assumed by Felcor Lodging Trust, Inc. ("Felcor", NYSE: FCH) in 1998. The lease of the Hotel to Felcor was terminated effective June 30, 2004. With the termination of the Hotel lease, Justice assumed the role of an owner/operator with the assistance of a third party management company. Effective July 1, 2004, the Hotel was operated as a Holiday Inn Select brand hotel pursuant to a short term franchise agreement until it was temporarily closed for major renovations on May 31, 2005. The Hotel was reopened on January 12, 2006 to operate as a full service Hilton hotel, pursuant to a Franchise License Agreement with Hilton Hotels Corporation. -4- The Partnership also derives income from its lease of the garage portion of the to Evon and the lease of approximately 5,400 square feet on the lobby level of the Hotel to Tru Spa, LLC for the operation of a health and beauty spa. The garage and Tru Spa remained open during the renovation work. The Company also derives income from management fees as a general partner in Justice, rental income from its multi-family, residential rental properties and from the investment of its cash and securities assets. The Company has invested in income-producing instruments, equity and debt securities and will consider other investments if such investments offer growth or profit potential. Please see discussion of Investment Policies under Item 2 "Description of Property" below. Recent Developments In August 2007, the Portsmouth's Board of Directors authorized an investment of $973,000 for Portsmouth to acquire a 50% equity interest in Intergroup Uluniu, Inc., a Hawaii corporation ("Uluniu") in a related party transaction. Uluniu is a 100% owned subsidiary of The InterGroup Corporation ("InterGroup"). Uluniu owns an approximately two-acre parcel of unimproved land located in Kihei, Maui, Hawaii which is held for development. The Company's investment in Uluniu represents an amount equal to the costs paid by InterGroup for the acquisition and carrying costs of the property through August 2007. The fairness of the financial terms of the transaction were reviewed and approved by the independent director of the Company. Uluniu intends to obtain the entitlements and permits necessary for the joint development of the parcel with an adjoining landowner into residential units. After the completion of this predevelopment phase, the Uluniu will determine whether it more advantageous to sell the entitled property or to commence with construction. As of September 5, 2007, $758,000 of the investment amount had been paid by Portsmouth and the proceeds were used by Uluniu to retire the mortgage on the property in the approximate amount of $756,000. The balance of the proceeds will be used to fund predevelopment costs and to meet other requirements to try to enhance the value of the property. HILTON HOTELS FRANCHISE LICENSE AGREEMENT With the termination of the Hotel Lease to Felcor, the Partnership was able to actively pursue a franchise agreement with a new nationally recognized brand in an effort to move the Hotel up-market and become more competitive. After considering and negotiating with several brands, the Partnership entered into a Franchise License Agreement with Hilton Hotels Corporation (the "Hilton Franchise Agreement") on December 10, 2004 for the right to operate the Hotel as a Hilton brand hotel. The term of the Hilton Franchise Agreement is for 15 years commencing on the opening date of the Hotel, January 12, 2006, with an option to extend that Agreement for another five years, subject to certain conditions. The Partnership will pay monthly royalty fees for the first two years of three percent (3%) of the Hotel's gross room revenue, as defined, for the preceding calendar month, the third year will be four percent (4%) of the Hotel's gross room revenue, and the fourth year until the end of the term will be five percent (5%) of the Hotel's gross room revenue. Justice also pays a monthly program fee of four percent of the Hotel's gross room revenue and an information technology recapture charge of 0.75% of the Hotel's gross revenue. The amount of the monthly program fee is subject to change; however, the monthly program fee will not exceed five percent of gross room revenue. -5- Prior to operating the Hotel as a Hilton hotel, the Partnership was required to make substantial renovations to the Hotel to meet Hilton standards in accordance with a product improvement plan ("PIP") agreed upon by Hilton and the Partnership, as well as comply with other brand standards. That project included a complete renovation and upgrade of all of the Hotel's guestrooms, meeting rooms, common areas and restaurant and bar. 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. The total cost of the construction-renovation project of the Hotel was approximately $37,030,000, which includes approximately $630,000 in interest costs incurred during the construction phase that were capitalized. To meet those substantial financial commitments, and the costs of operations during the renovation period and for the first five months when the Hotel ramped up its operations, the Partnership has relied on additional borrowings to meet its obligations. As discussed in Item 2 herein, the Partnership has been able to secure adequate financing, collateralized by the Hotel, to meet those commitments. HOTEL MANAGEMENT COMPANY AGREEMENTS In February 2007, the Partnership entered into a management agreement with Prism Hospitality ("Prism") to manage and operate the Hotel as its agent, effective February 10, 2007. Prism is an experienced Hilton approved operator of upscale and luxury hotels throughout the Americas. The agreement is effective for a term of ten years, unless the agreement is extended as provided in the agreement, and the Partnership has the right to terminate the agreement upon ninety days written notice without further obligation. Under the management agreement, the Partnership is to pay base management fees of 2.5% of gross operating revenues for the fiscal year. However, 0.75% of the stated management fee was due only if the partially adjusted net operating income for the subject fiscal year exceeds the amount of a minimum Partnership's return ($7 million) for that fiscal year. Prism is also entitled to an incentive management fee if certain milestones are accomplished. No incentive fees were earned during the year ended June 30, 2007. Management fees paid to Prism during the year ended June 30, 2007 were $212,000. Prior to the Prism management agreement, the Hotel was managed and operated by Dow Hotel Company, LLC ("DOW") from July 1, 2004 until February 9, 2007. On February 9, 2007, Justice entered into an agreement with Dow Hotel Company, to mutually terminate its management agreement and to transition the day-to-day management responsibilities of the Hotel to Prism. The management agreement with Dow was on the same basic terms and conditions as the agreement with Prism, with the exception of certain provisions that were unique to the renovation and transition of the Hotel. No incentive management fees were earned by Dow during the fiscal years ended June 2007 and 2006. Management fees paid to DOW during the years ended June 30 2007 and 2006 were $311,000 and $193,000, respectively. GARAGE LEASE AND OPERATIONS The garage lease between the Partnership and Evon provides for a monthly rental of sixty percent (60%) of gross parking revenues with a minimum rent of $19,764 per month. That lease expires in November 2010. The garage lessee, Evon, is responsible for insurance, repairs and maintenance, utilities and all taxes assessed against the improvements to the leased premises. The garage is operated by Ace Parking Management, Inc. ("Ace Parking") pursuant to a parking facility management agreement with the garage lessee. -6- TRU SPA LEASE Approximately 5,400 square feet of space on the lobby level of the Hotel is leased to Tru Spa, LLC ("Tru Spa") for the operation of a health and beauty spa. The lease expires in May 2013, with a five year option to extend the term. The spa lease provides for minimum monthly rent of $11,667, additional rent of $2,072 (up to a total of $250,000 to help defray certain relocation construction costs) and other tenant fees. Minimum rental amounts are subject to adjustment every three years based on increases in the Consumer Price Index. CHINESE CULTURE FOUNDATION LEASE On March 15, 2005, the Partnership entered into an amended lease with the Chinese Culture Foundation of San Francisco (the "Foundation") for the third floor space of the Hotel commonly known as the Chinese Cultural Center, which the Foundation had right to occupy pursuant to a 50-year nominal rent lease. The amended lease requires the Partnership to pay to the Foundation a monthly event space fee in the amount of $5,000, adjusted annually based on the local Consumer Price Index. The term of the amended lease expires on October 17, 2023, with an automatic extension for another 10 year term if the property continues to be operated as a hotel. This amendment allowed Justice to incorporate the third floor into the renovation of the Hotel resulting in a new ballroom for the joint use of the Hotel and new offices and a gallery for the Chinese Culture Center. COMPENSATION OF GENERAL PARTNERS AND REPOSITIONING FEES Effective May 31, 2004, and as amended on February 23, 2006, Justice entered into a new General Partner Compensation Agreement (the "Compensation Agreement") with its two general partners, Evon and Portsmouth, to compensate them for their services to the Partnership. In order to plan, implement, and administer the repositioning and major changes in the operations of the Hotel, it is necessary for Evon and Portsmouth to devote substantial time, expertise, and effort in the renovation and in managing the Partnership's assets. The Compensation Agreement is structured to provide adequate compensation to Evon and Portsmouth and provide incentives to the general partners to encourage excellence in the performance of their responsibilities. The Compensation Agreement provides that the general partners will receive annual base compensation of 1.5% of gross revenues, with a minimum annual base compensation of $263,000, adjusted for inflation. From the minimum annual base compensation, 80% will be paid to Evon for its services as the managing general partner and 20% will be paid to Portsmouth as the other general partner. Base annual compensation in excess of the minimum is payable in equal amounts to Evon and Portsmouth. The maximum base annual compensation that can be earned by the general partners is 1.5% of $40,000,000 of gross revenues. The Compensation Agreement also provides for incentive compensation to the general partners in a sum equal to the 5.0% of the annual net operating income of Justice, that is in excess of $7,000,000. Incentive compensation shall be payable in equal amounts to Evon and Portsmouth. In accordance with the General Partner Compensation Agreement as restated on February 23, 2006, the partners were also to receive a fee for services rendered to the Partnership with the respect to repositioning the hotel in the amount of $755,000, which amount was to be paid equally to both general partners after achieving certain milestones related to the renovation and repositioning of the Hotel. For the fiscal years ended June 30, 2007 and 2006, a total of $387,611 and $376,389 in repositioning fees were earned by the -7- general partners, with each general partner entitled to one half of those amounts. As of June 30, 2007, all milestones had been achieved and all repositioning fees had been paid. Seasonality Hotel's operations historically have been seasonal. Like most hotels in the San Francisco area, the Hotel generally maintains higher occupancy and room rates during the first and second quarters of its fiscal year (July 1 through December 31) than it does in the third and fourth quarters (January 1 through June 30). These seasonal patterns can be expected to cause fluctuations in the quarterly revenues from the Hotel. Competition The hotel industry is highly competitive. Competition is based on a number of factors, most notably convenience of location, brand affiliation, price, range of services and guest amenities or accommodations offered and quality of customer service. Competition is often specific to the individual market in which properties are located. The Hotel is located in an area of intense competition from other hotels in the Financial District and San Francisco in general as described more fully under Item 2. "Description of Property". Increased competition from new hotels, or hotels that have been recently undergone substantial renovation, could have an adverse effect on occupancy, average daily rate ("ADR") and room revenue per available room ("RevPar") and put pressure on the Partnership to make additional capital improvements to the Hotel to keep pace with the competition. Because the Hotel operates in an upper scale segment of the market, we could also face increased competition from providers of less expensive accommodations, such as limited service hotels, during periods of economic downturn when leisure and business travelers become more sensitive to room rates. As a result, there could be pressure to lower average daily rates during such periods to compete for these guests. The Hotel is also subject to certain operating risks common to all of the hotel industry, which could adversely impact performance. These risks include: * Competition for guests and meetings from other hotels including competition and pricing pressure from internet wholesalers and distributors; * increases in operating costs, including wages, benefits, insurance, property taxes and energy, due to inflation and other factors, which may not be offset in the future by increased room rates; * labor strikes, disruptions or lock outs; * dependence on demand from business and leisure travelers, which may fluctuate and is seasonal; * increases in energy costs, airline fares and other expenses related to travel, which may negatively affect traveling; * terrorism, terrorism alerts and warnings, wars and other military actions, SARS, pandemic or other medical events or warnings which may result in decreases in business and leisure travel; and * adverse effects of weak general and local economies. -8- Environmental Matters In connection with the ownership of the Hotel, the Company is subject to various federal, state and local laws, ordinances and regulations relating to environmental protection. Under these laws, a current or previous owner or operator of real estate may be liable for the costs of removal or remediation of certain hazardous or toxic substances on, under or in such property. Such laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the presence of hazardous or toxic substances. Environmental consultants retained by the Partnership or its lenders conducted updated Phase I environmental site assessments in fiscal year ended June 30, 2007 on the Hotel property. These Phase I assessments relied, in part, on Phase I environmental assessments prepared in connection with the Partnership's first mortgage loan obtained in July 2005. Phase I assessments are designed to evaluate the potential for environmental contamination on properties based generally upon site inspections, facility personnel interviews, historical information and certain publicly-available databases; however, Phase I assessments will not necessarily reveal the existence or extent of all environmental conditions, liabilities or compliance concerns at the properties. Although the Phase I assessments and other environmental reports we have reviewed disclose certain conditions on our properties and the use of hazardous substances in operation and maintenance activities that could pose a risk of environmental contamination or liability, we are not aware of any environmental liability that we believe would have a material adverse effect on our business, financial position, results of operations or cash flows. The Company believes that the Hotel and its rental properties are in compliance, in all material respects, with all federal, state and local environmental ordinances and regulations regarding hazardous or toxic substances and other environmental matters, the violation of which could have a material adverse effect on the Company. The Company has not received written notice from any governmental authority of any material noncompliance, liability or claim relating to hazardous or toxic substances or other environmental matters in connection with any of its present properties. EMPLOYEES As of June 30, 2007, the Company had three full-time employees. The employees of the Company are not part of any collective bargaining agreement, and the Company believes that its employee relations are satisfactory. Although the