INTERGROUP CORP annual report, FY2017

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InterGroup Corporation — FY2017 Form 10-K

Reporting period: Fiscal year ended June 30, 2017, compared with fiscal 2016. Although the request metadata refers to 2016 Q4, this filing is an annual report for FY2017.

Business context

InterGroup is a real estate and investment holding company. Its consolidated operations include the 543-room Hilton San Francisco Financial District, multifamily rental properties, and marketable and other investments. The Hotel is the principal revenue source. InterGroup owns about 81.9% of Santa Fe Financial; Santa Fe owns about 68.8% of Portsmouth Square, which holds a 93% interest in Justice Investors, the Hotel partnership. InterGroup also directly owns about 13.4% of Portsmouth.

Financial results and condition

  • Revenue: $69.0 million, down 5.3% from $72.9 million. Hotel revenue fell to $54.3 million from $58.6 million; real estate revenue rose to $14.7 million from $14.3 million.
  • Profit/loss: Consolidated net loss was $1.7 million, versus $9.3 million in FY2016. Net loss attributable to InterGroup was $1.65 million, or $0.70 per share, compared with $7.14 million, or $2.99 per share.
  • Hotel performance: Hotel operating income before non-recurring charges, interest and depreciation was $13.6 million (25.1% of Hotel revenue), versus $11.3 million (19.3%). Hotel operations reported net income of $3.5 million, compared with a $4.4 million loss. Average daily rate declined to $250 from $257; occupancy to 91% from 92%; and RevPAR to $227 from $237.
  • Other segments: Real estate operations reported $2.7 million of net income, versus $2.8 million. Investment transactions incurred a $4.5 million loss, improved from an $8.9 million loss, including a $3.5 million net loss on marketable securities.
  • Cash flow: Operating activities provided $6.3 million, compared with $9.0 million. Investing activities used $1.7 million; financing activities used $7.1 million. Cash and cash equivalents declined to $2.9 million from $5.4 million.
  • Assets, debt and liquidity: Total assets were $133.2 million and total liabilities $208.5 million; shareholders’ deficit was $75.3 million. Hotel mortgage debt was $115.6 million net of issuance costs, and real estate mortgage debt was $64.3 million net. Related-party and other notes payable were $6.1 million. Restricted cash was $7.4 million and is not equivalent to freely available cash. Contractual obligations, including stated interest, totaled approximately $245.9 million.
  • Investments: Marketable securities were $17.2 million, up from $14.3 million. Comstock Mining represented about 27.6% of the portfolio. Securities sold obligations were $3.7 million; the Company also reported $3.0 million due to securities brokers.

Material changes and outlook

  • FY2017’s lower net loss mainly reflected the absence of FY2016’s $5.4 million Hotel legal-settlement charge, lower Hotel operating expenses, and a smaller securities loss. Hotel expenses fell $6.5 million, partly offset by a $4.2 million revenue decline.
  • Management attributed weaker Hotel room and food-and-beverage revenue mainly to reduced group business during the Moscone Center expansion. The project was scheduled for completion in December 2018; management expected subsequent benefits to occupancy, rates and property value, but gave no quantified forecast.
  • Interstate took over Hotel management on February 3, 2017 under an initial 10-year agreement and advanced $2.0 million for restricted capital improvements. Planned work included technology upgrades, lobby and restaurant changes, and returning additional rooms to service. Management anticipated some rooms would enter service in FY2018.
  • The Hotel’s Hilton franchise was extended through 2030. Management cited guest experience, higher-rated business, international travel and meeting business as priorities. No formal earnings or revenue guidance was provided.
  • Management said available cash, securities, real estate and expected operating cash flows would meet obligations, and cited real estate value as potential borrowing support. These statements are subject to substantial debt, operating and market risks.

Risks, contingencies and unusual items

  • The Hotel depends heavily on the San Francisco market and faces competition, seasonality, wage and operating-cost pressures, and sensitivity to economic conditions. Hotel RevPAR declined year over year.
  • InterGroup became an additional guarantor and environmental indemnitor in May 2017 for Justice’s $97 million mortgage and $20 million mezzanine loan. The loans mature in January 2024; stated rates are 5.275% and 9.75%, respectively. Guarantees include specified full-recourse circumstances, and minimum net-worth and liquidity requirements apply. InterGroup reported compliance at year-end.
  • Marketable-security values can fluctuate materially; Comstock exposure, margin borrowing and short-sale obligations add investment risk. The portfolio had $13.3 million of unrealized losses on securities held over one year at June 30, 2017.
  • Management concluded disclosure controls and internal control over financial reporting were ineffective due to a material weakness in controls over the tax provision, including deferred-tax review and oversight of the outside tax preparer. Management reported hiring a tax specialist and assigning oversight to the audit committee. The auditor did not attest to internal controls.
  • A legal-malpractice arbitration related to the partnership redemption remained active, with a hearing scheduled for April 2018; the filing gave no prediction of the outcome. The Evon settlement was paid, and Justice received $900,000 in March 2017 from an insurer settlement.
  • Labor agreements covering Hotel employees were due to expire in July 2018, with negotiations expected to begin in late 2017. The filing also disclosed environmental, insurance, regulatory, litigation and capital-improvement risks.
  • After year-end, a $1.0 million short-term Portsmouth loan from InterGroup was repaid on September 13, 2017. The filing reports no other subsequent event outside normal operations requiring disclosure.

Important facts for investors to verify

  • Whether the tax-control material weakness has been fully remediated and whether deferred-tax balances require adjustment.
  • Available unrestricted liquidity, scheduled debt service and compliance with loan covenants and guarantor liquidity requirements.
  • Performance and costs under Interstate’s management agreement, use and repayment terms of the $2.0 million key-money advance, and progress on Hotel renovations and room additions.
  • Hotel demand trends after the Moscone Center work, including group revenue, ADR, occupancy and RevPAR.
  • Current market value and concentration of the securities portfolio, particularly Comstock, and the impact of margin and short positions.
  • Developments and potential financial exposure from the pending arbitration and other contingencies.