UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-Q [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2010 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______ to _____ Commission File Number: 0-4057 PORTSMOUTH SQUARE, INC. ----------------------- (Exact name of registrant as specified in its charter) CALIFORNIA 94-1674111 ------------------------------ ------------------ (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 10940 Wilshire Blvd., Suite 2150, Los Angeles, California 90024 --------------------------------------------------------- -------- (Address of principal executive offices) (Zip Code) (310) 889-2500 ----------------------------- (Registrant's telephone number) Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [x] Yes [ ] No Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [ ] Smaller reporting company [x] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.) [ ] Yes [x] No INDEX PORTSMOUTH SQUARE, INC. PART I. FINANCIAL INFORMATION PAGE Item 1. Condensed Consolidated Financial Statements Condensed Consolidated Balance Sheets As of March 31, 2010 and June 30, 2009 (Unaudited) 3 Condensed Consolidated Statements of Operations (Unaudited) For the Three Months ended March 31, 2010 and 2009 4 Condensed Consolidated Statements of Operations (Unaudited) For the Nine Months ended March 31, 2010 and 2009 5 Condensed Consolidated Statements of Cash Flows (Unaudited) For the Nine Months ended March 31, 2010 and 2009 6 Notes to Condensed Consolidated Financial Statements (Unaudited) 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 18 Item 4T. Controls and Procedures 28 PART II. OTHER INFORMATION Item 6. Exhibits 28 SIGNATURES 29 -2- PART 1 FINANCIAL INFORMATION Item 1 - Condensed Consolidated Financial Statements PORTSMOUTH SQUARE, INC. CONDENSED CONSOLIDATED BALANCE SHEETS March 31, 2010 June 30, 2009 ----------------- ------------- Assets Investment in hotel, net $ 34,797,000 $ 36,342,000 Investment in real estate 973,000 973,000 Investment in marketable securities 4,783,000 5,987,000 Other investments, net 2,600,000 2,409,000 Cash and cash equivalents 1,257,000 209,000 Accounts receivable, net 977,000 1,271,000 Other assets, net 1,889,000 1,684,000 Deferred tax asset 4,606,000 3,709,000 ------------ ------------ Total assets $ 51,882,000 $ 52,584,000 ============ ============ Liabilities and Shareholders' Equity (Deficit) Liabilities Accounts payable and other liabilities $ 9,481,000 $ 8,531,000 Due to securities broker 2,295,000 1,514,000 Obligations for securities sold 303,000 699,000 Line of Credit 2,500,000 1,811,000 Mortgage notes payable 46,186,000 46,757,000 ------------ ------------ Total liabilities 60,765,000 59,312,000 ------------ ------------ Commitments and contingencies Shareholders' equity (deficit): Common stock, no par value; 750,000 authorized shares; 734,183 shares issued and outstanding 2,092,000 2,092,000 Additional paid-in capital 916,000 916,000 Accumulated deficit (2,454,000) (1,140,000) ------------ ------------ Total Portsmouth shareholders' equity 554,000 1,868,000 Noncontrolling interest (9,437,000) (8,596,000) ------------ ------------ Total shareholders' deficit (8,883,000) (6,728,000) ------------ ------------ Total liabilities and shareholders' equity (deficit) $ 51,882,000 $ 52,584,000 ============ ============ The accompanying notes are an integral part of these condensed consolidated financial statements. -3- PORTSMOUTH SQUARE, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) For the three months ended March 31, 2010 2009 ---------- ---------- Revenue - hotel $ 7,456,000 $ 7,073,000 ---------- ---------- Costs and operating expenses Hotel operating expenses (6,670,000) (6,314,000) Depreciation and amortization expense (1,220,000) (1,118,000) General and administrative expense (150,000) (141,000) ---------- ---------- Total costs and operating expenses (8,040,000) (7,573,000) ---------- ---------- Loss from operations (584,000) (500,000) ---------- ---------- Other income(expense) Interest expense (732,000) (719,000) Net gain(loss) on marketable securities 120,000 (92,000) Net unrealized loss on other investments (26,000) - Impairment loss on other investments (84,000) (257,000) Dividend and interest income 45,000 39,000 Trading and margin interest expense (56,000) (44,000) ---------- ---------- Net other expense (733,000) (1,073,000) ---------- ---------- Loss before income taxes (1,317,000) (1,573,000) Income tax benefit 286,000 409,000 ---------- ---------- Net loss (1,031,000) (1,164,000) Less: Net loss attributable to the noncontrolling interest 617,000 - ---------- ---------- Net loss attributable to Portsmouth (414,000) (1,164,000) ========== ========== Basic and diluted loss per share attributable to Portsmouth $ (0.56) $ (1.59) ========== ========== Weighted average number of common shares Outstanding 734,183 734,183 ========== ========== The accompanying notes are an integral part of these condensed consolidated financial statements. -4- PORTSMOUTH SQUARE, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) For the nine months ended March 31, 2010 2009 ---------- ---------- Revenue - hotel $ 24,354,000 $ 25,016,000 ---------- ---------- Costs and operating expenses Hotel operating expenses (20,089,000) (20,833,000) Depreciation and amortization expense (3,551,000) (3,335,000) Loss on termination of garage lease - (684,000) General and administrative expense (424,000) (413,000) ---------- ---------- Total costs and operating expenses (24,064,000) (25,265,000) ---------- ---------- Income(loss) from operations 290,000 (249,000) ---------- ---------- Other income(expense) Interest expense (2,174,000) (2,162,000) Net gain(loss) on marketable securities (676,000) 28,000 Net unrealized gain on other investments 59,000 - Impairment loss on other investments (418,000) (615,000) Dividend and interest income 96,000 84,000 Trading and margin interest expense (229,000) (151,000) ---------- ---------- Net other expense (3,342,000) (2,816,000) ---------- ---------- Loss before income taxes (3,052,000) (3,065,000) Income tax benefit 897,000 806,000 ---------- ---------- Net loss (2,155,000) (2,259,000) Less: Net loss attributable to the noncontrolling interest 841,000 - ---------- ---------- Net loss attributable to Portsmouth (1,314,000) (2,259,000) ========== ========== Basic and diluted loss per share attributable to Portsmouth $ (1.79) $ (3.08) ========== ========== Weighted average number of common shares Outstanding 734,183 734,183 ========== ========== The accompanying notes are an integral part of these condensed consolidated financial statements. -5- PORTSMOUTH SQUARE, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) For the nine months ended March 31, 2010 2009 ---------- ---------- Cash flows from operating activities: Net loss $(2,155,000) $(2,259,000) Adjustments to reconcile net loss to net cash provided by operating activities: Net unrealized loss(gain) on marketable securities 2,693,000 (352,000) Net unrealized (gain) on other investments (59,000) - Impairment loss on other investments 418,000 615,000 Depreciation and amortization 3,551,000 3,335,000 Loss on termination of garage lease - 684,000 Changes in assets and liabilities: Investment in marketable securities (1,489,000) 1,060,000 Accounts receivable 294,000 (102,000) Other assets (205,000) (110,000) Deferred tax asset (897,000) (806,000) Accounts payable and other liabilities 784,000 553,000 Due to securities broker 781,000 (544,000) Obligations for securities sold (396,000) - ---------- ---------- Net cash provided by operating activities 3,320,000 2,074,000 ---------- ---------- Cash flows from investing activities: Capital expenditures for furniture, equipment and building improvements (1,255,000) (959,000) Other investments (550,000) (435,000) ---------- ---------- Net cash used in investing activities (1,805,000) (1,394,000) ---------- ---------- Cash flows from financing activities: Draw on line of credit 689,000 187,000 Principal payments on mortgage note payable (571,000) (540,000) Payment on other notes payable (585,000) - Distributions to noncontrolling interest - (425,000) ---------- ---------- Net cash used in financing activities (467,000) (778,000) ---------- ---------- Net increase(decrease) in cash and cash equivalents 1,048,000 (98,000) Cash and cash equivalents at the beginning of the period 209,000 485,000 ---------- ---------- Cash and cash equivalents at the end of the period $ 1,257,000 $ 387,000 ========== ========== Supplemental information: Interest paid $ 2,272,000 $2,172,000 ========== ========== Non cash investing and financing activities: Note payable on termination of garage lease $ - $ (727,000) ========== ========== Fixed assets acquired, net of liabilities, upon termination of garage lease $ - $ 43,000 ========== ========== Assets acquired through capital lease $ 700,000 ` $ - ========== ========== The accompanying notes are an integral part of these condensed consolidated financial statements. -6- PORTSMOUTH SQUARE, INC. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 1 - BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES The consolidated financial statements included herein have been prepared by Portsmouth Square, Inc. ("Portsmouth" or the "Company"), without audit, according to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes the disclosures that are made are adequate to make the information presented not misleading. Further, the consolidated financial statements reflect, in the opinion of management, all adjustments (which included only normal recurring adjustments) necessary for a fair statement of the financial position, cash flows and results of operations as of and for the periods indicated. As of March 31, 2010, Santa Fe Financial Corporation ("Santa Fe"), a public company, owns approximately 68.8% of the outstanding common shares of Portsmouth Square, Inc. ("Portsmouth" or the "Company"). Santa Fe is a 76%- owned subsidiary of The InterGroup Corporation ("InterGroup"), a public company. InterGroup also directly owns approximately 11.7% of the common stock of Portsmouth. Portsmouth's primary business is conducted through its general and limited partnership interest in Justice Investors, a California limited partnership ("Justice" or the "Partnership"). Portsmouth has a 50.0% limited partnership interest in Justice and serves as one of the two general partners. The other general partner, Evon Corporation ("Evon") served as the managing general partner until December 1, 2008. The Limited Partnership Agreement was amended, effective December 1, 2008, to provide for a change in the respective roles of the general partners. Pursuant to that amendment, Portsmouth became the Managing General Partner of Justice while Evon assumed the role of Co-General Partner of Justice. The financial statements of Justice are consolidated with those of the Company. Justice owns a 544-room hotel property located at 750 Kearny Street, San Francisco California, now known as the Hilton San Francisco Financial District (the Hotel) and related facilities including a five level underground parking garage. The Hotel is operated by the partnership as a full service Hilton brand hotel pursuant to a Franchise License Agreement with Hilton Hotels Corporation. Justice also has a Management Agreement with Prism Hospitality L.P. (Prism) to perform the day-to-day management functions of the Hotel. Justice leased the parking garage to Evon through September 30, 2008. Effective October 1, 2008, Justice and Evon entered into an Installment Sale Agreement whereby Justice purchased all of Evon's right, title, and interest in the remaining term of its lease of the parking garage, which was to expire on November 30, 2010, and other related assets. Justice also agreed to assume Evon's contract with Ace Parking Management, Inc. ("Ace Parking") for the management of the garage and any other liabilities related to the operation of the garage commencing October 1, 2008. The Partnership also leases a day spa -7- on the lobby level to Tru Spa. Portsmouth also receives management fees as a general partner of Justice for its services in overseeing and managing the Partnership's assets. Those fees are eliminated in consolidation. Certain prior period balances have been reclassified to conform with the current period presentation. Basic loss per share is calculated based upon the weighted average number of common shares outstanding during each fiscal year. During the three and nine months ended March 31, 2010 and 2009, the Company did not have any potentially dilutive securities outstanding. It is suggested that these financial statements be read in conjunction with the audited financial statements and the notes therein included in the Company's Form 10-K for the year ended June 30, 2009. The results of operations for the three and nine months ended March 31, 2010 are not necessarily indicative of results to be expected for the full fiscal year ending June 30, 2010. In June 2009, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles, which was primarily codified into Accounting Standards Codification (ASC) Topic 105. This standard will become the single source of authoritative nongovernmental U.S. generally accepted accounting principles (GAAP). The Codification was effective for interim or annual financial periods ended after September 15, 2009. The Company adopted ASC 105 beginning the quarter ended September 30, 2009. The adoption of ASC 105 did not have a material impact on our consolidated financial position, results of operations and cash flows. Additionally, the FASB now uses Accounting Standards Updates (ASU) to amend ASC. In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R) (SFAS 167), which has been codified ASU 2010-10 (ASU Topic 810). It clarifies that related parties should be considered when evaluating the criteria for determining whether a decision maker's or service provider's fee represents a variable interest. In addition, the amendments clarify that a quantitative calculation should not be the sole basis for evaluating whether a decision maker's or service provider's fee represents a variable interest. This guidance will be effective at the start of a reporting entity's first fiscal year beginning after November 15, 2009. Early application is not permitted. Management does not anticipate that the adoption of this guidance will have a material effect on the Company's consolidated financial statements. In May 2009, the FASB issued SFAS No. 165, Subsequent Events, which was primarily codified into ASC Topic 855 and updated by ASU 2010-09. The Company adopted ASC Topic 855 which requires an entity to recognize in the financial statements the effects of all subsequent events that provide additional evidence about conditions that existed at the date of the balance sheet. For non-recognized subsequent events that must be disclosed to keep the financial statements from being misleading, an entity will be required to disclose the nature of the event as well as an estimate of its financial effect, or a statement that such an estimate cannot be made. ASC Topic 855 is consistent with current practice and did not have any impact on the Company's consolidated financial statements. Subsequent events were evaluated through the date the condensed and consolidated financial statements were issued. -8- In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interest in Consolidated Financial Statements-an amendment of ARB No. 51" which was primarily codified into ASC Topic 810, "Consolidation." ASC Topic 810 states that accounting and reporting for minority interests will be recharacterized as noncontrolling interests and classified as a component of equity. This standard also establishes reporting requirements that provide disclosures that identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. ASC Topic 810 required retrospective adoption of the presentation and disclosure requirements for previously existing minority interests. All other requirements are to be applied prospectively. This standard is effective for fiscal years beginning after December 15, 2008. The Company adopted the provisions beginning July 1, 2009. Prior to adopting this standard, the Company absorbed 100% of the net loss and accumulated deficit of Justice Investors as of June 30, 2009. Effective July 1, 2009 under ASC Topic 810, losses attributable to the parent and the noncontrolling interest in a subsidiary shall be attributed to those respective interests. That is, the noncontrolling interest shall continue to be attributed its share of losses even if that attribution results in a deficit noncontrolling interest balance. As a result, upon adoption, the Company recalculated the accumulated deficit pertaining to noncontrolling interest totaling $8,596,000 as of June 30, 2009 and reclassified such amount as a separate component of the shareholders' equity (deficit). However, the losses attributed to the noncontrolling interest were not adjusted in the consolidated statement of operations the three and nine months ended March 31, 2009. In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" which was primarily codified into ASC Topic 825, "Financial Instruments." ASC Topic 825 provides entities with an irrevocable option to report