employees of Portsmouth and Justice are not unionized, most employees of the Hotel are part of Local 2 of the Hotel Employees and Restaurant Employees Union ("UNITE HERE"). In September 2007, a new contract was reached with Local 2 that expires on August 14, 2009. As part of that agreement, Justice also settled all claims with Local 2 arising out of the temporary closing of the hotel for renovations. The Hotel also has labor agreements with Stationary Engineers, Local 39 and Teamsters, Local 856. Those contracts expire on January 11, 2009 and December 31, 2008, respectively. -9- Item 2. Description of Property. SAN FRANCISCO HOTEL PROPERTY The Hotel is owned directly by the Partnership. The Hotel is centrally located near the Financial District, one block from the Transamerica Pyramid. The Embarcadero Center is within walking distance and North Beach is two blocks away. Chinatown is directly across the bridge that runs from the Hotel to Portsmouth Square Park. The hotel is a 31-story (including parking garage), steel and concrete, A-frame building, built in 1970. The Hotel has 544 well appointed guest rooms and luxury suites situated on 22 floors as well as a 5,400 square foot Tru Spa health and beauty spa on the lobby level. The third floor houses the Chinese Culture Center and grand ballroom. The Hotel has approximately 15,000 square feet of meeting room space, including the grand ballroom. Other features of the Hotel include a 5-level underground parking garage and pedestrian bridge across Kearny Street connecting the Hotel and the Chinese Culture Center with Portsmouth Square Park in Chinatown. The bridge, built and owned by the Partnership, is included in the lease to the Chinese Culture Center. The Hotel is located in an area of intense competition from other hotels in the Financial District. After being closed for more than seven months for a substantial renovation project in fiscal 2006, it has taken some time for the Hotel, now operating as a Hilton, to gain recognition as a totally upgraded and higher level property after being under the Holiday Inn brand for almost 35 years. The Hotel is also somewhat limited by having only 15,000 square feet of meeting room space. Other hotels, with greater meeting room space, may have a competitive advantage by being able to attract larger groups and small conventions. Management, in conjunction with its management company Prism and Hilton, will make every effort to market the Hotel as an upscale property to business travelers, leisure customers and small to medium size groups. While it may take some time for the Hotel to be fully recognized and reach its full potential, Management believes that the substantial renovations made to the Hotel, coupled with the strength of the Hilton brand and its Hilton Honors program, have provided the foundation for the Hotel to meet or exceed all of its competition. Since the Hotel just completed renovations, there is no present program for any further major renovations; however, the Partnership expects to reserve approximately 4% of gross annual Hotel revenues each year for future capital requirements. In the opinion of management, the property is adequately covered by insurance. HOTEL PERFORMANCE The following table presents certain statistical data and certain performance information for the Hotel for the fiscal years ended June 30, 2007 and 2006. For additional information, see Item 7. "Financial Statements" - Note 2 to the Company's consolidated financial statements. Fiscal Year Ended Average Average June 30, Daily Rate Occupancy% RevPar - ----------------- ---------- ---------- --------- 2007 $159.90 75.8% $121.53 2006(1) $147.39 50.2% $ 74.29 - ----------------- (1) Includes only five and one half months of operations after the Hotel was reopened in January 2006 after major renovations. -10- HOTEL FINANCINGS On July 27, 2005, Justice entered into a first mortgage loan with The Prudential Insurance Company of America in a principal amount of $30,000,000 (the "Prudential Loan"). The term of the Prudential Loan is for 120 months at a fixed interest rate of 5.22% per annum. The Prudential Loan calls for monthly installments of principal and interest in the amount of approximately $165,000, calculated on a 30 year amortization schedule. The 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. 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. As a condition of the Second Prudential Loan, Justice was required to obtain a standby letter of credit in an amount of $1,500,000 to serve as security for potential liabilities arising out of the litigation pending between the Partnership and Allied Construction Management, Inc. and its subcontractors (the "Allied Litigation") over disputed construction change orders. Justice believes that it has good and meritorious defenses to the claims asserted in the Allied Litigation and that the funds provided for by the letter of credit will not have to be used. From the proceeds of the Second Prudential Loan, Justice retired its existing line of credit facility with United Commercial Bank ("UCB") paying off the outstanding balance of principal and interest of approximately $16,403,000 on March 27, 2007. The Partnership also obtained a new unsecured $3,000,000 revolving line of credit facility from UCB to be utilized by the Partnership to meet any emergency or extraordinary cash flow needs arising from any disruption of business due to labor issues, natural causes affecting tourism and other unexpected events. The term of the new line of credit facility is for 60 months at an annual interest rate, based on an index selected by Justice at the time of advance, equal to the Wall Street Journal Prime Rate or the Libor Rate plus two percent. As of June 30, 2007, there were no amounts borrowed by Justice under the new line of credit; however, $1,500,000 of that line was utilized in the form of a standby letter of credit related to the Allied Litigation. The annual fee for the letter of credit is one and one half percent of $1,500,000, which fee is to be paid in quarterly installments for the periods in which the letter of credit is in effect. LOS ANGELES, CALIFORNIA APARTMENT BUILDINGS The property owned and consolidated by the Company's 55.4% subsidiary, Woodland Village, is a 27-unit apartment complex located Los Angeles, California. The Company's equity interest in Woodland Village was acquired on September 29, 1999 at a cost of $4,075,000. For the year ended June 30, 2007, real estate property taxes were approximately $53,000. Depreciation is recorded on the -11- straight-line method based upon an estimated useful life of 40 years. As of June 30, 2007, the outstanding mortgage balance was $1,782,000. The mortgage carries a fixed interest rate of 7.73% and matures in October 2029. The second Los Angeles property, Acanto, which is wholly owned by the Company, is a two-story apartment building with 2 units. The property was acquired on February 1, 2002 at an initial cost of $785,000. For the year ended June 30, 2007, real estate property taxes were approximately $10,000. Depreciation is recorded on the straight-line method, based upon an estimated useful life of 40 years. The outstanding mortgage balance was approximately $431,000 at June 30, 2007 and the maturity date of the mortgage is January 2032 and is collateralized by the property. The interest rate is variable and was 7.00% at June 30, 2007. Effective August 1, 2005, the Company entered into a Management Agreement with Century West Properties, Inc. ("Century West") to act as an agent of the Company to rent and manage both of the Company's residential rental properties in the Los Angeles, California area. The Management Agreement with Century West is for a term of twelve months ending on July 31, 2006 and will continue thereafter on a month-to-month basis, unless terminated upon 30 days prior written notice. The Management Agreements provide for a monthly fee equal to 4% of the monthly gross receipts from the properties with resident managers and a fee of 4 1/2% of monthly gross receipts for properties without resident mangers. For the year ended June 30, 2007 and 2006, management fees were $20,000 and $17,000, respectively. Woodland Village and Acanto lease units in the apartment buildings on a short- term basis, with no lease extending beyond one year. For the year ended June 30, 2007, the economic occupancy (gross potential less rent below market, vacancy loss, bad debt, discounts and concessions divided by gross potential rent) for Woodland Village and Acanto was 72% and 98%, respectively. The physical occupancy(gross potential rent less vacancy loss divided by gross potential rent) for the year ended June 30, 2007 for Woodland Village and Acanto was 98% and 98%, respectively. In the opinion of management, both rental properties are adequately covered by insurance. INVESTMENT POLICIES The most significant real estate investment of the Company is the San Francisco Hotel through its control of Portsmouth. The Company will continue to explore ways to increase the value of Justice Investors and to improve operations of the Hotel. The Company has also invested in multifamily residential properties through its 55.4% controlling interest in Woodland Village and its wholly owned subsidiary Acanto. The Company may also look for new real estate investment opportunities in hotels, apartments, office buildings and shopping centers. The acquisition of any new real estate investments will depend on the Company's ability to find suitable investment opportunities and the availability of sufficient financing to acquire such investments. To help fund any such acquisition, the Company may borrow funds to leverage its investment capital. The amount of any such debt will depend on a number of factors including, but not limited to, the availability of financing and the sufficiency of the acquisition property's projected cash flows to support the operations and debt service. The Company also invests from time to time in income producing instruments, corporate debt and equity securities, mortgage backed securities, and securities issued by REIT's, where financial benefit can be obtained through income and/or capital gain. -12- The Company's securities investments are made under the supervision of a Securities Investment Committee of the Board of Directors. The Committee currently has three members and is chaired by the Company's Chairman of the Board and President, John V. Winfield. The Committee has delegated authority to manage the portfolio to the Company's Chairman and President together with such assistants and management committees he may engage. The Committee has established investment guidelines for the Company's investments. These guidelines presently include: (i) corporate equity securities should be listed on the New York or American Stock Exchanges or the Nasdaq Stock Market; (ii) securities should be priced above $5.00 per share; and (iii) investment in a particular issuer should not exceed 5% of the market value of the total portfolio. The investment policies do not require the Company to divest itself of investments, which initially meet these guidelines but subsequently fail to meet one or more of the investment criteria. Non-conforming investments require the approval of the Securities Investment Committee. The Committee has in the past approved non-conforming investments and may in the future approve non-conforming investments. The Securities Investment Committee may modify these guidelines from time to time. The Company's investment portfolio is diversified with 31 different equity positions. The portfolio contains six individual equity security positions that are more than 5% of the total equity value of the portfolio, with the largest representing approximately 14.9% of the total equity value of the entire 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 June 30, 2007, the market value of the Company's marketable securities was $13,693,000. The Company may also use exchange traded funds, options and futures to manage market risk against certain stock positions and index futures and to enhance the performance of the Company's portfolio while reducing the overall portfolio's risk and volatility. As part of its investment strategies, the Company may assume short positions in marketable securities. Short sales are used by the Company to potentially offset normal market risks undertaken in the course of its investing activities or to provide additional return opportunities. As of June 30, 2007, the Company had obligations for securities sold (equities short) of $1,056,000. The Company has no naked short positions. The Company may also invest, with the approval of the Securities Investment Committee, in unlisted securities, such as convertible notes, through private placements including private equity investment funds. Those investments in non-marketable securities are carried at cost on the Company's balance sheet as part of other investments and reviewed for impairment on a periodic basis. As of June 30, 2007, the Company had other investments of $4,175,000. In addition, the Company may utilize margin for its marketable securities purchases through the use of standard margin agreements with national brokerage firms. The use of available leverage is guided by the business judgment of management and is subject to any internal investment guidelines, which may be imposed by the Securities Investment Committee. The margin used by the Company may fluctuate depending on market conditions. The use of leverage could be viewed as risky and the market values of the portfolio may be subject to large -13- fluctuations. As of June 30, 2007, the Company had a margin balance of $5,901,000 and incurred $395,000 and $352,000 in margin interest during the fiscal years ended June 30, 2007 and 2006, respectively. On July 18, 2003, the disinterested members of the Board of Directors established a performance based compensation program for the Company's CEO, John V. Winfield, to keep and retain his services as a direct and active manager of the Company's securities portfolio. The terms of that compensation arrangement is discussed in detail in Item 10 "Executive Compensation" of this Report. During the years ended June 30, 2007 and 2006, no performance based compensation was earned by the Company's CEO. As Chairman of the Securities Investment Committee, the Company's President and Chief Executive Officer, John V. Winfield, directs the investment activity of the Company in public and private markets pursuant to authority granted by the Board of Directors. Mr. Winfield also serves as Chief Executive Officer and Chairman of Portsmouth and InterGroup and oversees the investment activity of those companies. 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. Item 3. LEGAL PROCEEDINGS Bacon Plumbing Co., Inc. and Golden Electric Company v. Allied Construction, et al., San Francisco County Superior Court, Case No. 06-455440. This is to update matters previously reported regarding the litigation and lien claims filed by Allied Construction Management, Inc. ("Allied") and eight subcontractors arising out of the renovation work performed on the San Francisco Hotel property. All of those claims were consolidated into the above entitled action. In August 2007, the Partnership reached tentative settlements, subject to court approval, with all of the subcontractors that filed liens in an aggregate amount of approximately $1,580,000. The total amount of the liens filed by the subcontractors was approximately $1,756,000. Still unresolved is the balance of the claim asserted by Allied in the approximate amount of $600,000. Justice, Evon and Portsmouth dispute that any amounts are owed to Allied and will vigorously defend the balance of this action against the Allied claims. Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this Report. -14- PART II Item 5. Market For Common Equity and Related Stockholder Matters. MARKET INFORMATION Santa Fe's common stock is traded on the OTC Bulletin Board ("OTCBB") under the symbol: SFEF.OB The following table sets forth the range of the high and low bid information as reported by the OTCBB for Santa Fe's common stock for each full quarterly period for the fiscal years ended June 30, 2007 and 2006. The quotations reflect inter-dealer prices, without retail mark-up, markdown or commissions and may not represent actual transactions. Fiscal 2007 High Low - ----------- ----- ----- First Quarter (7/1 to 9/30) $18.01 $15.50 Second Quarter (10/1 to 12/31) $20.00 $17.50 Third Quarter (1/1 to 3/31) $20.00 $17.50 Fourth Quarter (4/1 to 6/30) $18.25 $17.85 Fiscal 2006 High Low - ----------- ----- ----- First Quarter (7/1 to 9/30) $18.00 $15.35 Second Quarter (10/1 to 12/31) $18.70 $18.00 Third Quarter (1/1 to 3/31) $20.00 $18.35 Fourth Quarter (4/1 to 6/30) $22.00 $16.50 As of September 14, 2007, the number of holders of record of the Company's Common Stock was 264. Such number of owners was determined from the Company's shareholders records and does not include beneficial owners of the Company's Common Stock whose shares are held in the names of various brokers, clearing agencies or other nominees. There are approximately 400 beneficial shareholders of the Company's Common Stock. Dividends On February 1, 2000, the Board of Directors of the Company determined that it did not foresee the Company paying any cash dividends on its Common Stock in the immediate future. Instead, it is the intent of the Company to deploy its capital in a manner to increase its operating activities. On December 31, 1997, the Company issued 31,800 shares of 6% cumulative, convertible voting preferred stock (the "Preferred Stock") in exchange for a 55.4% interest in Woodland from InterGroup. As a result of the Company's two- for-one stock split, the number of Preferred Shares was adjusted to 63,600. Each share of Preferred Stock had a liquidation preference of $13.50 and was convertible into one share of restricted common stock of the Company at an exercise price of $13.50 per share, with an eight-year conversion exercise period. The preferred stock had voting rights as if converted into common stock. On December 31, 2005, InterGroup converted the 63,600 shares of preferred stock into 63,600 shares of common stock. During the year ended June 30, 2006, the Company paid Preferred Stock dividends of $26,000. SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS Santa Fe has no securities authorized for issuance under equity compensation plans. -15- PURCHASES OF EQUITY SECURITIES Santa Fe did not repurchase any of its own securities during the last 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 last 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 (April 1- - - - N/A April 30) - -------------------------------------------------------------------------------------- Month #2 (May 1- - - - N/A May 31) - -------------------------------------------------------------------------------------- Month #3 (June 1- 12,295 $18.02 - N/A June 30) - -------------------------------------------------------------------------------------- Total 12,295 $18.02 - N/A - --------------------------------------------------------------------------------------
-16- Item 6. Management's Discussion and Analysis of Financial Condition and Results of Operations RESULTS OF OPERATIONS The Company's principal sources of revenue continue to be derived from the investment of its 68.8% owned subsidiary, Portsmouth, in the Justice Investors limited partnership ("Justice" or the "Partnership"), rental income from its investments in multi-family real estate properties and income received from investment of its cash and securities assets. Portsmouth has a 50.0% ownership interest in the Justice and serves as one of the general partners. Justice owns the land, improvements and leaseholds at 750 Kearny Street, San Francisco, California, known as the Hilton San Francisco Financial District 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 Prism Hospitality L.P. ("Prism Hospitality") 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. Recent Developments On March 28, 2007, Justice paid a special distribution to its limited partners in a total amount of $1,000,000, of which $500,000 is eliminated in consolidation. The general partners believed that operations of the Hotel had stabilized under the Hilton brand and new management, and that cash flows were sufficient to warrant a special distribution, especially with the new financings in place to meet any additional capital needs. The general partners expect to conduct regular reviews to set the amount of any future distributions that may be appropriate based on the results of operations of the Hotel and other factors. -17- In August 2007, Portsmouth's Board of Directors authorized an investment of $973,000 for Portsmouth to acquire a 50% equity interest in Intergroup Uluniu, Inc., a Hawaii corporation ("Uluniu") in a related party transaction. Uluniu is a 100% owned subsidiary of The InterGroup Corporation ("InterGroup"). Uluniu owns an approximately two-acre parcel of unimproved land located in Kihei, Maui, Hawaii which is held for development. The Company's investment in Uluniu represents an amount equal to the costs paid by InterGroup for the acquisition and carrying costs of the property through August 2007. The fairness of the financial terms of the transaction were reviewed and approved by the independent director of the Company. Uluniu intends to obtain the entitlements and permits necessary for the joint development of the parcel with an adjoining landowner into residential units. After the completion of this predevelopment phase, the Uluniu will determine whether it more advantageous to sell the entitled property or to commence with construction. As of September 5, 2007, $758,000 of the investment amount had been paid by Portsmouth and the proceeds were used by Uluniu to retire the mortgage on the property in the approximate amount of $756,000. The balance of the proceeds will be used to fund predevelopment costs and to meet other requirements to try to enhance the value of the property. Fiscal Year Ended June 30, 2007 Compared to Fiscal Year Ended June 30, 2006 The Company had a net loss of $1,962,000 for the year ended June 30, 2007 compared to a net loss of $602,000 for the year ended June 30, 2006. The increase in the net loss was attributable to the decrease in income from investment related activities to $639,000 for the year ended June 30, 2007 from income of $2,305,000 for the year ended June 30, 2006, significantly offset by the Company's portion of the loss related to Justice Investors. For the year ending June 30, 2007, the Company consolidated the operations of Justice Investors for the first time. The net loss from the operations of Justice Investors was $4,601,000 for the fiscal year ended June 30, 2007, compared to a net loss of $8,330,000 for the fiscal year ended June 30, 2006 (see Note 2 for more details). The decrease was primarily attributable to net income generated from the operations of the Hotel for a full fiscal year in 2007, compared to the prior fiscal year when the Hotel did not reopen until January 12, 2006 after undergoing major renovations, and from higher garage rental income in the current year. Those results were partially offset by greater depreciation and amortization expenses of $4,172,000 for fiscal 2007 from $2,285,000 in fiscal 2006, an increase in interest expense to $2,919,000 in fiscal 2007 from $1,373,000 in 2006 and an increase in insurance costs to $1,230,000 for fiscal 2007 compared to $367,000 in fiscal 2006. The increase in those costs are attributable to the renovation and improvements to the Hotel. Justice also incurred higher general and administrative expenses due to an increase in certain legal and consulting fees in the current year. Those nonrecurring costs related to the Allied Litigation, the termination and transition of the Hotel management agreement from Dow to Prism, and zoning issues were approximately $1.5 million. For the fiscal year ended June 30, 2007, the operations of the Hotel on a standalone basis (see Note 2) generated net income of $2,443,000 on total operating revenues of approximately $29,984,000 compared to a loss from Hotel operations of $3,787,000 on total operating revenues of $9,054,000 for the fiscal year ended June 30, 2006, when the Hotel first reopened on a limited basis on January 12, 2006. Garage rent increased to $1,533,000 for fiscal 2007 from $945,000 in fiscal 2006 primarily due to the Hotel being open for a full year in fiscal 2007. -18- The following table sets forth the average daily room rate ("ADR"), average occupancy percentage and room revenue per available room ("RevPar") of the Hotel for the fiscal years ended June 30, 2007 and 2006. Fiscal Year Ended Average Average June 30, Daily Rate Occupancy% RevPar - ----------------- ---------- ---------- --------- 2007 $159.90 75.8% $121.53 2006(1) $147.39 50.2% $ 74.29 - ----------------- (1) Includes only five and one half months of operations after the Hotel was reopened in January 2006 after major renovations. Average daily room rates have continued to improve since the Hotel's reopening in January 2006 and average occupancy rates have increased dramatically this fiscal year. As a result, the Hotel has shown an approximately $47 increase in RevPar. We believe that many of the new programs implemented to increase revenues and efficiencies at the Hotel, as well as certain management personnel changes, have helped improve operations. While the Hotel's food and beverage operations remain challenging, management was able to reduce losses in that department during the current fiscal year. Due 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, food and beverage operations will continue to be challenging. Management will continue to work to address those issues and to explore all options to improve the operations of the Hotel. We anticipate that the operating results of the Hotel will continue to improve in fiscal 2008 with increases in ADRs, occupancy and RevPar as the Hotel approaches full stabilization and gets further penetration into the Financial District hotel market. We also foresee a reduction in Partnership general and administrative expenses for legal and consulting fees in fiscal 2008, as many of those expenses were attributable to nonrecurring legal and transition matters that took place in fiscal 2007. We also expect that the Partnership will start making more regular distributions to its limited partners in fiscal 2008 if cash flows from the Hotel operations continue to improve. Income(loss) from real estate operations improved to income of $3,000 compared to a loss of $11,000. The increase is primarily as the result the increase rental income to $501,000 from $441,000 from the Company's two multi-family apartment complexes as the result of improved occupancy. Property operating expense also increased to $246,000 from $203,000 as the result of the increase in occupancy. Net gains on marketable securities decreased to $2,038,000 for the year ended June 30, 2007 from $2,666,000 for the year ended June 30, 2006. For the year ended June 30, 2007, the Company had net realized gains of $1,936,000 and net unrealized gains $102,000. For the year ended June 30, 2006, the Company had net realized gains of $468,000 and unrealized gains of $2,198,000. Gains and losses on marketable securities and other investments 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 and other investments 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. -19- During the year ended June 30, 2007, the Company performed an impairment analysis of its other investments and determined that one of its investments had an other than temporary impairment and recorded an impairment loss on other investments of $875,000. During the year ended June 30, 2006, the Company recorded an other than temporary impairment loss on other investments of $16,000. Dividend and interest income decreased to $251,000 for the year ended June 30, 2007 from $344,000 for the year ended June 30, 2006 as a result of the decreased investment in income yielding securities during most recent fiscal year. Margin interest and trading expenses increased to $775,000 for the year ended June 30, 2007 from $689,000 for the year ended June 30, 2006. The increase is primarily due to the increase in margin interest expense to $395,000 for the year ended June 30, 2007 as compared to $352,000 for the year ended June 30, 2006. The increase is due to the higher margin interest rates and the higher average daily margin balances. The provision for income tax benefit decreased to $199,000 for the year ended June 30, 2007 from $1,656,000 for the year ended June 30, 2006 primarily as the result of management recording a valuation allowance of $839,000 against the total deferred assets during the year ended June 30, 2007. Management believes that it is more likely than not that the Company will not realize the benefit of the deferred asset as of June 30, 2007. Minority interest benefit increased to $2,896,000 from $506,000 primarily as the result of the $2,423,000 minority interest benefit recognized during the year ended June 30, 2007 related to the consolidation of Justice Investors. For the year ended June 30, 2006, the Company's investment in Justice Investors was recorded on an equity basis. MARKETABLE SECURITIES As of June 30, 2007, the Company had investments in marketable equity securities totaling $13,693,000. The following table shows the composition of the Company's marketable securities portfolio by selected industry groups as of June 30, 2007. % of Total Investment Industry Group Market Value Securities -------------- ------------ ---------- Technology $ 2,636,000 19.3% Retail and consumer goods 2,250,000 16.4% Insurance, banks and brokers 1,663,000 12.1% REITs 1,507,000 11.0% Telecommunications and media 1,185,000 8.7% Diary products 1,157,000 8.4% Services 1,049,000 7.7% Holding companies 642,000 4.7% Pharmaceuticals and healthcare 506,000 3.7% Other 1,098,000 8.0% ------------ ---------- $ 13,693,000 100.0% ============ ========== The Company's investment portfolio is diversified with 31 different equity positions. The portfolio contains six individual equity security positions that are more than 5% of the total equity value of the portfolio, with the largest representing approximately 14.9% of the total equity value of the -20- entire 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. The Company's securities investments are made under the supervision of a Securities Investment Committee of the Board of Directors. The Committee currently has three members and is chaired by the Company's Chairman of the Board and President, John V. Winfield. The Committee has delegated authority to manage the portfolio to the Company's Chairman and President together with such assistants and management committees he may engage. The Committee has established investment guidelines for the Company's investments. These guidelines presently include: (i) corporate equity securities should be listed on the New York or American Stock Exchanges or the Nasdaq Stock Market; (ii) securities should be priced above $5.00 per share; and (iii) investment in a particular issuer should not exceed 5% of the market value of the total portfolio. The investment policies do not require the Company to divest itself of investments, which initially meet these guidelines but subsequently fail to meet one or more of the investment criteria. Non-conforming investments require the approval of the Securities Investment Committee. The Committee has in the past approved non-conforming investments and may in the future approve non-conforming investments. The Securities investment Committee may modify these guidelines at any time from time to time. As part of its investment strategies, the Company may assume short positions in marketable securities. Short sales are used by the Company to potentially offset normal market risks undertaken in the course of its investing activities or to provide additional return opportunities. As of June 30, 2007, the Company had obligations for securities sold (equities short) of $1,056,000. The Company has no naked short positions. In addition, the Company may utilize margin for its marketable securities purchases through the use of standard margin agreements with national brokerage firms. The use of available leverage is guided by the business judgment of management and is subject to any internal investment guidelines, which may be imposed by the Securities Investment Committee. The margin used by the Company may fluctuate depending on market conditions. The use of leverage could be viewed as risky and the market values of the portfolio may be subject to large fluctuations. As of June 30, 2007, the Company had a margin balance of $5,901,000. 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 years. For the years ended June 30, 2007 2006 ------------- ------------- Net gains on marketable securities $ 2,038,000 $ 2,666,000 Impairment loss on other investments (875,000) (16,000) Dividend and interest income 251,000 344,000 Margin interest expense (395,000) (352,000) Trading and management expenses (380,000) (337,000) ---------- ---------- $ 639,000 $ 2,305,000 ========== ========== -21- 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 were temporarily closed down 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 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 $37,030,000, which includes approximately $630,000 in interest costs incurred during 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 with The Prudential Insurance Company of America in a principal amount of $30,000,000 (the "Prudential Loan"). The term of the Prudential Loan is for 120 months at a fixed interest rate of 5.22% per annum. The Prudential Loan calls for monthly installments of principal and interest in the amount of approximately $165,000, calculated on a 30 year amortization schedule. The Prudential Loan is collateralized by a first deed of trust on the Partnership's Hotel property, including all improvements and personal property thereon and an assignment of all present and future leases and rents. The Prudential Loan is without recourse to the limited and general partners of Justice. As of June 30, 2007, the total amount outstanding of the Prudential Loan was approximately $29,203,000. 