selected financial assets and financial liabilities at fair value. It also establishes presentation and disclosure requirements that are designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. The Company adopted ASC Topic 825 on July 1, 2008 and chose not to elect the fair value option for its financial assets and liabilities that had not been previously carried at fair value. Therefore, material financial assets and liabilities not carried at fair value, such as other assets, accounts payable, line of credit, and mortgage payables are reported at their carrying values. In January 2010, the FASB issued ASU 2010-06, "Improving Disclosures About Fair Value Measurements." Effective January 1, 2010, ASU 2010-06 requires the separate disclosure of significant transfers into and out of the Level 1 and Level 2 categories and the reasons for such transfers, and also requires fair value measurement disclosures for each class of assets and liabilities as well as disclosures about valuation techniques and inputs used for recurring and nonrecurring Level 2 and Level 3 fair value measurements. Effective in fiscal years beginning after December 31, 2010, ASU 2010-06 also requires Level 3 disclosure of purchases, sales, issuances and settlements activity on a gross rather than a net basis. These amendments resulted in additional disclosures in the Company's interim financial statements. In December 2007, the FASB issued SFAS No. 141(R), "Business Combinations", which was primarily codified into ASC Topic 805, "Business Combinations". It establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any controlling -9- interest; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. This standard is to be applied prospectively to business combinations for which the acquisition date is on or after an entity's fiscal year that begins after December 15, 2008. The Company adopted this standard beginning July 1, 2009 and adoption of this standard had no material impact on the Company's consolidated financial statements. NOTE 2 - INVESTMENT IN HOTEL, NET Property and equipment consisted of the following: Accumulated Net Book As of March 31, 2010 Cost Depreciation Value ------------ ------------ ------------ Land $ 1,124,000 $ - $ 1,124,000 Furniture and equipment 18,288,000 (13,835,000) 4,453,000 Building and improvements 46,432,000 (17,212,000) 29,220,000 ------------ ------------ ------------ $ 65,844,000 $(31,047,000) $ 34,797,000 ============ ============ ============ Accumulated Net Book As of June 30, 2009 Cost Depreciation Value ------------ ------------ ------------ Land $ 1,124,000 $ - $ 1,124,000 Furniture and equipment 16,939,000 (11,262,000) 5,677,000 Building and improvements 45,693,000 (16,152,000) 29,541,000 ------------ ------------ ------------ $ 63,756,000 $(27,414,000) $ 36,342,000 ============ ============ ============ NOTE 3 - INVESTMENT IN MARKETABLE SECURITIES The Company's investment in marketable securities consists primarily of corporate equities. The Company has also invested in corporate bonds and income producing securities, which may include interests in real estate based companies and REITs, where financial benefit could insure to its shareholders through income and/or capital gain. At March 31, 2010, all of the Company's marketable securities are classified as trading securities. The change in the unrealized gains and losses on these investments are included in earnings. -10- Trading securities are summarized as follows: Gross Gross Net Fair Investment Cost Unrealized Gain Unrealized Loss Unrealized Gain Value - ---------- ----------- --------------- --------------- --------------- ------------ As of March 31, 2010 Corporate Equities $ 4,290,000 $ 787,000 ($ 294,000) $ 493,000 $ 4,783,000 As of June 30, 2009 Corporate Equities $ 2,896,000 $ 3,442,000 ($ 351,000) $ 3,091,000 $ 5,987,000 As of March 31, 2010 and June 30, 2009, the Company had unrealized losses of $146,000 and $137,000, respectively, related to securities held for over one year. Net gain(loss) on marketable securities on the statement of operations is comprised of realized and unrealized gains(losses). Below is the composition of the net gain(loss) for the three and nine months ended March 31, 2010 and 2009, respectively. For the three months ended March 31, 2010 2009 ----------- ----------- Realized gain(loss) on marketable securities $ (97,000) $ 37,000 Unrealized gain(loss) on marketable securities 217,000 (129,000) ----------- ----------- Net gain(loss) on marketable securities $ 120,000 $ (92,000) =========== =========== For the nine months ended March 31, 2010 2009 ----------- ----------- Realized gain(loss) on marketable securities $ 2,017,000 $ (324,000) Unrealized gain(loss) on marketable securities (2,693,000) 352,000 ----------- ----------- Net gain(loss) on marketable securities $ (676,000) $ 28,000 =========== =========== NOTE 4 - OTHER INVESTMENTS, NET The Company may also invest, with the approval of the Securities Investment Committee and other Company guidelines, in private investment equity funds and other unlisted securities, such as convertible notes through private placements. Those investments in non-marketable securities are carried at cost on the Company's balance sheet as part of other investments, net of other than temporary impairment losses. -11- As of March 31, 2010 and June 30, 2009, the Company had net other investments of $2,600,000 and $2,409,000, respectively, which consist of the following: Type March 31, 2010 June 30, 2009 --------------------------- ------------------ ---------------- Private equity hedge fund $ 1,591,000 $ 2,009,000 Corporate debt instruments 794,000 400,000 Warrants 215,000 - ----------------- ---------------- $ 2,600,000 $ 2,409,000 ================= ================ During the three months ended March 31, 2010 and 2009, the Company recorded impairment losses on other investments of $84,000 and $257,000, respectively. During the nine months ended March 31, 2010 and 2009, the Company recorded impairment losses on other investments of $418,000 and $615,000, respectively. As of March 31, 2010, the Company had investments in corporate debt and equity instruments which had attached warrants that were considered derivative instruments. These warrants have an allocated cost basis of $156,000 and a fair market value of $215,000. During the three months ended March 31, 2010, the Company had an unrealized loss of $26,000 related to these warrants. During the nine months ended March 31, 2010, the Company had an unrealized gain of $59,000 related to these warrants. Derivative financial instruments, as defined in ASC 815-10-15-83 Derivatives and Hedging (pre-Codification FAS No. 133 Accounting for Derivative Financial Instruments and Hedging Activities ), consist of financial instruments or other contracts that contain a notional amount and one or more underlying (e.g. interest rate, security price or other variable), require no initial net investment and permit net settlement. Derivative financial instruments may be free-standing or embedded in other financial instruments. Further, derivative financial instruments are initially, and subsequently, measured at fair value on the Company's consolidated balance sheet with the related unrealized gain or loss recorded in the Company's consolidated statement of operations. The Company used the Black-Scholes option valuation model to estimate the fair value these instruments which requires management to make significant assumptions including trading volatility, estimated terms, and risk free rates. Estimating fair values of derivative financial instruments requires the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors. In addition, option-based models are highly volatile and sensitive to changes in the trading market price of the underlying common stock, which has a high-historical volatility. Since derivative financial instruments are initially and subsequently carried at fair values, the Company's consolidated statement of operations will reflect the volatility in these estimate and assumption changes. -12- NOTE 5 - FAIR VALUE MEASUREMENTS In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" ("SFAS No. 157"), which was primarily codified into ASC Topic 820, which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. ASC Topic 820 is effective as of the beginning of the Company's 2009 fiscal year. In February 2008, the FASB deferred the effective date of ASC Topic 820 for non-financial assets and liabilities that are recognized or disclosed at fair value on a nonrecurring basis until the beginning of fiscal year 2010. The Company adopted ASC Topic 820 with respect to financial