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 without recourse to the limited and general partners of Justice. As of June 30, 2007, the total amount outstanding of the Second Prudential Loan was approximately $18,965,000. From the proceeds of the Second Prudential Loan, Justice retired its existing line of credit facility with United Commercial Bank ("UCB") paying off the outstanding balance of principal and interest of approximately $16,403,000 on March 27, 2007. The Partnership also obtained a new unsecured $3,000,000 revolving line of credit facility from UCB to be utilized by the Partnership to meet any emergency or extraordinary cash flow needs arising from any disruption of business due to labor issues, natural causes affecting tourism and other unexpected events. The term of the new line of credit facility is for 60 months at an annual interest rate, based on an index selected by Justice at the time of advance, equal to the Wall Street Journal Prime Rate or the Libor Rate plus two percent. As of June 30, 2007, there were no amounts borrowed by Justice -22- under the new line of credit; however, $1,500,000 of that line was utilized in the form of a standby letter of credit related for the Allied Litigation. The annual fee for the letter of credit is one and one half percent of $1,500,000, which fee is to be paid in quarterly installments for the periods in which the letter of credit is in effect. The Hotel started to generate net income from its operations in June 2006 (see Note 2 for more details), which have continued to improve during the Company's fiscal year ended June 30, 2007. As a result, Justice was able to pay a special limited partnership distribution in a total amount of $1,000,000 on March 28, 2007, of which Portsmouth received $500,000. The general partners believed that operations of the Hotel had stabilized under the Hilton brand and new management, and that cash flows were sufficient to warrant a special distribution, especially with the new financings in place to meet any additional capital needs. The general partners expect to conduct regular reviews to set the amount of any future distributions that may be appropriate based on the results of operations of the Hotel and other factors. While the debt service requirements related to the two Prudential Loans, as well as any utilization of the UCB line of credit, may create some additional risk for the Company and its ability to generate cash flows in the future since the Partnership's assets had been virtually debt free for an number of years, management believes that cash flows from the operations of the Hotel and the garage lease will continue to be sufficient to meet all of the Partnership's current and future obligations and financial requirements. Management also believes that there is sufficient equity in the Hotel assets to support future borrowings, if necessary, to fund any new capital improvements and other requirements. 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 statement of operations. Management believes that its cash, securities assets, and the cash flows generated from those assets and from partnership distributions and management fees, will be adequate to meet the Company's current and future obligations. MATERIAL CONTRACTUAL OBLIGATIONS Other than Justice's mortgage loans with Prudential, the Company's contractual obligations and commercial commitments are its mortgage notes payable on its rental properties. The annual principal payments on all of the mortgage notes payable for the five-year period commencing July 1, 2007 are approximately as follows: For the year ending June 30, 2008 $ 724,000 2009 766,000 2010 812,000 2011 859,000 2012 910,000 Thereafter 46,310,000 ----------- $50,381,000 =========== -23- 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 Prism 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 Critical accounting policies are those that are most significant to the portrayal of our financial position and results of operations and require judgments by management in order to make estimates about the effect of matters that are inherently uncertain. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts in our consolidated financial statements. We evaluate our estimates on an on-going basis, including those related to the consolidation of our subsidiaries, to our revenues, allowances for bad debts, accruals, asset impairments, other investments, income taxes and commitments and contingencies. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. The actual results may differ from these estimates or our estimates may be affected by different assumptions or conditions. -24- Item 7. Financial Statements INDEX TO CONSOLIDATED FINANCIAL STATEMENTS PAGE Report of Independent Registered Public Accounting Firm 25 Consolidated Balance Sheet -June 30, 2007 26 Consolidated Statements of Operations - For Years Ended June 30, 2007 and 2006 27 Consolidated Statements of Shareholders' Equity - For Years Ended June 30, 2007 and 2006 28 Consolidated Statements of Cash Flows - For Years Ended June 30, 2007 and 2006 29 Notes to Consolidated Financial Statements 30 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of Santa Fe Financial Corporation: In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of operations, shareholders' equity and cash flows present fairly, in all material respects, the financial position of Santa Fe Financial Corporation and its subsidiaries at June 30, 2007, and the results of their operations and their cash flows for each of the two years in the period ended June 30, 2007 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for a partnership investment on July 1, 2006. /s/ PricewaterhouseCoopers LLP Irvine, California September 28, 2007 -25- SANTA FE FINANCIAL CORPORATION CONSOLIDATED BALANCE SHEET As of June 30, 2007 ----------- ASSETS Cash and cash equivalents $ 851,000 Restricted cash 1,500,000 Investment in marketable securities 13,693,000 Other investments 4,175,000 Accounts receivable, net 1,044,000 Other assets, net 1,516,000 Deferred tax asset 2,218,000 Minority interest 1,128,000 Investment in real estate, net 4,476,000 Investment in hotel, net 45,233,000 ----------- Total assets $ 75,834,000 =========== LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities Accounts payable and other liabilities $ 8,554,000 Due to securities broker 5,901,000 Obligations for securities sold 1,056,000 Mortgage notes payable - real estate 2,213,000 Mortgage notes payable - hotel 48,168,000 ----------- Total liabilities 65,892,000 ----------- Commitments and contingencies (Note 13) Shareholders' equity 6% Cumulative, convertible, voting preferred stock par value $.10 per share; none issued 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 1,951,000 Treasury stock, at cost, 97,828 shares (951,000) ----------- Total shareholders' equity 9,942,000 ----------- Total liabilities & shareholders' equity $ 75,834,000 ===========
The accompanying notes are an integral part of the consolidated financial statements. -26- Santa Fe Financial Corporation Consolidated Statements of Operations For the years ended June 30, 2007 2006 ---------- ----------- Justice Investors operations: Hotel and garage revenue $ 31,715,000 $ - Operating expense (28,664,000) - Interest expense (2,919,000) - Real estate taxes (561,000) - Depreciation and amortization (4,172,000) - ---------- ---------- Loss from Justice Investors operations (4,601,000) - ---------- ---------- Equity in net loss of Justice Investors - (4,288,000) Management fees from Justice Investors - 271,000 ---------- ---------- - (4,017,000) ---------- ---------- Real estate operations: Rental income 501,000 441,000 Property operating expense (246,000) (203,000) Mortgage interest expense (172,000) (173,000) Depreciation expense (80,000) (76,000) ---------- ---------- Income(loss) from real estate operations 3,000 (11,000) ---------- ---------- General and administrative expenses (1,013,000) (956,000) Other expense (85,000) (85,000) ---------- --------- (1,098,000) (1,041,000) ---------- --------- Investment transactions: Net gains on marketable securities 2,038,000 2,666,000 Impairment loss on other investments (875,000) (16,000) Dividend and interest income 251,000 344,000 Margin interest and trading expenses (775,000) (689,000) ---------- ---------- Total other income 639,000 2,305,000 ---------- ---------- Loss before income taxes and minority interest (5,057,000) (2,764,000) Minority interest - Justice Investors, pretax 2,423,000 - ---------- ---------- Loss before income taxes (2,634,000) (2,764,000) Income tax benefit 199,000 1,656,000 ---------- ---------- Loss before minority interest (2,435,000) (1,108,000) Minority interest benefit, net of tax 473,000 506,000 ---------- ---------- Net loss (1,962,000) (602,000) Preferred stock dividend - (26,000) ---------- ---------- Loss available to common shareholders $(1,962,000) $ (628,000) ========== ========== Basic loss per share $ (1.58) $ (0.52) ========== ========== Weighted average number of shares outstanding 1,241,810 1,210,187 ========== ==========
The accompanying notes are an integral part of the consolidated financial statements. -27- SANTA FE FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Preferred Stock Common Stock --------------- -------------------- Additional Paid-In Retained Treasury Shares Amount Shares Amount Capital Earnings Stock Total ------ ------- --------- --------- ---------- ---------- --------- ----------- Balance at June 30, 2005 63,600 $6,000 1,276,038 $128,000 $8,808,000 $4,541,000 $(951,000) $12,532,000 Net loss (602,000) (602,000) Conversion of (63,600) (6,000) 63,600 6,000 - Preferred Stock To Common Stock Dividend paid to preferred shareholders (26,000) (26,000) ------ ------- --------- --------- ---------- ---------- --------- ----------- Balance at June 30, 2006 - - 1,339,638 134,000 8,808,000 3,913,000 (951,000) 11,904,000 Net loss (1,962,000) (1,962,000) ------ ------- --------- --------- ---------- ---------- --------- ----------- Balance at June 30, 2007 - - 1,339,638 $134,000 $8,808,000 $1,951,000 $(951,000) $ 9,942,000 ====== ====== ========= ======== ========== ========== ========= ===========
The accompanying notes are an integral part of the consolidated financial statements -28- Santa Fe Financial Corporation Consolidated Statements of Cash Flows For the years ended June 30, 2007 2006 ---------- ---------- Cash flows from operating activities: Net loss $(1,962,000) $ (602,000) Adjustments to reconcile net loss to net cash provided by operating activities: Equity in net loss of Justice Investors - 4,288,000 Net unrealized gains on marketable securities (102,000) (2,198,000) Impairment loss on other investments 875,000 16,000 Minority interest (2,896,000) (506,000) Depreciation expense 4,252,000 76,000 Changes in operating assets and liabilities: Investment in marketable securities 5,025,000 (3,472,000) Other investments (2,650,000) (1,585,000) Other assets 278,000 339,000 Accounts payable and other liabilities 1,431,000 201,000 Due to securities broker (1,728,000) 4,524,000 Obligations for securities sold (2,136,000) 951,000 Deferred tax asset (200,000) (1,603,000) ---------- ---------- Net cash provided by operating activities 187,000 429,000 ---------- ---------- Cash flows from investing activities: Capital expenditures for furniture, equipment and building improvements (2,364,000) - Investment in Justice Investors - (180,000) Restricted cash (1,500,000) - ---------- ---------- Net cash used in investing activities (3,864,000) (180,000) ---------- ---------- Cash flows from financing activities: Proceeds from new mortgage note payable 19,000,000 - Pay-off of letter of credit (16,403,000) - Principal payments on mortgage payable (183,000) (33,000) Dividends paid to preferred shareholders - (26,000) Cash distributions to minority partners (500,000) - ---------- ---------- Net cash provided by(used in) financing activities 1,914,000 (59,000) ---------- ---------- Net (decrease)increase in cash and cash equivalents (1,763,000) 190,000 Cash and cash equivalents at beginning of period 2,614,000 72,000 ---------- ---------- Cash and cash equivalents at end of period $ 851,000 $ 262,000 ========== ========== Supplemental information Net income tax refunds $ 3,000 $ 467,000 ========== ========== Margin interest paid $ 394,000 $ 352,000 ========== ========== Mortgage interest paid $ 3,091,000 $ 173,000 ========== ========== Supplemental disclosure of non-cash activities: Consolidation of Justice Investors as of July 1, 2006 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) -
The accompanying notes are an integral part of the consolidated financial statements. -29- SANTA FE FINANCIAL CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES Description of Business Santa Fe Financial Corporation ("Santa Fe" or the "Company") was incorporated under the name of Tri Financial Corporation in the State of Nevada on July 25, 1967 as a wholly owned subsidiary of Crateo, Inc, a public company. On October 31, 1969, Crateo issued a one-for-one stock dividend of all of its shares of Tri Financial to its common shareholders. On September 17, 1970, the name of the Corporation was changed to Santa Fe Financial Corporation. As of June 30, 2007, Santa Fe owns approximately 68.8% of the outstanding common shares of Portsmouth Square, Inc. ("Portsmouth"), a public company. Santa Fe is a 75.1%- owned subsidiary of The InterGroup Corporation ("InterGroup"), a public company. InterGroup also directly owns approximately 10.9% of the common stock of Portsmouth. The Company's operations primarily consist of managing a hotel property through the Portsmouth's general and limited partnership interest in Justice Investors, a California limited partnership ("Justice" or the "Partnership"). In April 2006, Portsmouth purchased a 0.20% limited partnership interest in Justice from another limited partner for $180,000, which brought Portsmouth's limited partnership interest in Justice to exactly 50.00%. Portsmouth also serves as one of the two general partners of Justice. The other general partner, Evon Corporation ("Evon"), acts as the managing general partner. As discussed in Note 2, the financial statements of Justice are consolidated with those of the Company, effective the fiscal year beginning July 1, 2006. Justice owns a 544 room hotel property located at 750 Kearny Street, San Francisco, California 94108, now known as the "Hilton San Francisco Financial District" (the "Hotel") and related facilities, including a five level underground parking garage. Justice serves as the owner/operator of the Hotel with the assistance of a third party management company. Effective July 1, 2004, the Hotel was operated as a Holiday Inn Select brand hotel pursuant to a short term franchise agreement until it was temporarily closed for major renovations on May 31, 2005. The total construction costs related to the Hotel renovation was approximately $36.4 million and approximately $630,000 in capitalized interest. The Hotel was reopened on January 12, 2006 to operate as a full service Hilton hotel, pursuant to a Franchise License Agreement with Hilton Hotels Corporation. Santa Fe 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 InterGroup. 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. Principles of Consolidation The consolidated financial statements include the accounts of the Company and all controlled subsidiaries. All significant inter-company transactions and balances have been eliminated. -30- Cash Equivalents Cash equivalents consist of highly liquid investments with an original maturity of three months or less when purchased and are carried at cost, which approximates fair value. Restricted Cash The Company is required to reserve cash in accordance with loan covenants. The required reserve at June 30, 2007 was approximately $1,500,000. Investment in Marketable Securities 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 securities with all unrealized gains and losses on the Company's investment portfolio recorded through the consolidated statements of operations. Other Investments Other investments in non-marketable securities are carried at cost as the Company has no significant influence or control. Other investments are recorded on the Company's balance sheet as part of other investments and reviewed for other than temporary impairment on a periodic basis. Accounts Receivable Accounts receivable from Hotel and rental property customers are carried at cost less an allowance for doubtful accounts that is based on management's assessment of the collectibility of accounts receivable. The Company extends unsecured credit to its customers but mitigates the associated credit risk by performing ongoing credit evaluations of its customers. Other Assets Other assets includes inventory, prepaid expenses, loan fees and franchise fees. Loan fees are stated at cost and amortized over the term of the loan using the straight-line method which approximates the effective interest method. Franchise fees are stated at cost and amortized over the life of the agreement of 15 years. Investment in Hotel, Net The Hotel and equipment are stated at cost less accumulated depreciation. Building and improvements are being depreciated on a straight-line basis over their estimated useful lives ranging from 5 to 39 years. Furniture, fixtures, and equipment are being depreciated on a straight-line basis over their estimated useful lives ranging from 5 to 7 years. Repairs and maintenance are charged to expense as incurred, and costs of significant renewals and improvements are capitalized. In accordance with Statement of Financial Accounting Standards No. 144 (SFAS 144), "Accounting for Impairment or Disposal of Long-Lived Assets", the Company reviews its investment in Hotel for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If expected future cash flows (undiscounted and excluding interest costs) are less than the carrying value of the asset, the asset is written down to its estimated fair value. The estimation of expected future -31- net cash flows is inherently uncertain and relies to a considerable extent on assumptions regarding current and future economic and market conditions, and the availability of capital. If, in future periods, there are changes in the estimates or assumptions incorporated into the impairment review analysis, the changes could result in an adjustment to the carrying amount of the long-lived asset. No impairment losses on the investment in Hotel have been recorded for the year ended June 30, 2007. Rental Properties Rental properties are stated at cost less accumulated depreciation. Depreciation of rental property is provided on the straight-line method based upon estimated useful lives of 5 to 40 years for buildings and improvements and 5 to 10 years for equipment. Expenditures for repairs and maintenance are charged to expense as incurred and major improvements are capitalized. In accordance with SFAS 144, the Company also reviews its rental property assets for impairment. No impairment losses on the investment in real estate have been recorded for the year ended June 30, 2007 and 2006. Due to Securities Broker Various securities brokers have advanced funds to the Company for the purchase of marketable securities under standard margin agreements. These advanced funds are recorded as a liability. Obligations for Securities Sold Obligation for securities sold represents the fair market value of shares sold with the promise to deliver that security at some future date and the fair market value of shares underlying the written call options with the obligation to deliver that security when and if the option is exercised. The obligation may be satisfied with current holdings of the same security or by subsequent purchases of that security. Unrealized gains and losses from changes in the obligation are included in the statement of operations. Fair Value of Financial Instruments The carrying amount of cash and cash equivalents, marketable securities, amounts due to securities broker and obligations for securities sold approximates fair market value. The recorded values of cash, accounts receivable, rents receivable, inventories, prepaid expenses, accounts payable, and accrued expenses approximate their fair values based on their short-term nature. As of June 30, 2007, the estimated fair value of the mortgage notes payable is $49,445,000. Treasury Stock The Company records the acquisition of treasury stock under the cost method. Environmental Remediation Costs Liabilities for environmental remediation costs are recorded and charged to expense when it is probable that obligations have been incurred and the amounts can be reasonably estimated. Recoveries of such costs are recognized when received. As of June 30, 2007, there were no liabilities for environmental remediation. -32- Revenue Recognition The Company recognizes rental revenue on the straight-line method of accounting as required by GAAP under which contractual rent payment increases are recognized evenly over the lease term, regardless of when the rent payments are received by Justice. The leases contain provisions for base rent plus a percentage of the lessees' revenues, which are recognized when earned. Room revenues are recognized on the date upon which a guest occupies a room and/or utilizes the Hotel's services. Food and beverage revenues are recognized upon delivery. The Company leases the parking garage to Evon. The Company receives 60% of the gross parking revenues. Revenue is recognized and paid at the end of each month. Rental income is recognized when earned. Revenue recognition from apartment rentals commences when an apartment unit is placed in service and occupied by a rent-paying tenant. Apartment units are leased on a short-term basis, with no lease extending beyond one year. Basic Earnings per Share Basic earnings per share are calculated based upon the weighted average number of common shares outstanding during each fiscal year. As of June 30, 2007 and 2006, the Company did not have any potentially dilutive securities outstanding; and therefore, does not report diluted earnings per share. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Income Taxes The provision for income tax expense or benefit differs from the amounts of income taxes currently payable because certain items of income and expense included in the consolidated financial statements are recognized in different time periods by taxing authorities. Deferred income taxes are determined using the liability method. A deferred tax asset or liability is determined based on the difference between the financial statement and tax basis of assets and liabilities as measured by the enacted tax rates. Deferred tax expense is the result of changes in the amount of deferred income taxes during the period. Deferred tax assets, including net operating loss and tax credit carry forwards, are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that any portion of these tax attributes will not be realized. As of June 30, 2007, a valuation allowance of $839,000 was recorded against the Company's deferred tax assets. From time to time, management must assess the need to accrue or disclose a possible loss contingency for proposed adjustments from various Federal, state and foreign tax authorities that regularly audit the company in the normal course of business. In making these assessments, management must often analyze complex tax laws of multiple jurisdictions. -33- Reclassifications Certain prior year balances have been reclassified to conform with the current year presentation. Recent Accounting Pronouncements In July 2006, the FASB issued FASB Interpretation No. 48 ("FIN 48"), Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109, which clarifies the accounting for uncertainty in tax positions. FIN 48 requires that the Company recognize the impact of a tax position in the Company's financial statements if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective as of the beginning of the Company's 2008 fiscal year, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. The adoption of FIN 48 is not expected to have a material impact on the Company's consolidated financial statements. In September 2006, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 157, "Fair Value Measurements" ("SFAS 157"), which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 is effective as of the beginning of the Company's 2008 fiscal year. In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115" ("SFAS 159"), which permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS 159 is effective as of the beginning of the Company's 2008 fiscal year. The Company is currently evaluating the impact of adopting SFAS 157 and SFAS 159 on its consolidated financial statements. NOTE 2 - JUSTICE INVESTORS 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. In accordance with guidance set forth in FSP SOP 78-9-1, 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 effective beginning the fiscal year beginning July 1, 2006. For the year ended June 30, 2007, the results of operations for Justice were consolidated with those of the Company. However, for the year ended June 30, 2006, the Company's investment in Justice was accounted for under the equity method. For comparative purposes, the statement of operations for the Hotel (on a standalone basis) for the year ended June 30, 2007 and 2006 are included below. -34- 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 six and one-half months of fiscal 2006. 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. Below are the comparative standalone statements of operations for the Hotel for the years ended June 30, 2007 and 2006. Unaudited For the years ended June 30, 2007 2006 ---------- ---------- Revenues: Hotel rooms $ 24,431,000 $ 7,190,000 Food and beverage 5,110,000 1,686,000 Other operating departments 443,000 178,000 ---------- ---------- Total revenues 29,984,000 9,054,000 ---------- ---------- Operating expenses: Hotel rooms (7,780,000) (2,966,000) Food and beverage (5,620,000) (2,441,000) General and administrative (2,194,000) (1,384,000) Advertising and sales (2,321,000) (1,051,000) Franchise fees (1,702,000) (503,000) Repairs and maintenance (1,460,000) (951,000) Utilities (1,136,000) (529,000) Insurance (1,230,000) (367,000) CEP fee (1,051,000) (271,000) Other operating departments (911,000) (378,000) Credit card commissions (721,000) (224,000) Property taxes (561,000) (331,000) Management fees (523,000) (193,000) Other expenses (331,000) (22,000) Start-up costs - reopening of Hotel - (1,230,000) ---------- ---------- Total operating expenses (27,541,000) (12,841,000) ---------- ---------- Hotel net income(loss) 2,443,000 (3,787,000) Income(expense) at Justice Interest expense (2,919,000) (1,373,000) Depreciation and amortization expense (4,172,000) (2,285,000) Other income(expense) 47,000 (885,000) ---------- ---------- Justice net loss $ (4,601,000) $(8,330,000) ========== ========== -35- NOTE 3 - INVESTMENT IN HOTEL, NET, AND INVESTMENT IN REAL ESTATE, NET Hotel property and equipment as of June 30, 2007 consisted of the following: Accumuluated Net Book Cost Depreciation Value ------------ ------------ ------------ Land $ 1,896,000 $ - $ 1,896,000 Furniture and equipment 15,458,000 (4,819,000) 10,639,000 Building and improvements 47,161,000 (14,463,000) 32,698,000 ------------ ------------ ------------ $ 64,515,000 $(19,282,000) $ 45,233,000 ------------ ------------ ------------ Depreciation expense for the years ended June 30, 2007 and 2006 was $4,130,000 and $2,251,000 respectively. The Company also owns and operates a 27-unit and 2-unit multi-family apartment complex located in Los Angeles, California. At June 30, 2007, investment in real estate included the following: Land $ 2,430,000 Buildings, improvements and equipment 2,575,000 Accumulated depreciation (529,000) --------- $4,476,000 ========= Depreciation expense for the years ended June 30, 2007 and 2006 was $80,000 and $76,000 respectively. NOTE 4 - INVESTMENT IN MARKETABLE SECURITIES AND OTHER INVESTMENTS The Company's investment portfolio consists primarily of corporate equities. The Company has also invested 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 June 30, 2007, all of the Company's marketable securities are classified as trading securities. In accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," the change in the unrealized gains and losses on these investments are included in the statements of operations. Trading securities are summarized as follows: As of June 30, 2007 Gross Gross Net Market Investment Cost Unrealized Gain Unrealized Loss Unrealized Gain Value - ---------- ----------- --------------- --------------- --------------- ------------ Corporate Equities $ 9,959,000 $ 5,258,000 ($1,524,000) $3,734,000 $13,693,000
As of June 30, 2007, the Company had $347,000 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 and/or to provide additional return opportunities. The Company has no naked short positions. As of June 30, 2007, the Company had obligations for securities sold (equities short) of $1,056,000. -36- 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 years ended June 30, 2007 and 2006, respectively. For the years ended June 30, 2007 2006 ----------- ----------- Realized gains on marketable securities $ 1,936,000 $ 468,000 Unrealized gains on marketable securities 102,000 2,198,000 ----------- ----------- Net gains on marketable securities $ 2,038,000 $ 2,666,000 =========== =========== NOTE 5 - MORTGAGE NOTES PAYABLE Each mortgage note payable is secured by its respective land and building. As of June 30, 2007, the Company had the following two mortgages on its Hotel and two mortgages on its two rental apartments: Mortgage balance Property Interest Rate Origination Date Maturity Date - ---------------- -------- ------------- ---------------- -------------- $ 29,203,000 Hotel 5.22% Fixed July 27, 2005 August 5, 2015 18,965,000 Hotel 6.42% Fixed March 27, 2007 August 5, 2015 1,782,000 Apartment 7.73% Fixed October 29, 1999 October 1,2029 431,000 Apartment 7.00% Variable January 1, 2002 January 18, 2032 ---------- $ 50,381,000 ==========
On July 27, 2005, Justice entered into a first mortgage loan with The Prudential Insurance Company of America in a principal amount of $30,000,000 (the "Prudential Loan"). The term of the Prudential Loan is for 120 months at a fixed interest rate of 5.22% per annum. The Prudential Loan calls for monthly installments of principal and interest in the amount of approximately $165,000, calculated on a 30 year amortization schedule. The 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. In March 2007, Justice entered into a second mortgage loan with The Prudential Insurance Company of America (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 Partnership's first mortgage loan with Prudential. 