assets and liabilities on July 1, 2008. There was no material effect on the financial statements upon adoption of this new accounting pronouncement. ASC Topic 820 discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow), and the cost approach (cost to replace the service capacity of an asset or replacement cost). The statement utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels: Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. Level 2: Inputs, other than quoted prices, that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active. Level 3: Unobservable inputs that reflect the reporting entity's own assumptions The assets measured at fair value on a recurring basis as of March 31, 2010 are as follows: Assets: Level 1 Level 2 Level 3 March 31, 2010 - ----------- --------- --------- --------- -------------- Cash $1,257,000 $ - $ - $1,257,000 --------- --------- Other investments - warrants - 215,000 - 215,000 ------- --------- Investment in marketable securities REITs 1,083,000 1,083,000 Healthcare 842,000 842,000 Investment funds 760,000 760,000 Financial services 611,000 611,000 Technology 510,000 510,000 Services 254,000 254,000 Other 723,000 723,000 --------- --------- 4,783,000 4,783,000 --------- -------- -------- --------- $6,040,000 $ 215,000 $ - $6,255,000 ========= ======== ======== ========= -13- The assets measured at fair value on a recurring basis as of June 30, 2009 are as follows: Assets: Level 1 Level 2 Level 3 June 30, 2010 - ----------- --------- --------- --------- ------------- Cash $ 209,000 $ - S - $ 209,000 --------- --------- Investment in marketable securities Dairy product 2,935,000 2,935,000 REITS and financial 1,294,000 1,294,000 Basic materials and energy 563,000 563,000 Electronic traded funds 498,000 498,000 Services 241,000 241,000 Other 456,000 456,000 ---------- --------- 5,987,000 5,987,000 --------- -------- -------- --------- $6,196,000 $ - $ - $6,196,000 ========= ======== ======== ========= The fair values of investments in marketable securities are determined by the most recently traded price of each security at the balance sheet date. The fair value of the warrants was determined based upon a Black-Scholes option valuation model. Financial assets that are measured at fair value on a non-recurring basis and are not included in the tables above include "Other investments in non- marketable securities," that were initially measured at cost and have been written down to fair value as a result of impairment. The following table shows the fair value hierarchy for these assets measured at fair value on a non- recurring basis are as follows: Gain(loss) for the nine months ended Assets: Level 1 Level 2 Level 3 March 31, 2010 March 31, 2010 - ----------- --------- --------- --------- ------------------ ------------------ Other non-marketable investments - - $2,385,000 $2,385,000 $(418,000) Gain(loss) for the For the year ended Assets: Level 1 Level 2 Level 3 June 30, 2009 June 30, 2009 - ----------- --------- --------- --------- ------------------ ------------------ Other non-marketable investments - - $2,409,000 $2,409,000 $(615,000) Other investments in non-marketable securities are carried at cost net of any impairment loss. The Company has no significant influence or control over the entities that issue these investments. These investments are reviewed on a periodic basis for other-than-temporary impairment. The Company reviews several factors to determine whether a loss is other-than-temporary. These factors include but are not limited to: (i) the length of time an investment is in an unrealized loss position, (ii) the extent to which fair value is less than cost, (iii) the financial condition and near term prospects of the issuer and (iv) our ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in fair value. -14- NOTE 6 - TERMINATION OF GARAGE LEASE Effective October 1, 2008, Justice and Evon entered into an Installment Sale Agreement whereby Justice purchased all of Evon's right title and interest in the remaining term of its lease of the parking garage, which was to expire on November 30, 2010, and other related assets. Justice also agreed to assume Evon's contract with Ace Parking for the management of the garage and any other liabilities related to the operation of the garage commencing October 1, 2008. The purchase price for the garage lease and related assets was approximately $755,000, payable in one down payment of approximately $28,000 and 26 equal monthly installments of approximately $29,000, which includes interest at the rate of 2.4% per annum. Future installment payments as of March 31, 2010 are as follows: For the year ending June 30, 2010 87,000 2011 144,000 -------- Total $231,000 ======== As of March 31, 2010, the present value of the liability of $231,000 was included in the accounts payable and other liabilities balance of $9,481,000 on the Company's condensed consolidated balance sheet. NOTE 7 - LINE OF CREDIT As of March 31, 2010, the Partnership has a $2,500,000 unsecured revolving line of credit facility with a bank that was to mature on April 30, 2010. Borrowings under the line of credit bear interest at Prime plus 3.0% per annum or based on the Wall Street Journal Prime Rate (3.25%) plus 3.0% per annum, floating, (but subject to a minimum floor rate at 5.0% per annum). The interest rate at March 31, 2010 was 6.25%. The outstanding balance on the line of credit was $2,500,000 and $1,811,000 as of March 31, 2010 and June 30, 2009, respectively. Borrowings under the line of credit are subject to certain financial covenants, which are measured annually at June 30th and December 31st based on the credit arrangement. The Partnership was not in compliance with the financial covenants of its line of credit as of December 31, 2009, but was able to obtain a waiver of such non-compliance from the bank as well a modification of its credit facility effective April 29, 2010. The modification provides that Justice will pay the $2,500,000 existing balance on its line of credit facility over a period of four years, to mature on April 30, 2014. This term loan calls for monthly principal and interest payments, calculated on a six-year amortization schedule, with interest only from May 1, 2010 to August 31, 2010. The annual floating interest rate has been reduced by 0.5% to the WSJ Prime Rate plus 2.5% and the financial covenants have been rewritten to reflect the current economic conditions that all hotels are facing. The Partnership paid a loan modification fee of $10,000. The loan continues as unsecured. -15- NOTE 8 - SEGMENT INFORMATION The Company operates in two reportable segments, the operation of the hotel ("Hotel Operations") and the investment of its cash in marketable securities and other investments ("Investment Transactions"). These two operating segments, as presented in the consolidated financial statements, reflect how management internally reviews each segment's performance. Management also makes operational and strategic decisions based on this same information. Information below represents reporting segments for the three and nine months ended March 31, 2010 and 2009, respectively. Operating income(loss) from Hotel operations consists of the operation of the hotel and operation of the garage. Operating income(loss) for investment transactions consist of net investment gain (loss) and dividend and interest income. As of and for the Three months ended Hotel Investment March 31, 2010 Operations Transactions Other Total ----------- ------------ ----------- ------------ Revenues $ 7,456,000 $ - $ - $ 7,456,000 Expenses (7,890,000) - (150,000) (8,040,000) ----------- ----------- ----------- ------------ Income(loss)from operations (434,000) - (150,000) (584,000) Interest expense (732,000) - - (732,000) Net loss from investments - (1,000) - (1,000) Income tax benefit - - 286,000 286,000 ----------- ----------- ----------- ------------ Net income(loss) $(1,166,000) $ (1,000) $ 136,000 $ (1,031,000) =========== =========== =========== ============ Total Assets $34,797,000 $ 7,383,000 $ 9,702,000 $ 51,882,000 =========== =========== =========== ============ As of and for the Three months ended Hotel Investment March 31, 2009 Operations Transactions Other Total ----------- ------------ ----------- ------------ Revenues $ 7,073,000 $ - $ - $ 7,073,000 Expenses (7,432,000) - (141,000) (7,573,000) ----------- ----------- ----------- ------------ Loss from operations (359,000) - (141,000) (500,000) Interest expense (719,000) - - (719,000) Net income from investments - (354,000) - (354,000) Income tax benefit - - 409,000 409,000 ----------- ----------- ----------- ------------ Net income(loss) $(1,078,000) $ (354,000) $ 268,000 $ (1,164,000) =========== =========== =========== ============ Total Assets $40,278,000 $ 4,559,000 $12,752,000 $ 57,589,000 =========== =========== =========== ============ -16- As of and for the Nine months ended Hotel Investment March 31, 2010 Operations Transactions Other Total ----------- ------------ ----------- ------------ Revenues $24,354,000 $ - $ - $ 24,354,000 Expenses (23,640,000) - (424,000) (24,064,000) ----------- ----------- ----------- ------------ Income(loss)from operations 714,000 - (424,000) 290,000 Interest expense (2,174,000) - - (2,174,000) Net loss from investments - (1,168,000) - (1,168,000) Income tax benefit - - 897,000 897,000 ----------- ----------- ----------- ------------ Net income(loss) $(1,460,000) $(1,168,000) $ 473,000 $ (2,155,000) =========== =========== =========== ============ Total Assets $34,797,000 $ 7,383,000 $ 9,702,000 $ 51,882,000 =========== =========== =========== ============ As of and for the Nine months ended Hotel Investment March 31, 2009 Operations Transactions Other Total ----------- ------------ ----------- ------------ Revenues $25,016,000 $ - $ - $25,016,000 Expenses (24,852,000) - (413,000) (25,265,000) ----------- ----------- ----------- ------------ Income(loss)from operations 164,000 - (413,000) (249,000) Interest expense (2,162,000) - - (2,162,000) Net loss from investments - (654,000) - (654,000) Income tax benefit - - 806,000 806,000 ----------- ----------- ----------- ------------ Net income(loss) $(1,998,000) $ (654,000) $ 393,000 $ (2,259,000) =========== =========== =========== ============ Total Assets $40,278,000 $ 4,559,000 $12,752,000 $ 57,589,000 =========== =========== =========== ============ NOTE 9 - RELATED PARTY TRANSACTIONS Certain shared costs and expenses, primarily administrative expenses, rent and insurance are allocated among the Company, the Company's parent, Santa Fe and InterGroup, the parent of Santa Fe, based on management's estimate of the pro rata utilization of resources. For the three months ended March 31, 2010 and 2009, these expenses were approximately $18,000 for each respective period. For the nine months ended March 31, 2010 and 2009, these expenses were approximately $54,000 for each respective period. Four of the Portsmouth directors serve as directors of Intergroup. Three of those directors also serve as directors of Santa Fe. The three Santa Fe directors also serve as directors of Intergroup. Evon, a general partner of Justice, was the lessee of the parking garage until September 30, 2008. Under the terms of the lease agreement, Evon paid the Partnership rent of $399,000 for the nine months ended March 31, 2009. As discussed in Note 6, Justice and Evon entered into an installment sale agreement whereby Justice purchased the remaining term of the lease agreement and related assets for a total of approximately $755,000. During the three and nine months ended March 31, 2010, the Company received management fees from Justice Investors totaling $64,000 and $214,000, respectively. These amounts were eliminated in consolidation. -17- John V. Winfield serves as Chief Executive Officer and Chairman of the Company, Santa Fe, and InterGroup. Depending on certain market conditions and various risk factors, the Chief Executive Officer, his family, Santa Fe and InterGroup may, at times, invest in the same companies in which the Company invests. The Company encourages such investments because it places personal resources of the Chief Executive Officer and his family members, and the resources of Santa Fe and InterGroup, at risk in connection with investment decisions made on behalf of the Company. Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS AND PROJECTIONS The Company may from time to time make forward-looking statements and projections concerning future expectations. When used in this discussion, the words "anticipate," "estimate," "expect," "project," "intend," "plan," "believe," "may," "could," "might" and similar expressions, are intended to identify forward-looking statements. These statements are subject to certain risks and uncertainties, such as national and worldwide economic conditions, including the impact of recessionary conditions on tourism, travel and the lodging industry, the impact of terrorism and war on the national and international economies, including tourism and securities markets, energy and fuel costs, natural disasters, general economic conditions and competition in the hotel industry in the San Francisco area, seasonality, labor relations and labor disruptions, actual and threatened pandemics such as swine flu, partnership distributions, the ability to obtain financing at favorable interest rates and terms, securities markets, regulatory factors, litigation and other factors discussed below in this Report and in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2009, that could cause actual results to differ materially from those projected. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as to the date hereof. The Company undertakes no obligation to publicly release the results of any revisions to those forward-looking statements, which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. RESULTS OF OPERATIONS The Company's principal business is conducted through its general and limited partnership interest in the Justice Investors limited partnership ("Justice" or the "Partnership"). The Company has a 50.0% limited partnership interest in Justice and serves as the managing general partner of Justice. Evon Corporation ("Evon") serves as the other general partner. Justice owns the land, improvements and leaseholds at 750 Kearny Street, San Francisco, California, known as the Hilton San Francisco Financial District (the "Hotel"). The financial statements of Justice are consolidated with those of the Company. The Hotel is operated by the Partnership as a full service Hilton brand hotel pursuant to a Franchise License Agreement with Hilton Hotels Corporation. The term of the Agreement is for a period of 15 years commencing on January 12, 2006, with an option to extend the license term for another five years, subject -18- to certain conditions. Justice also has a Management Agreement with Prism Hospitality L.P. ("Prism") to perform the day-to-day management functions of the Hotel. Until September 30, 2008, the Partnership also derived income from the lease of the parking garage to Evon. Effective October 1, 2008, Justice entered into an installment sale agreement with Evon to purchase the remaining term of the garage lease and related garage assets, and assumed the contract with Ace Parking for the operations of the garage. Justice also leases a portion of the lobby level of the Hotel to a day spa operator. Portsmouth also receives management fees as a general partner of Justice for its services in overseeing and managing the Partnership's assets. Those fees are eliminated in consolidation. Three Months Ended March 31, 2010 Compared to Three Months Ended March 31, 2009 The Company had a net loss of $1,031,000 for the three months ended March 31, 2010 compared to a net loss of $1,164,000 for the three months ended March 31, 2009. The decrease in the net loss is primarily attributable to the significantly lower net loss from investment activities partially offset by a higher net loss from hotel operations. During the three months ended March 31, 2010, the Company had a loss on hotel operations of $1,166,000 compared to a loss of $1,078,000 for the three months ended March 31, 2009. The increase in the loss was primarily attributable to an increase in depreciation and amortization expense due to improvements made to the Hotel, including upgrades to the guest rooms and installation of energy saving controls and devices. The following table sets forth a more detailed presentation of Hotel operations for the three months ended March 31, 2010 and 2009. For the three months ended March 31, 2010 2009 ---------- ---------- Hotel revenues: Hotel rooms $ 5,392,000 $ 5,251,000 Food and beverage 1,329,000 1,106,000 Garage 603,000 571,000 Other 132,000 145,000 ---------- ---------- Total hotel revenues 7,456,000 7,073,000 Operating expenses, excluding interest and depreciation and amortization (6,670,000) (6,314,000) ---------- ---------- Operating income before interest, depreciation and amortization 786,000 759,000 Interest expense (732,000) (719,000) Depreciation and amortization expense (1,220,000) (1,118,000) ---------- ---------- Loss from hotel operations $(1,166,000) $(1,078,000) ========== ========== -19- For the three months ended March 31, 2010, the Hotel generated operating income of approximately $786,000, before interest, depreciation and amortization, on operating revenues of approximately $7,456,000 compared to operating income of approximately $759,000, before interest, depreciation and amortization, on operating revenues of approximately $7,073,000 for the three months ended March 31, 2009. The increase in Hotel operating income is primarily attributable to an increase in both room and food and beverage revenues, partially offset by greater operating expenses attributable to the Hotel running at a higher occupancy rate and higher food and beverage operating expenses. Room revenues increased by approximately $141,000 for the three months ended March 31, 2010 when compared to the three months ended March 31, 2009 and food and beverage revenues increased by approximately $223,000 for the same period. The increase in room revenues was primarily attributable to an approximately 3% increase in occupancy, while average daily room rates remained relatively flat compared to the prior period. Achieving higher room rates in the San Francisco continues to be very challenging due to a severe reduction in higher rated corporate and group business travel, which has been replaced by discounted business from Internet channels. The increase in food and beverage revenues is primarily attributable to higher Hotel occupancy and the hosting of some large events and groups during the current period. However, higher rated banquet and catering business remains very difficult to obtain as companies continue with cuts in business travel, corporate meetings and events. The following table sets forth the average daily room rate, average occupancy percentage and room revenue per available room ("RevPar") of the Hotel for the three months ended March 31, 2010 and 2009. Three Months Ended Average Average March 31, Daily Rate Occupancy% RevPar - ----------------- ---------- --------- -------- 2010 $134 82.4% $110 2009 $135 79.5% $107 Although the Hotel's average daily room rate was relatively flat for the three months ended March 31, 2010 compared to the three months ended March 31, 2009, the San Francisco market has not seen much recovery in Hotel rates compared to 2008, when economic downturn began. The Hotel has continued to increase its sales and marketing efforts in the face of these difficult economic conditions and greater competition. As a result, the Hotel was able to increase its occupancy rates by over the comparable period, enabling it to achieve a RevPar number that was near the top of its competitive set. In this highly competitive market, Management has also continued to focus on ways to enhance the guest experience as well as improve operating efficiencies. The Hotel has recently upgraded its guest room with newer flat panel televisions systems that provide guests with greater entertainment options. The Hotel has also installed many energy saving controls and devices as part of its efforts to become greener and reduce operating costs. Management will continue to explore new and innovative ways to improve operations and to attract new guests to the Hotel at higher room rates. -20- The Company had a net gain on marketable securities of $120,000 for the three months ended March 31, 2010 compared to a net loss on marketable securities of $92,000 for the three months ended March 31, 2009. For the three months ended March 31, 2010, the Company had a net realized loss of $97,000 and a net unrealized gain of $217,000. For the three months ended March 31, 2009, the Company had a net realized gain of $37,000 and a net unrealized loss of $129,000. Gains and losses on marketable securities may fluctuate significantly from period to period in the future and could have a significant impact on the Company's results of operations. However, the amount of gain or loss on marketable securities for any given period may have no predictive value and variations in amount from period to period may have no analytical value. For a more detailed description of the composition of the Company's marketable securities see the Marketable Securities section below. The Company may also invest, with the approval of the Securities Investment Committee and other Company guidelines, in private investment equity funds and other unlisted securities, such as convertible notes through private placements. Those investments in non-marketable securities are carried at cost on the Company's balance sheet as part of other investments, net of other than temporary impairment losses. As of March 31, 2010, the Company had net other investments of $2,600,000. Included in other investments are investments in corporate debt and equity instruments which had attached warrants that were considered derivative instruments. The Company recorded an unrealized loss of $26,000 related to these warrants during the three months ended March 31, 2010. During the three months ended March 31, 2010 and 2009, the Company performed an impairment analysis of its other investments and determined that its investments had other than temporary impairments and recorded impairment losses of $84,000 and $257,000 respectively. The provision for income tax benefit as a percentage of the loss before taxes was lower for the three months ended March 31, 2010 as compared to the three months ended March 31, 2009 primarily as the result of quarterly tax timing differences. Nine Months Ended March 31, 2010 Compared to Nine Months Ended March 31, 2009 The Company had a net loss of $2,155,000 for the nine months ended March 31, 2010 compared to a net loss of $2,259,000 for the nine months ended March 31, 2009. The decrease in the net loss is primarily attributable to a reduction in the loss from hotel operations, partially offset by an increase in the loss from investing activities. During the nine months ended March 31, 2010, the Company had a loss on hotel operations of $1,460,000 compared to a loss of $1,998,000 for the nine months ended March 31, 2009. The reduction in the loss was primarily attributable to a one-time loss related to the termination of the hotel garage lease in the amount of $684,000 which was incurred during the three months ended December 31, 2008, partially offset by an increase in depreciation and amortization expense due to improvements to the Hotel during the current period. -21- The following table sets forth a more detailed presentation of Hotel operations for the nine months ended March 31, 2010 and 2009. For the nine months ended December 31, 2010 2009 ---------- ---------- Hotel revenues: Hotel rooms $ 18,598,000 $ 19,451,000 Food and beverage 3,398,000 3,633,000 Garage 1,869,000 1,541,000 Other 489,000 391,000 ---------- ---------- Total hotel revenues 24,354,000 25,016,000 Operating expenses, excluding loss on termination of garage lease, interest, depreciation and amortization (20,089,000) (20,833,000) ---------- ---------- Operating income before loss on termination of garage lease, interest, depreciation and amortization 4,265,000 4,183,000 Loss on termination of garage lease - (684,000) Interest expense (2,174,000) (2,162,000) Depreciation and amortization expense (3,551,000) (3,335,000) ---------- ---------- Loss from hotel operations $(1,460,000) $(1,998,000) ========== ========== For the nine months ended March 31, 2010, the Hotel generated operating income of approximately $4,265,000 before interest, depreciation and amortization, on operating revenues of approximately $24,354,000 compared to operating income of approximately $4,183,000 before the loss on termination of garage lease, interest, depreciation and amortization, on operating revenues of approximately $25,016,000 for the nine months ended March 31, 2009. The increase in Hotel operating income is primarily attributable to a decline in operating expenses and an increase in garage revenues resulting from the termination of the garage lease in October 2008 and integration of those operations into those of the Hotel, partially offset by a decrease in room and food and beverage revenues. Room revenues decreased by approximately $853,000 for the nine months ended March 31, 2010 when compared to the nine months ended March 31, 2009 and food and beverage revenues decreased by approximately $235,000 for the same period. The decrease in room revenues was primarily attributable to a significant decline in average daily room rates as during the first six months of the period as hotels in the San Francisco market continued to reduce room rates in an effort to maintain occupancy levels in a very competitive market. Many hotels have been forced to adopt this strategy due to a severe reduction in higher