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 360 month amortization schedule. The 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 Loan is without recourse to the limited and general partners of Justice. From the proceeds of the Second Prudential Loan, Justice retired its existing line of credit facility with United Commercial Bank ("UCB") paying off the outstanding balance of principal and interest of approximately $16,403,000 on March 27, 2007. The Partnership also obtained a new unsecured $3,000,000 revolving line of credit facility from UCB to be utilized by the Partnership to meet any emergency or extraordinary cash flow needs arising from any disruption of business due to labor issues, natural causes affecting tourism and other unexpected events. The term of the new line of credit facility is for 60 months at an annual interest rate, based on an index selected by Justice at the time -37- of advance, equal to the Wall Street Journal Prime Rate or the Libor Rate plus two percent. As of June 30, 2007, there were no amounts borrowed by Justice under the new line of credit; however, $1,500,000 of that line was utilized in the form of a standby letter of credit related to the Allied Litigation (See NOTE 14). The annual fee for the letter of credit is one and one half percent of $1,500,000, which fee is to be paid in quarterly installments for the periods in which the letter of credit is in effect. Future minimum payments for mortgage notes payable are as follows: For the year ending June 30, 2008 $ 724,000 2009 766,000 2010 812,000 2011 859,000 2012 910,000 Thereafter 46,310,000 ----------- $50,381,000 =========== NOTE 6 - RENTAL INCOME The Partnership leases the parking garage and spa facility to others for various terms through May 2013 that have been classified as operating leases. Contingent rental income is recognized when specified sales targets are met by the lessee. The Partnership has a lease agreement with Evon for the use of the parking garage expiring in November 2010. The lease provides the Partnership with minimum monthly payments of $20,000 and additional contingent rental income based on 60% of the gross parking revenues. For the years ended June 30, 2007 and 2006, the Partnership recorded contingent rental income from Evon of $1,296,000 and $708,000, respectively. The Partnership has a lease agreement with Tru Spa, LLC for the use of the spa facilities expiring in May 2013. The lease provides the Partnership with minimum monthly payments of $14,000, subject to increases based on the Consumer Price Index. Future minimum rentals to be received under existing non-cancelable operating leases as of June 30, 2007 for each of the next five years and in the aggregate are: For the year ending June 30, Parking Garage Spa Facilities Total -------------- -------------- ---------- 2008 $ 237,000 $ 165,000 $ 402,000 2009 237,000 165,000 402,000 2010 237,000 165,000 402,000 2011 99,000 165,000 264,000 2012 - 165,000 165,000 Thereafter - 151,000 151,000 -------------- -------------- ---------- $ 810,000 $ 976,000 $1,786,000 ============== ============== ========== -38- NOTE 7 - MANAGEMENT AGREEMENT On February 2, 2007, the Partnership entered into an agreement with Prism to manage and operate the Hotel as its agent. The agreement is effective for a term of ten years, unless the agreement is extended or earlier terminated as provided in the agreement. Under the management agreement, the Partnership is to pay base management fees of 2.5% of gross operating revenues for the fiscal year. However, 0.75% of the stated management fee was due only if the partially adjusted net operating income for the fiscal year exceeded the amount of the Partnership's required return ($7 million) for the fiscal year. Prism is also entitled to an incentive management fee if certain milestones are accomplished. No incentive fees were earned during the year ended June 30, 2007. Management fees paid to Prism during the year ended June 30, 2007 were $212,000. Prior to the Prism management agreement, the Hotel was managed and operated by Dow. Under the Dow management agreement, the Partnership was to pay base management fees of 2.5% of gross operating revenues for the fiscal year. However, 0.75% of the stated management fee was due only if the partially adjusted net operating income for the subject fiscal year exceeds the amount of the Partnership's required return ($7 million) for that fiscal year. Dow was also entitled to incentive management fees if certain milestones were accomplished, no incentive management fees were earned during the years ended June 30, 2007 and June 30, 2006. Management fees paid to DOW during the years ended June 30, 2007 and 2006 were $311,000 and $193,000, respectively. NOTE 8 - HILTON FRANCHISE LICENSE AGREEMENT Partnership entered into a Franchise License Agreement with Hilton Hotels Corporation (the "Hilton Franchise Agreement") on December 10, 2004 for the right to operate the Hotel as a Hilton brand hotel. The term of the Hilton Franchise Agreement is for 15 years commencing on the opening date of the Hotel, January 12, 2006, with an option to extend that Agreement for another five years, subject to certain conditions. The Partnership will pay monthly royalty fees for the first two years of three percent (3%) of the Hotel's gross room revenue, as defined, for the preceding calendar month, the third year will be four percent (4%) of the Hotel's gross room revenue, and the fourth year until the end of the term will be five percent (5%) of the Hotel's gross room revenue. Justice also pays a monthly program fee of four percent of the Hotel's gross room revenue and an information technology recapture charge of 0.75% of the Hotel's gross revenue. The amount of the monthly program fee is subject to change; however, the monthly program fee will not exceed five percent of gross room revenue. The franchise fee for years ended June 30, 2007 and 2006 were $1,702,000 and $503,000, respectively. The royalty fee and monthly program fee for years ended June 30, 2007 and 2006 was $183,000 and $54,000, respectively. At June 30, 2007 and 2006, the amount payable to Hilton Hotels Corporation for royalty, monthly program fee, and franchise fee was $160,000 and $131,000, respectively. -39- NOTE 9 - INCOME TAXES The Company and Portsmouth file separate tax returns for both federal and state purposes. The provision for income tax benefit (expense) consists of the following: For the year ended June 30, 2007 2006 ---------- ---------- Federal Current $ - $ (1,000) Deferred (62,000) 1,463,000 ---------- ---------- (62,000) 1,462,000 ---------- ---------- State Current (3,000) 53,000 Deferred 264,000 141,000 ---------- ---------- 261,000 194,000 ---------- ---------- $ 199,000 $ 1,656,000 ========== ========== A reconciliation of the statutory federal income tax rate to the effective tax rate is as follows: For the year ended June 30, 2006 2005 ------ ------ Statutory federal tax rate 34.0% 34.0% State income taxes, net of federal tax benefit 5.5% 5.7% Valuation allowance (31.8%) - Other (0.1%) 2.1% ------ ------ 7.6% 41.8% ====== ====== The components of the Company's deferred tax assets and (liabilities) as of June 30, 2007 are as follows: Deferred tax assets Net operating loss carryforwards $ 5,826,000 Other investment impairment reserve 375,000 Constructive sales 51,000 Wash sales 14,000 Other 39,000 Valuation allowance (839,000) ---------- 5,466,000 Deferred tax liabilities Unrealized gains on marketable securities (1,467,000) Deferred gains on real estate sale (912,000) Book/tax basis difference in the investment in Justice Investors (721,000) State taxes (148,000) ---------- (3,248,000) ---------- Net deferred tax asset $ 2,218,000 ========== -40- As of June 30, 2007, the Company had net operating loss carryforwards of $14,279,000 and $10,996,000 for federal and state purposes, respectively. These carryforwards begin to expire in varying amounts through 2025. For the year ended June 30, 2007, the Company recorded a valuation allowance of $839,000 against the total deferred tax assets. Management believes that it is more likely than not that the Company will not realize the entire benefit of the deferred asset as of June 30, 2007. NOTE 10 - SEGMENT INFORMATION The Company operates in three reportable segments, the operation of Justice Investors, the operations of 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. Information below represents reporting segments for the year ended June 30, 2007 and 2006. Operating income for rental properties consist of rental income. Operating income from Justice Investors consists of the operations of the hotel and garage included in the equity in net income of Justice Investors. Operating income for investment transactions consist of net investment gains and dividend and interest income. REAL ESTATE AS OF AND ------------------------- FOR THE YEAR ENDED JUSTICE RENTAL INVESTMENT JUNE 30, 2007 INVESTORS PROPERTIES TRANSACTIONS OTHER TOTAL ----------- ----------- ------------ ----------- ------------ Operating income $ 31,715,000 $ 501,000 $ 1,414,000 $ - $ 33,630,000 Operating expenses (29,225,000) (246,000) (775,000) - (30,246,000) ----------- ----------- ----------- ----------- ------------ 2,490,000 255,000 639,000 - 3,384,000 Mortgage interest expense (2,919,000) (172,000) - - (3,091,000) Depreciation and amort. (4,172,000) (80,000) - - (4,252,000) General and administrative Expense - - - (1,013,000) (1,013,000) Other expense (85,000) - - - (85,000) Income tax benefit - - - 199,000 199,000 Minority interest 2,423,000 - - 473,000 2,896,000 ----------- ----------- ----------- ----------- ------------ Net income (loss) $ (2,263,000) $ 3,000 $ 639,000 $ (341,000) $ (1,962,000) =========== =========== =========== =========== ============ Total Assets $ 50,921,000 $ 4,476,000 $17,868,000 $ 2,569,000 $ 75,834,000 =========== =========== =========== =========== ============
-41- REAL ESTATE AS OF AND ------------------------- FOR THE YEAR ENDED JUSTICE RENTAL INVESTMENT JUNE 30, 2006 INVESTORS PROPERTIES TRANSACTIONS OTHER TOTAL ----------- ----------- ------------ ----------- ------------ Operating income(loss) $ (4,017,000) $ 441,000 $ 2,994,000 $ - $ (582,000) Operating expenses - (203,000) (689,000) - (892,000) ----------- ----------- ----------- ----------- ------------ (4,017,000) 238,000 2,305,000 - (1,474,000) Mortgage interest expense - (173,000) - - (173,000) Depreciation and amort. - (76,000) - - (76,000) General and administrative Expense - - - (956,000) (956,000) Other expense (85,000) - - - (85,000) Income tax benefit - - - 1,656,000 1,656,000 Minority interest - - - 506,000 506,000 ----------- ----------- ----------- ----------- ------------ Net income (loss) $ (4,102,000) $ (11,000) $ 2,305,000 $ 1,206,000 $ (602,000) =========== =========== =========== =========== ============ Total Assets $ 1,605,000 $ 4,547,000 $21,016,000 $ 2,820,000 $ 29,988,000 =========== =========== =========== =========== ============
NOTE 11 - RELATED PARTY TRANSACTIONS The contractor that was selected to oversee the garage and the first four floors' renovation (excluding room upgrades) of the Hotel is the contractor who originally constructed the Hotel. He is also a partner in the Partnership and is a director of Evon Corporation, the managing general partner of the Partnership. The contractor is also a board member of Evon Corporation. As of June 30, 2007 and 2006, there were $33,000 and $501,000, respectively, payable to the contractor. Services performed by the contractor were capitalized as fixed assets which totaled $1,256,000 and $18,300,000 as of June 30, 2007 and 2006, respectively. Management believes these renovations were competitively priced. The garage lessee, Evon, is the Partnership's managing general partner. Evon paid the Partnership $1,533,000 and $945,000 for the years ended June 30, 2007 and 2006, respectively, under the terms of the lease agreement. See Note 7- Rental Income. Rent receivable from Evon at June 30, 2007 and 2006 was $33,000 and $127,000, respectively. The InterGroup Corporation allocates corporate expenses to the Company and its subsidiaries based on management's estimate of the pro rata utilization of resources. During the years ended June 30, 2007 and 2006, the Company made payments to InterGroup of approximately $146,000 and $160,000, respectively, for administrative costs and reimbursement of direct and indirect costs associated with the management of the Companies and their investments, including the partnership asset. On July 18, 2003, the disinterested members of the Board of Directors established a performance based compensation program for the Company's CEO to keep and retain his services as a direct and active manager of the Company's securities portfolio. Pursuant to the criteria established by the Board, Mr. Winfield is entitled to performance based compensation for his management of the Company's securities portfolio equal to 20% of all net investment gains generated in excess of the performance of the S&P 500 Index. Compensation amounts are calculated and paid quarterly based on the results of the Company's investment portfolio for that quarter. Should the Company have a net investment loss during any quarter, Mr. Winfield would not be entitled to any -42- further performance-based compensation until any such investment losses are recouped by the Company. On February 26, 2004, the Board of Directors amended the performance threshold to require an annualized return equal to the Prime Rate of Interest (as published in the Wall Street Journal) plus 2% instead of the S&P 500 Index, effective with the quarterly period commencing January 1, 2004. During the year ended June 30, 2007 and June 30, 2006 Mr. Winfield did not receive any performance based compensation. This performance based compensation program may be further modified or terminated at the discretion of the Board. All of the Company's Directors serve as directors of InterGroup and all three of the Company's Directors serve on the Board of Portsmouth. See also Note 11 - "SUBSEQUENT EVENT" below. NOTE 12 - SUBSEQUENT EVENT In August 2007, Portsmouth agreed to acquire 50% interest in Intergroup Uluniu, Inc., a Hawaiian corporation and a 100% owned subsidiary of The Intergroup Corporation, for $973,000, which represents an amount equal to the costs paid by Intergroup for the acquisition and carrying costs of approximately 2 acres of unimproved land located in Maui, Hawaii. In September 2007, the Company paid Intergroup $758,000 of the $973,000. With the proceeds, Intergroup paid off the $750,000 mortgage note on the land including accrued interest. As a related party transaction, the fairness of the financial terms of the transaction were reviewed and approved by the independent director of Portsmouth. NOTE 13 - COMMITMENTS AND CONTINGENCIES The Portsmouth, Evon and Justice are parties to several mechanic lien claims filed by Allied Construction Management and several subcontractors arising out of the renovation of the Hotel (the "Allied Claims") which have been consolidated into one action in the San Francisco County Superior Court. In August 2007, the Partnership reached tentative settlements, subject to court approval, with all of the subcontractors that filed liens in an aggregate amount of approximately $1,580,000 for which the Partnership had previously recorded a payable. Still unresolved is the balance of the claim asserted by Allied in the approximate amount of $600,000. Justice, Evon and Portsmouth dispute that any amounts are owed to Allied and will vigorously defend the balance of this action against Allied and the Company has not reserved for that amount. From time to time, the Company may be a defendant or co-defendant in other legal actions involving various claims incident to the conduct of its business. Most of such claims are covered by insurance. Management does not anticipate the Company to suffer any material liability by reason of such actions. Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None. -43- Item 8A. 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 Annual Report on Form 10-KSB. Based upon such evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company's disclosure controls and procedures are effective in ensuring that information required to be disclosed in this filing is accumulated and communicated to management and is recorded, processed, summarized and reported in a timely manner and in accordance with Securities and Exchange Commission rules and regulations. (b) Internal Control Over Financial Reporting. There have been no changes in the Company's internal control over financial reporting during the last quarterly period covered by this Annual Report on Form 10-KSB that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. Item 8B. Other Information. Effective August 20, 2007, Computershare Trust Company, N.A. ("Computershare") is now acting as the new transfer agent and registrar for the Company. The change was a result of the acquisition of Portsmouth's prior transfer agent and registrar, U.S. Stock Transfer Corporation, by Computershare. The contact information for Computershare is as follows: For Standard U.S. Postal Mail ----------------------------- Computershare Trust Company, N.A. P.O. Box 43070 Providence, RI 02940-3070 For Overnight/Express Delivery ------------------------------ Computershare Trust Company, N.A. 250 Royall Street Canton, MA 02021 Telephone and Fax ----------------- Toll free in U.S. 800-962-4284 Telephone 303-262-0600 Fax 303-262-0700 For DWAC Instructions Provided by Brokers ----------------------------------------- Fast Transfer Agent Number - 50173 Website ------- www.computershare.com E-Mail Inquiries ---------------- web.queries@computershare.com -44- PART III Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act. The following table sets forth certain information with respect to the Directors and Executive Officers of the Company as of June 30, 2007: Present Position Director Name Age with the Company Since Term to Expire - -------------------------------------------------------------------------------------- John V. Winfield 60 Chairman, President 1995 2007 Annual Meeting and Chief Executive Officer (1) William J. Nance 62 Director (1)(2) 1996 2007 Annual Meeting John C. Love 67 Director (1)(2) 1998 2007 Annual Meeting Michael G. Zybala 55 Vice President, Secretary, and General Counsel N/A N/A David T. Nguyen 34 Treasurer and N/A N/A Controller - ---------------------------