rated corporate and group business travel, which has been replaced by discounted business from Internet channels. The decrease in food and beverage revenues is primarily attributable to decline in banquet and catering business as companies continue with cuts in business travel, corporate meetings and events. -22- The following table sets forth the average daily room rate, average occupancy percentage and room revenue per available room ("RevPar") of the Hotel for the nine months ended March 31, 2010 and 2009. Nine Months Ended Average Average March 31, Daily Rate Occupancy% RevPar - ----------------- ---------- --------- -------- 2010 $143 87.1% $125 2009 $163 79.9% $131 The operations of the Hotel continued to be impacted by the significant downturn in the domestic and international economies and markets. Room rates continue to be the toughest challenge as the Hotel's average daily room rate was approximately $20 lower for the nine months ended March 31, 2010 compared to the nine months ended March 31, 2009. However, due to increased sales and marketing efforts in the face of difficult economic conditions and greater competition, the Hotel was able to boost occupancy rates by approximately 7% over the comparable period. As a result, the Hotel was able to achieve a RevPar number that was near the top of its competitive set. In this highly competitive market, Management has also continued to focus on ways to enhance the guest experience as well as improve operating efficiencies. The Hotel has recently upgraded its guest room with newer flat panel televisions systems that provide guests with greater entertainment options. The Hotel has also installed many energy saving controls and devices as part of its efforts to become greener and reduce operating costs. Management will continue to explore new and innovative ways to improve operations and attract new guests to the Hotel at higher room rates. The Company had a net loss on marketable securities of $676,000 for the nine months ended March 31, 2010 compared to a net gain on marketable securities of $28,000 for the nine months ended March 31, 2009. For the nine months ended March 31, 2010, the Company had a net realized gain of $2,017,000 and a net unrealized loss of $2,693,000. For the nine months ended March 31, 2009, the Company had a net realized loss of $324,000 and a net unrealized gain of $352,000. Gains and losses on marketable securities may fluctuate significantly from period to period in the future and could have a significant impact on the Company's results of operations. However, the amount of gain or loss on marketable securities for any given period may have no predictive value and variations in amount from period to period may have no analytical value. For a more detailed description of the composition of the Company's marketable securities see the Marketable Securities section below. The Company may also invest, with the approval of the Securities Investment Committee and other Company guidelines, in private investment equity funds and other unlisted securities, such as convertible notes through private placements. Those investments in non-marketable securities are carried at cost on the Company's balance sheet as part of other investments, net of other than temporary impairment losses. As of March 31, 2010, the Company had net other investments of $2,600,000. Included in other investments are investments in corporate debt and equity instruments which had attached warrants that were considered derivative instruments. The Company recorded an unrealized gain of $59,000 related to these warrants during the nine months ended March 31, 2010. -23- During the nine months ended March 31, 2010 and 2009, the Company performed an impairment analysis of its other investments and determined that its investments had other than temporary impairments and recorded impairment losses of $418,000 and $615,000, respectively. Margin interest and trading expenses increased to $229,000 for the nine months ended March 31, 2010 from $151,000 for the nine months ended March 31, 2009 primarily as the result of the increase in margin interest expense related to the increase in the use of margin. The provision for income tax benefit as a percentage of the loss before taxes remained relatively consistent for the nine months ended March 31, 2010 as compared to the nine months ended March 31, 2009. MARKETABLE SECURITIES AND OTHER INVESTMENTS As of March 31, 2010 and June 30, 2009, the Company had investments in marketable equity securities of $4,783,000 and $5,987,000, respectively. The following table shows the composition of the Company's marketable securities portfolio by selected industry groups as March 31, 2010 and June 30, 2009. As of March 31, 2010: % of Total Investment Industry Group Fair Value Securities -------------- ------------ ---------- REITs 1,083,000 22.6% Healthcare 842,000 17.6% Investment funds 760,000 15.9% Financial services 611,000 12.8% Technology 510,000 10.7% Services 254,000 5.3% Other 723,000 15.1% ------------ ---------- $ 4,783,000 100.0% ============ ========== As of June 30, 2009: % of Total Investment Industry Group Fair Value Securities -------------- ------------ ---------- Dairy products $ 2,935,000 49.0% REITs and financial 1,294,000 21.6% Basic materials and energy 563,000 9.4% Electronic traded funds(ETFs) 498,000 8.3% Services 241,000 4.0% Other 456,000 7.7% ---------- ------ $ 5,987,000 100.0% ========== ====== As of March 31, 2010, the Company's investment portfolio is diversified with 35 different equity positions. The portfolio contains five individual equity securities that are more than 5% of the equity value of the portfolio with the largest security being 14.4% of the value of the portfolio. The amount of the -24- 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. The Company may also invest, with the approval of the Securities Investment Committee and other Company guidelines, in private investment equity funds and other unlisted securities, such as convertible notes through private placements. Those investments in non-marketable securities are carried at cost on the Company's balance sheet as part of other investments, net of other than temporary impairment losses. As of March 31, 2010 and June 30, 2009, the Company had net other investments of $2,600,000 and $2,409,000, respectively. As of March 31, 2010, the Company had a net other investment in a public company in a basic materials sector totaling $500,000. As of March 31, 2010, the Company holds notes and convertible notes of this company totaling approximately $3,901,000 which includes $2,718,000 of principal and $1,183,000 of accrued interest and penalties. LIQUIDITY AND SOURCES OF CAPITAL The Company's cash flows are primarily generated from its Hotel operations and general partner fees from Justice. The Company also receives revenues generated from the investment of its cash and marketable securities and other investments. Since the operations of the Hotel were temporarily suspended on May 31, 2005, and significant amounts of money were expended to renovate and reposition the Hotel as a Hilton, Justice did not pay any partnership distributions until the end of March 2007. The Hotel started to generate cash flows from its operations in June 2006. During the months ended September 30, 2008, Justice paid a total of $850,000 in limited partnership distributions, of which the Company received $425,000. Following the payment of those distributions, the San Francisco hotel market began to feel the full impact of the significant downturn in domestic and international economies that continued throughout fiscal 2009 and into fiscal 2010. As a result, no partnership distributions were paid for the nine months ended March 31, 2010. Since no significant improvement in economic conditions is expected in the lodging industry until sometime during the second half of calendar 2010, no limited partnership distributions are anticipated in the foreseeable future. The general partners will continue to monitor and review the operations and financial results of the Hotel and to set the amount of any future distributions that may be appropriate based on operating results, cash flows and other factors, including establishment of reasonable reserves for debt payments and operating contingencies. The new Justice Compensation Agreement that became effective on December 1, 2008, when Portsmouth assumed the role of managing general partner of Justice, has provided additional cash flows to the Company. Under the new Compensation Agreement, Portsmouth is now entitled to 80% of the minimum base fee to be paid to the general partners