(1) Member of Securities Investment Committee (2) Member of Audit Committee BUSINESS EXPERIENCE: The principal occupation and business experience during the last five years for each of the Directors and Executive Officers of the Company are as follows: John V. Winfield - Mr. Winfield was first elected to the Board in May of 1995 and currently serves as the Company's Chairman of the Board, President and Chief Executive Officer, having been appointed as such in April 1996. Mr. Winfield is also the Chairman of the Board, President and Chief Executive Officer of the Company's subsidiary Portsmouth, having held those positions since May of 1996. Mr. Winfield is Chairman of the Board, President and Chief Executive Officer of The InterGroup Corporation ("InterGroup"), a public company, and has held those positions since 1987. William J. Nance - Mr. Nance was first elected to the Board in May of 1996. Mr. Nance is also a director of Portsmouth. Mr. Nance is the President and CEO of Century Plaza Printers, Inc., a company he founded in 1979. He has also served as a consultant in the acquisition and disposition of multi-family and commercial real estate. Mr. Nance is a Certified Public Accountant and, from 1970 to 1976, was employed by Kenneth Leventhal & Company where he was a Senior Accountant specializing in the area of REITS and restructuring of real estate companies, mergers and acquisitions, and all phases of real estate development and financing. Mr. Nance is also Director of InterGroup, a public company, and has held such position since 1984. Mr. Nance also serves as a director of Goldspring, Inc., a public company. -45- John C. Love - Mr. Love was appointed a Director of the Company on March 5, 1998. Mr. Love is an international hospitality and tourism consultant and a hotel broker. He was formerly a partner in the national CPA and consulting firm of Pannell Kerr and Forster. Mr. Love has extensive experience in hotel development, acquisition and development. He is Chairman Emeritus of Golden Gate University in San Francisco. Mr. Love is also a Director of Portsmouth, having first been appointed in March 1998 and a Director of InterGroup, having first been appointed in January 1998. Michael G. Zybala - Mr. Zybala was appointed as Vice President and Secretary of the Company on February 20, 1998 and was appointed Treasurer on May 16, 2000, which was a position he held until February 27, 2003. He is also Vice President, Secretary and General Counsel of Portsmouth. Mr. Zybala has served as the Company's General Counsel since 1995 and has represented the Company as its corporate counsel since 1978. Mr. Zybala also serves as Assistant Secretary and counsel to InterGroup and served as its Vice President Operations from January 1999 to July 15, 2002. David T. Nguyen - Mr. Nguyen was appointed as Treasurer of the Company on February 27, 2003. Mr. Nguyen also serves as Treasurer of InterGroup and Portsmouth, having been appointed to those positions on February 26, 2003 and February 27, 2003, respectively. Mr. Nguyen is a Certified Public Accountant and, from 1995 to 1999, was employed by PricewaterhouseCoopers LLP where he was a Senior Accountant specializing in real estate. Mr. Nguyen has also served as the Company's Controller from 1999 to December 2001 and from December 2002 to present. Family Relationships: There are no family relationships among directors, executive officers, or persons nominated or chosen by the Company to become directors or executive officers. Involvement in Certain Legal Proceedings: No director or executive officer, or person nominated or chosen to become a director or executive officer, was involved in any legal proceeding requiring disclosure. BOARD AND COMMITTEE INFORMATION Santa Fe is an unlisted company and a small business issuer under the rules and regulations of the Securities and Exchange Commission ("SEC"). The majority of its Board of Directors consists of "independent" directors as independence is defined by the applicable rules of the SEC and the National Association of Securities Dealers' ("NASD"). AUDIT COMMITTEE AND AUDIT COMMITTEE FINANCIAL EXPERT Santa Fe is an unlisted company and small business issuer under SEC rules. The Company's Audit Committee is currently comprised of Messrs. Nance (Chairperson) and Love, each of whom are independent directors as independence is defined by the applicable rules of the SEC and the NASD, and as may be modified or supplemented. Each of these directors also meets the audit committee financial expert test. Procedures for Recommendations of Nominees to Board of Directors There have been no changes to the procedures previously disclosed by which security holders may recommend nominees to the Company's Board of Directors. -46- SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Securities Exchange Act of 1934 requires the Company's officers and directors, and each beneficial owner of more than ten percent of the Common Stock of the Company, to file reports of ownership and changes in ownership with the Securities and Exchange Commission. Officers, directors and greater than ten-percent shareholders are required by SEC regulations to furnish the Company with copies of all Section 16(a) forms they file. Based solely on its review of the copies of such forms received by the Company, or written representations from certain reporting persons that no Forms 5 were required for those persons, the Company believes that during fiscal 2007 all filing requirements applicable to its officers, directors, and greater than ten-percent beneficial owners were complied with. Code of Ethics. The Company has adopted a Code of Ethics that applies to its principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. A copy of the Code of Ethics is filed as Exhibit 14 to this Report. The Company will provide to any person without charge, upon request, a copy of its code of ethics by sending such request to: Santa Fe Financial Corporation, Attn: Treasurer, 820 Moraga Drive, Los Angeles 90049. The Company does not maintain an Internet website. The Company will promptly disclose any amendments or waivers to its Code of Ethics on Form 8-K. Item 10. Executive Compensation The following table provides certain summary information concerning compensation awarded to, earned by, or paid to the Company's principal executive officer and other named executive officers of the Company whose total compensation exceeded $100,000 for all services rendered to the Company and its subsidiary for each of the Company's last two competed fiscal years ended June 30, 2007 and June 30, 2006. No stock awards, long-term compensation, options or stock appreciation rights were granted to any of the named executive officers during the last two fiscal years. SUMMARY COMPENSATION TABLE Fiscal All Other Name and Principal Position Year Salary Bonus Compensation Total - --------------------------- ---- ---------- ---------- ------------ ------------ John V. Winfield 2007 $267,000(1) $ - $42,500(2) $ 309,500 Chairman, President and 2006 $267,000(1) $ - $42,500(2) $ 309,500 Chief Executive Officer Michael G. Zybala 2007 $135,000(3) $ - $ - $ 135,000 Vice President, Secretary 2006 $ 85,500(3) $ - $ - $ 85,500 and General Counsel - ---------------------------
(1) Includes salary and director's fees received from the Company's subsidiary, Portsmouth, in the amounts of $133,000 for each of the fiscal years ended June 30, 2007 and 2006 and directors fees in the amount of $6,000 per year paid by Santa Fe. Does not include compensation received from Santa Fe's parent corporation, InterGroup, of $255,000 for each of the fiscal years ended June 30, 2007 and June 30, 2006. -47- (2) During fiscal 2007 and 2006, the Company and Portsmouth also paid combined annual premiums of $42,500, for each respective year, for split dollar whole life insurance policies, owned by, and the beneficiary of which is, a trust for the benefit of Mr. Winfield's family. Portsmouth's share of those premiums was $17,000 per year. These policies were obtained in December 1998 and provide for an aggregate death benefit of $2,500,000. The Company has a secured right to receive, from any proceeds of the policy, reimbursement of all premiums paid prior to any payments to the beneficiary. (3) Includes salary and Special Hotel Committee monthly fee and meeting fees paid by Portsmouth in the aggregate amounts of $118,800 and $72,000 for fiscal years ended June 30, 2007 and June 30, 2006, respectively. Does not include $27,000 and $22,000 paid by Santa Fe's parent company, InterGroup, for fiscal 2007 and 2006, respectively. As a small business issuer, Santa Fe has no compensation committee. Executive Officer compensation is set by disinterested members of the Board of Directors. Santa Fe has no stock option plan or stock appreciation rights for its executive officers. The Company has no pension or long-term incentive plans. There are no employment contracts between Santa Fe and any executive officer, nor is there any termination-of-employment or change-in-control arrangements. On July 18, 2003, the disinterested members of the Board of Directors established a performance based compensation program for the Company's CEO, John V. Winfield, to keep and retain his services as a direct and active manager of the Company's securities portfolio. The Company's previous experience and results with outside money managers was not acceptable. Pursuant to the criteria established by the Board, Mr. Winfield was be entitled to performance compensation for his management of the Company's securities portfolio equal to 20% of all net investment gains generated in excess of the performance of the S&P 500 Index. Compensation amounts will be calculated and paid quarterly based on the results of the Company's investment portfolio for that quarter. Should the Company have a net investment loss during any quarter, Mr. Winfield would not be entitled to any further performance-based compensation until any such investment losses are recouped by the Company. On February 26, 2004, the Board of Directors amended the performance threshold to require an annualized return equal to the Prime Rate of Interest (as published in the Wall Street Journal) plus 2% instead of the S&P 500 Index, effective with the quarterly period commencing January 1, 2004. This change was made to make the Company's plan be consistent with that established by its parent company, InterGroup. This performance based compensation program may be further modified or terminated at the discretion of the Board. No performance based compensation was paid for fiscal years ended June 30, 2007 or 2006. Internal Revenue Code Limitations Section 162(m) of the Internal Revenue Code of 1986, as amended (the "Code"), provides that, in the case of a publicly held corporation, the corporation is not generally allowed to deduct remuneration paid to its chief executive officer and certain other highly compensated officers to the extent that such remuneration exceeds $1,000,000 for the taxable year. Certain remuneration, however, is not subject to disallowance, including compensation paid on a commission basis and, if certain requirements prescribed by the Code are satisfied, other performance based compensation. No compensation paid by the Company to its CEO or other executive officers was subject the deduction disallowance prescribed by Section 162(m) of the Code. -48- Outstanding Equity Awards at Fiscal Year End. The Company did not have any outstanding equity awards at the end of its fiscal year ended June 30, 2007 and has no equity compensation plans in effect. DIRECTOR COMPENSATION Fees Earned or Paid All Other Name in Cash Compensation Total - ----------------- ----------- ------------ ------- John C. Love $ 70,000(1) - $70,000 William J. Nance $ 70,000(1) - $70,000 John V. Winfield(2) - ------------------ (1) Mr. Love and Mr. Nance also serve as directors of the Company's subsidiary, Portsmouth. Amounts shown include $8,000 in regular board and audit committee fees paid by Santa Fe and $8,000 in regular board and audit committee fees paid by Portsmouth. These amounts also include $54,000 in special hotel committee monthly fees and meeting fees paid to Mr. Love and Mr. Nance by Portsmouth related to active oversight of the operations, renovations and repositioning of its Hotel asset. (2) As an executive officer Mr. Winfield director's fees are reported in the Summary Compensation Table. The bylaws of Santa Fe permit directors to be paid a fixed sum for attendance at each meeting of the Board or a stated retainer fee as director. Each director is paid a fee of $1,500 per quarter for a total annual compensation of $6,000. This policy has been in effect since July 1, 1985. Members of the Company's Audit Committee also receive a fee of $500 per quarter. -49- Item 11. Security Ownership of Certain Beneficial Owners and Management (a) Security ownership of Certain Beneficial Owners The following table sets forth, as of September 14, 2007, certain information with respect to the beneficial ownership of the Company's voting securities owned by those persons or groups known by the Company to own more than five percent of any class of the Company's voting securities. Name and Address of Amount and Nature Percent of Beneficial Owner of Beneficial Owner (1) Class (2) - ------------------- ---------------------- ---------- Guinness Peat Group plc ("GPG") 89,858(3) 7.2% Allied Mutual Insurance Services ("AMI") First Floor, Times Place, 45 Pall Mall London SW1Y 5GP, UK The InterGroup Corporation 932,459 75.1% 820 Moraga Drive Los Angeles, CA 90049 John V. Winfield 49,400 4.0% 820 Moraga Drive Los Angeles, CA 90049 The InterGroup Corporation and 981,859(4) 79.1% John V. Winfield as a group - ------------------------------ (1) Unless otherwise indicated, and subject to applicable community property laws, each person has sole voting and investment power with respect to the shares beneficially owned. (2) Percentages are calculated on the basis of 1,241,810 shares of Common Stock issued and outstanding as of September 14, 2007, plus any securities that person has the right to acquire within 60 days pursuant to options, warrants, conversion privileges or other rights. (3) Based on their Statement on Schedule 13D (Amendment No. 6) dated June 13, 2001, GPG and its wholly-owned subsidiary AMI claim shared power to vote, or to direct the vote, and to dispose of, or to direct the disposition of, the shares of Santa Fe's Common Stock owned of record by AMI. (4) Pursuant to Voting Trust Agreement dated June 30, 1998, InterGroup has the power to vote the 49,400 shares of Common Stock owned by Mr. Winfield. As President, Chairman of the Board and a 62.6% shareholder of InterGroup, Mr. Winfield has voting and dispositive power over the shares owned of record and beneficially by InterGroup. -50- (b) Security Ownership of Management The following table sets forth, as of September 14, 2007, certain information with respect to the beneficial ownership as to each class of the Company's equity securities beneficially owned by all directors, each of the named executive officers and directors and executive officers as a group. Name and Address of Amount and Nature Percent of Beneficial Owner of Beneficial Owner(1) Class (2) - ------------------- ------------------- ---------- John V. Winfield 981,859(3) 79.1% 820 Moraga Drive Los Angeles, CA 90049 John C. Love 0(4) * 820 Moraga Drive Los Angeles, CA 90049 William J. Nance 0(4) * 820 Moraga Drive Los Angeles, CA 90049 Michael G. Zybala 0 * 820 Moraga Drive Los Angeles, CA 90049 David T. Nguyen 0 * 820 Moraga Drive Los Angeles, CA 90049 All of the above as a group 981,859 79.1% - --------------------------- * Ownership does not exceed 1% (1) Unless otherwise indicated, and subject to applicable community property laws, each person has sole voting and investment power with respect to the shares beneficially owned. (2) Percentages are calculated on the basis of 1,241,810 shares of Common Stock issued and outstanding as of September 14, 2007, plus any securities that person has the right to acquire within 60 days pursuant to options, warrants, conversion privileges or other rights. (3) John V. Winfield is the sole beneficial owner of 49,400 shares of Common Stock. InterGroup is the beneficial owner of 932,459 shares of Common Stock. As the President, Chairman of the Board and a 62.6% shareholder of InterGroup, Mr. Winfield has voting and dispositive power with respect to the shares of Santa Fe owned of record and beneficially by InterGroup. (4) William J. Nance is a 3.3% shareholder of InterGroup as well as a Director thereof. John C. Love is also a Director of InterGroup and a 1.2% shareholder. -51- Security Ownership of Management in Subsidiary As of September 14, 2007, Santa Fe was the record and beneficial owner of 505,437 shares of its subsidiary, Portsmouth, and 79,700 shares are owned by Santa Fe's parent company InterGroup. The President and Chairman of the Board of Santa Fe and InterGroup has voting power with respect to common shares of Portsmouth owned by Santa Fe and InterGroup which represent 79.7% of the voting power of Portsmouth. No other director or executive officer of Santa Fe has a beneficial interest in Portsmouth's shares. (c) Changes in Control There are no arrangements that may result in a change in control of the Company. Securities Authorized for Issuance Under Equity Compensation Plans. Santa Fe has no securities authorized for issuance under any equity compensation plans. Item 12. Certain Relationships and Related Transactions, and Director Independence As of September 10, 2007, Santa Fe and InterGroup owned 79.7% of the common stock of Portsmouth, and InterGroup and John V. Winfield, in the aggregate, owned approximately 79.1% of the voting stock of Santa Fe. All of the Company's Directors serve as directors of InterGroup and all three of the Company's Directors serve on the Board of Portsmouth. Certain costs and expenses, primarily administrative salaries, rent and insurance, are allocated among the Company, its subsidiary, Portsmouth, and parent InterGroup based on management's estimate of the pro rata utilization of resources. During the fiscal years ended June 30, 2007 and 2006, the Company and Portsmouth made payments to InterGroup of approximately $146,000 and $160,000 respectively, for administrative costs and reimbursement of direct and indirect costs associated with the management of the Companies and their investments, including the partnership asset. During fiscal year 2006, the Company paid $26,000 in preferred stock dividends to InterGroup. As Chairman of the Securities Investment Committee, the Company's President and Chief Executive officer, John V. Winfield, directs the investment activity of the Company in public and private markets pursuant to authority granted by the Board of Directors. Mr. Winfield also serves as Chief Executive Officer and Chairman of Portsmouth and InterGroup and oversees the investment activity of those companies. 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. On July 18, 2003, the disinterested members of the Board of Directors established a performance based compensation program for the Company's CEO to keep and retain his services as a direct and active manager of the Company's -52- securities portfolio. Pursuant to the criteria established by the Board, Mr. Winfield is entitled to performance compensation for his management of the Company's securities portfolio equal to 20% of all net investment gains generated in excess of the performance of the S&P 500 Index. Compensation amounts are calculated and paid quarterly based on the results of the Company's investment portfolio for that quarter. Should the Company have a net investment loss during any quarter, Mr. Winfield would not be entitled to any further performance-based compensation until any such investment losses are recouped by the Company. On February 26, 2004, the Board of Directors amended the performance threshold to require an annualized return equal to the Prime Rate of Interest (as published in the Wall Street Journal) plus 2% instead of the S&P 500 Index, effective with the quarterly period commencing January 1, 2004. No such compensation was paid for fiscal years 2007 and 2006. This performance based compensation program may be further modified or terminated at the discretion of the Board. In December 1998, Board of Directors authorized the Company to obtain whole life insurance and split dollar insurance policies covering the Company's President and Chief Executive Officer, Mr. Winfield. During fiscal years 2007 and 2006, the Company paid annual premiums of $25,500 for the split dollar whole life insurance policy, owned by, and the beneficiary of which is, a trust for the benefit of Mr. Winfield's family. The Company has a secured right to receive, from any proceeds of the policy, reimbursement of all premiums paid prior to any payments to the beneficiary. During fiscal 2007 and 2006, Portsmouth paid annual premiums of $17,000 for a split dollar policy also covering Mr. Winfield. The premiums associated with that spilt dollar policy are considered additional compensation to Mr. Winfield. In August 2007, Portsmouth's Board of Directors authorized an investment of $973,000 for Portsmouth to acquire a 50% equity interest in Intergroup Uluniu, Inc., a Hawaii corporation ("Uluniu") in a related party transaction. Uluniu is a 100% owned subsidiary of InterGroup. Uluniu owns an approximately two-acre parcel of unimproved land located in Kihei, Maui, Hawaii which is held for development. The Company's investment in Uluniu represents an amount equal to the costs paid by InterGroup for the acquisition and carrying costs of the property through August 2007. The fairness of the financial terms of the transaction were reviewed and approved by the independent director of Portsmouth. As of September 5, 2007, $758,000 of the investment amount had been paid by Portsmouth. There are no other relationships or related transactions between the Company and any of its officers, directors, five-percent security holders or their families which require disclosure. Director Independence Santa Fe is an unlisted company and a small business issuer under the rules and regulations of the Securities and Exchange Commission ("SEC"). With the exception of the Company's President and CEO, John V. Winfield, all of Portsmouth's Board of Directors consists of "independent" directors as independence is defined by the applicable rules of the SEC and the National Association of Securities Dealers' ("NASD"). -53- Item 13. Exhibits. (a) Listing of Exhibits by Table Number ----------------------------------- Set forth below is an index of applicable exhibits filed with this report according to exhibit table number. Exhibit Page ------- ---- 3.(i) Articles of Incorporation *** (ii) Bylaws (Amended February 15, 2000) **** 4. Instruments defining he rights of Security Holders, * including indentures (see Articles of Incorporation and Bylaws) 10. Material Contracts (a) Securities Purchase Agreement dated December 20, ** 1994 between Santa Fe Financial Corporation and The InterGroup Corporation 14. Code of Ethics (filed herewith) 21. Subsidiaries: (1) Portsmouth Square, Inc. (68.8%) Incorporated on July 6, 1967 in California (2) Intergroup Woodland Village, Inc. (55.4%) Incorporated on August 5, 1993 in Ohio (3) 614 Acanto Properties, Inc. (100%) Incorporated on November 7, 2001 in California 31.1 Certification of Chief Executive Officer of Periodic Report Pursuant to Rule 13a-14(a) and Rule 15d-14(a). (filed herewith) 31.2 Certification of Chief Financial Officer of Periodic Report Pursuant to Rule 13a-14(a) and Rule 15d-14(a). (filed herewith) 32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350. (filed herewith) 32.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350. (filed herewith) * All exhibits marked by an asterisk have been previously filed with other documents, including Registrant's Form 10 filed on October 27, 1967, and subsequent filings on forms 8-K, 10-K and 10-Q which are incorporated herein by reference. ** Securities Purchase Agreement dated December 20, 1994 between Santa Fe Financial Corporation and The InterGroup Corporation was previously filed on March 31, 1995 with Registrant's Form 10-K Annual Report for the year ended December 31, 1994 and is incorporated herein by reference. -54- *** Restated Articles of Incorporation, dated August 12, 1997, were previously filed on March 31, 1998 with Registrant's Form 10-KSB Annual Report for the year ended December 31, 1997 and is incorporated herein by reference. **** Amendment to Bylaws are incorporated herein by reference to the Company's Form 10-KSB filed with the Commission March 29, 2000. (b) Reports on Form 8-K ------------------- No Reports on Form 8-K were filed by the Company during the last quarter of the period covered by this Report. Item 14. Principal Accountant Fees and Services. Audit Fees - The aggregate fees billed for each of the last two fiscal years ended June 30, 2007 and 2006 for professional services rendered by PricewaterhouseCoopers LLP, the principal accountant for the audit of the Company's annual financial statements and review of financial statements included in the Company's Form 10-QSB or services normally provided by the accountant in connection with statutory and regulatory filings or engagements for those fiscal years, were as follows: Fiscal Year -------------------- 2007 2006 -------- -------- Audit Fees $222,000 $254,000 Audit-Related Fees $ - $ - Tax Fees $ - $ - All Other Fees $ - $ - -------- -------- TOTAL: $222,000 $254,000 Audit Committee Pre-Approval Policies The Audit Committee shall pre-approve all auditing services and permitted non- audit services (including the fees and terms thereof) to be performed for the Company by its independent auditor, subject to any de minimus exceptions that may be set for non-audit services described in Section 10A(i)(1)(B) of the Exchange Act which are approved by the Committee prior to the completion of the audit. The Committee may form and delegate authority to subcommittees consisting of one or more members when appropriate, including the authority to grant pre-approvals of audit and permitted non-audit services, provided that decisions of such subcommittee to grant pre-approvals shall be presented to the full Committee at its next scheduled meeting. All of the services described herein were approved by the Audit Committee pursuant to its pre-approval policies. None of the hours expended on the principal accountant's engagement to audit the Company's financial statements for the most recent fiscal year were attributed to work performed by persons other than the principal accountant's full-time permanent employees. -55- SIGNATURES ---------- Pursuant to the requirements of Section 13 or 15(d) 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: September 28, 2007 by /s/ John V. Winfield ------------------ --------------------------- John V. Winfield, President, Chairman of the Board and Chief Executive Officer Date: September 28, 2007 by /s/ Michael G. Zybala ------------------ --------------------------- Michael G. Zybala, Vice President and Secretary Date: September 28, 2007 by /s/ David T. Nguyen ------------------ --------------------------- David T. Nguyen, Treasurer and Controller (Principal Financial Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Date: September 28, 2007 /s/ John V. Winfield ------------------ --------------------------------------- John V. Winfield, Chairman of the Board Date: September 28, 2007 /s/ John C. Love ------------------ --------------------------------------- John C. Love Director Date: September 28, 2007 /s/ William J. Nance ------------------ --------------------------------------- William J. Nance, Director -56- EX-14 2 sfex14.txt EXHIBIT 14 Exhibit 14 SANTA FE FINANCIAL CORPORATION CODE OF ETHICS FOR SENIOR FINANCIAL OFFICERS This Code of Ethics applies to Santa Fe Financial Corporation's ("Santa Fe" or the "Company") Senior Financial Officers. "Senior Financial Officers" shall include the principal executive officer, the principal accounting officer or controller, or persons performing similar functions, including Santa Fe's President and Chief Executive Officer, Chief Financial Officer, Treasurer, Controller, Vice President, and such other individuals as determined from time to time by the Audit Committee of the Company for purposes of this Code of Ethics. The Company expects all employees, in carrying out their job responsibilities, to act in accordance with the highest standards of personal and professional integrity, to comply with all applicable laws, and to abide by Santa Fe's other corporate policies and procedures adopted from time to time by the Company. This Code of Ethics supplements the foregoing with respect to all Senior Financial Officers. Santa Fe's Senior Financial Officers will: 1. Engage in and promote honest and ethical conduct, acting with integrity and exercising at all times their best independent judgment; 2. Avoid actual or apparent conflicts of interest between personal and professional relationships and disclose to the Company's Audit Committee and counsel any material transaction or relationship that reasonably could be expected to give rise to such a conflict; 3. Produce full, fair, accurate, timely and understandable disclosure in reports and documents that Santa Fe files with, or submits to, the Securities and Exchange Commission and in other public communications made by Santa Fe; 4. Comply with applicable governmental laws, rules and regulations, as well as the rules and regulations of self-regulatory organizations of which Santa Fe is a member; 5. Maintain the confidentiality of Company information, except when authorized or otherwise required to make any disclosure, and avoid the use of any Company information for personal advantage; 6. Promote ethical and honest behavior among employees under your supervision; and 7. Promptly report any possible violation of this Code of Ethics to the Audit Committee and the Company's counsel. All Senior Financial Officers are prohibited from directly or indirectly taking any action to coerce, manipulate, mislead or fraudulently influence Santa Fe's independent public accountant engaged in the performance of an audit or review of the financial statements of the Company for the purpose of rendering the financial statements of Santa Fe misleading. The Audit Committee of the Board of Directors shall approve any waiver or amendment of this Code of Ethics, and any such waiver or amendment shall be disclosed promptly as required by law and SEC regulations. All Senior Financial Officers will be held accountable for their adherence to this Code of Ethics. Failure to observe the terms of this Code of Ethics may result in disciplinary action, up to and including termination of employment. Violations of this Code of Ethics may also constitute violations of law, and may result in civil and criminal penalties for the individual, his or her supervisor and/or InterGroup. If a Senior Financial Officer has any questions regarding the best course of action in a particular situation, he or she should promptly contact the Chairman of the Audit Committee or the Company's counsel. An individual may choose to remain anonymous in reporting any possible violation of this Code of Ethics. -2- EX-31 3 sfex311.txt EXHIBIT 31.1 EXHIBIT 31.1 CERTIFICATION I, John V. Winfield, certify that: 1. I have reviewed this annual report on Form 10-KSB of Santa Fe Financial Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing equivalent functions): a) all significant deficiencies and material weakness in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in registrant's internal control over financial reporting. Date: September 28, 2007 /s/ John V. Winfield --------------------------- John V. Winfield, President and Chief Executive Officer EX-31 4 sfex312.txt EXHIBIT 31.2 EXHIBIT 31.2 CERTIFICATION I, David T. Nguyen, certify that: 1. I have reviewed this annual report on Form 10-KSB of Santa Fe Financial Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing equivalent functions): a) all significant deficiencies and material weakness in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in registrant's internal control over financial reporting. Date: September 28, 2007 /s/ David T. Nguyen --------------------------- David T. Nguyen, Treasurer and Controller (serving as Chief Financial Officer) EX-32 5 sfex321.txt EXHIBIT 32.1 EXHIBIT 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Santa Fe Financial Corporation (the "Company") on Form 10-KSB for the fiscal year ended June 30, 2007, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I John V. Winfield, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, to the best of my knowledge, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: September 28, 2007 /s/ John V. Winfield ---------------------------- John V. Winfield, President and Chief Executive Officer [A signed original of this written statement required by Section 906 has been provided to Santa Fe Financial Corporation and will be retained by Santa Fe Financial Corporation and furnished to the Securities and Exchange Commission or its staff upon request.] EX-32 6 sfex322.txt EXHIBIT 32.2 EXHIBIT 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Santa Fe Financial Corporation (the "Company") on Form 10-KSB for the fiscal year ended June 30, 2007, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I David T. Nguyen, Treasurer and Controller of the Company, serving as Chief Financial Officer, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, to the best of my knowledge, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: September 28, 2007 /s/ David T. Nguyen ---------------------------- David T. Nguyen, Treasurer and Controller (serving as Chief financial Officer) [A signed original of this written statement required by Section 906 has been provided to Santa Fe Financial Corporation and will be retained by Santa Fe Financial Corporation and furnished to the Securities and Exchange Commission or its staff upon request.] -----END PRIVACY-ENHANCED MESSAGE-----