of $285,000, while under the prior agreement, Portsmouth was entitled to receive only 20% of the minimum base fee. During the three and nine months ended March 31, 2010, the Company received management fees from Justice Investors totaling $64,000 and $214,000, respectively. -25- To meet its substantial financial commitments for the renovation and transition of the Hotel to a Hilton, Justice had to rely on borrowings to meet its obligations. On July 27, 2005, Justice entered into a first mortgage loan with The Prudential Insurance Company of America in a principal amount of $30,000,000 (the "Prudential Loan"). The term of the Prudential Loan is for 120 months at a fixed interest rate of 5.22% per annum. The Prudential Loan calls for monthly installments of principal and interest in the amount of approximately $165,000, calculated on a 30-year amortization schedule. The Loan is collateralized by a first deed of trust on the Partnership's Hotel property, including all improvements and personal property thereon and an assignment of all present and future leases and rents. The Prudential Loan is without recourse to the limited and general partners of Justice. The principal balance of the Prudential Loan was $27,855,000 as of March 31, 2010. On March 27, 2007, Justice entered into a second mortgage loan with Prudential (the "Second Prudential Loan") in a principal amount of $19,000,000. The term of the Second Prudential Loan is for approximately 100 months and matures on August 5, 2015, the same date as the first Prudential Loan. The Second Prudential Loan is at a fixed interest rate of 6.42% per annum and calls for monthly installments of principal and interest in the amount of approximately $119,000, calculated on a 30-year amortization schedule. The Second Prudential Loan is collateralized by a second deed of trust on the Partnership's Hotel property, including all improvements and personal property thereon and an assignment of all present and future leases and rents. The Second Prudential Loan is also without recourse to the limited and general partners of Justice. The principal balance of the Second Prudential Loan was $18,331,000 as of March 31, 2010. Justice also had a $2,500,000 unsecured revolving line of credit facility from EastWest Bank (formerly United Commercial Bank) that can be used for short term business requirements. The line of credit was to mature on February 2, 2010, but the Partnership received an extension of the maturity date to April 30, 2010. Borrowings bear interest at an annual interest rate based on the Wall Street Journal ("WSJ") Prime Rate plus 3%, floating, with an interest rate floor of 5%. As of March 31, 2010, there was a balance of approximately $2,500,000 drawn by Justice under the line of credit facility, with an annual interest rate of 6.25% (Prime at 3.25% as of March 31, 2010, plus 3%). The Partnership was not in compliance with the financial covenants of its line of credit as of December 31, 2010, but was able to obtain a waiver of such non- compliance from the bank as well a modification of its credit facility effective April 29, 2010. The modification provides that Justice will pay the $2,500,000 existing balance on its line of credit facility over a period of four years, to mature on April 30, 2014. This term loan calls for monthly principal and interest payments, calculated on a six-year amortization schedule, with interest only from May 1, 2010 to August 31, 2010. The annual floating interest rate has been reduced by 0.5% to the WSJ Prime Rate plus 2.5% and the financial covenants have been rewritten to reflect the current economic conditions that all hotels are facing. The Partnership paid a loan modification fee of $10,000. The loan continues as unsecured. -26- Despite the downturns in the economy, the Hotel has continued to generate positive cash flows. While the debt service requirements related to the two Prudential loans, and the payment of its line of credit, may create some additional risk for the Company and its ability to generate cash flows in the future since the Partnership's assets had been virtually debt free for an number of years, management believes that cash flows from the operations of the Hotel and the garage will continue to be sufficient to meet all of the Partnership's current and future obligations and financial requirements. Management also believes that there is sufficient equity in the Hotel assets to support future borrowings, if necessary, to fund any new capital improvements and other requirements. The Company has invested in short-term, income-producing instruments and in equity and debt securities when deemed appropriate. The Company's marketable securities are classified as trading with unrealized gains and losses recorded through the consolidated statements of operations. MATERIAL CONTRACTUAL OBLIGATIONS The following table provides a summary of the Company's material financial obligations which also includes interest. Total Year 1 Year 2 Year 3 Year 4 Year 5 Thereafter ----------- ---------- ---------- ---------- ---------- ---------- ----------- Mortgage notes payable $59,764,000 $ 852,000 $3,410,000 $3,410,000 $3,410,000 $3,410,000 $45,272,000 Line of credit 2,940,000 24,000 437,000 495,000 495,000 1,489,000 - Other notes payable 959,000 325,000 634,000 - - - - Leases 1,172,000 108,000 430,000 202,000 187,000 128,000 117,000 ---------- --------- --------- --------- --------- --------- ---------- Total $64,835,000 $1,309,000 $4,911,000 $4,107,000 $4,092,000 $5,027,000 $45,389,000 ---------- --------- --------- --------- --------- --------- ---------- OFF-BALANCE SHEET ARRANGEMENTS The Company has no off balance sheet arrangements. IMPACT OF INFLATION Hotel room rates are typically impacted by supply and demand factors, not inflation, since rental of a hotel room is usually for a limited number of nights. Room rates can be, and usually are, adjusted to account for inflationary cost increases. Since Prism has the power and ability under the terms of its management agreement to adjust hotel room rates on an ongoing basis, there should be minimal impact on partnership revenues due to inflation. Partnership revenues are also subject to interest rate risks, which may be influenced by inflation. For the two most recent fiscal years, the impact of inflation on the Company's income is not viewed by management as material. CRITICAL ACCOUNTING POLICIES Critical accounting policies are those that are most significant to the presentation of our financial position and results of operations and require judgments by management in order to make estimates about the effect of matters that are inherently uncertain. The preparation of these condensed financial statements requires us to make estimates and judgments that affect the reported -27- 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. Item 4T. Controls and Procedures EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES The Company's management, with the participation of the Company's Chief Executive Officer and Principal Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the quarterly period covered by this Quarterly Report on Form 10-Q. Based upon such evaluation, the Chief Executive Officer and Principal Financial Officer have concluded that, as of the end of such period, the Company's disclosure controls and procedures are effective in ensuring that information required to be disclosed in this filing is accumulated and communicated to management and is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms. CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING There have been no changes in the Company's internal control over financial reporting during the last quarterly period covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. PART II. OTHER INFORMATION Item 6. Exhibits. 31.1 Certification of Chief Executive Officer of Periodic Report Pursuant to Rule 13a-14(a) and Rule 15d-14(a). 31.2 Certification of Principal Financial Officer of Periodic Report Pursuant to Rule 13a-14(a) and Rule 15d-14(a). 32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350. 32.2 Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350. -28- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PORTSMOUTH SQUARE, INC. (Registrant) Date: May 13, 2010 by /s/ John V. Winfield --------------------------- John V. Winfield, President, Chairman of the Board and Chief Executive Officer Date: May 13, 2010 by /s/ Michael G. Zybala --------------------------- Michael G. Zybala, Vice President and Secretary Date: May 13, 2010 by /s/ David T. Nguyen -------------------------- David Nguyen, Treasurer (Principal Financial Officer) -29-