Item 1. Business -----------
Some of the statements included in Items 1 and 2, Business and Properties, or elsewhere in this report, may be considered to be "forward-looking statements" since such statements relate to matters which have not yet occurred. For example, phrases such as "the Fund anticipates," "believes" or "expects" indicate that it is possible that the event anticipated, believed or expected may not occur. Should such event not occur, then the result which the Fund expected also may not occur or occur in a different manner, which may be more or less favorable to the Fund. The Fund does not undertake any obligations to publicly release the result of any revisions to these forward-looking statements that may be made to reflect any future events or circumstances.
Capitalized terms shall have the meaning ascribed them in the "Glossary" on pages 75 to 81 of the Fund's Prospectus, which is filed herewith and incorporated herein by reference.
The following narrative does not reflect the impact, if any, of the proposed transactions discussed at the end of Item 1.
NTS Mortgage Income Fund (the "Fund"), a Delaware corporation, was formed on September 26, 1988. The Fund operates as a real estate investment trust (REIT) under the Internal Revenue Code of 1986 (the "Code"), as amended. NTS Corporation is the sponsor of the Fund (the "Sponsor") and its affiliate, NTS Advisory Corporation, is the advisor to the Fund (the "Advisor"). The Fund commenced an offering of Shares of Common Stock (Shares) on March 31, 1989. The Fund extended the offering from March 31, 1990 to March 31, 1991. The Fund terminated the offering March 31, 1991, after which time the Fund issued shares pursuant to its Dividend Reinvestment Plan. During the second quarter of 1992, the Fund's Dividend Reinvestment Plan was terminated. The Fund raised approximately $64 million from the sale of approximately 3,187,000 shares including shares issued pursuant to the Fund's Dividend Reinvestment Plan.
The Fund's objectives as orignially described in the Prospectus are to (i) preserve and protect capital; (ii) distribute cash flow on a regular basis as it is available; and (iii) increase the value of the Fund's Net Assets and the Shares through receipt of Incentive Interest or Gross Receipts Interest and, to a lesser extent, through the acquisition, operation and disposition of Real Estate Investments. Incentive Interest is the Fund's share in the Increase in Value of a property securing a Mortgage Loan and shall be payable in connection with Mortgage Loans secured by Real Estate not held for sale in the ordinary course of business. Gross Receipts Interest is an amount equal to a specified percentage of the Affiliated Borrower's Gross Receipts from the sale of the underlying Real Estate received during the term of the Mortgage Loan and shall be payable in connection with Mortgage Loans secured by Real Estate held for sale in the ordinary course of business. It is not an objective of the Fund to provide tax-sheltered income. There can be no assurance that these investment objectives will be attained.
The Fund has elected and is qualified to be treated as a real estate investment trust under the Internal Revenue Code Sections 856-860 for the years ended December 31, 1996, 1995 and 1994. The Fund is required to terminate and liquidate its assets by December 31, 2008.
There are currently five directors of the Fund, two of whom are affiliated with the Advisor and three of whom are Independent Directors. The Directors are responsible for the management and control of the affairs of the Fund.
- 3 -
Item 1. Business - Continued ---------------------
However, in accordance with the Fund's Certificate of Incorporation and By-Laws, the Directors have, in the Advisory Agreement, delegated broad powers to the Advisor to administer the day-to-day operations of the Fund. The Advisor has delegated substantially all its duties to the Sponsor. All personnel rendering services to the Fund are employees of the Sponsor or its affiliated companies. The Fund does not directly employ any persons other than the Independent Directors and the Advisor.
The business of the Fund is not seasonal and the Fund does no foreign or export business.
The Fund has used the proceeds of this offering primarily to make Residential Land Development Loans to Affiliated Borrowers. It is anticipated that substantially all of any future Mortgage Loans will be made to Affiliates of the Sponsor. In addition, the Fund may make investments in real estate in amounts not to exceed approximately 10% of funds available for investment. Mortgage Loans are secured by a lien on the Borrower's real estate or by other REIT qualifying security approved by the Board of Directors, including, without limitation, by an interest in the Borrower or by a similar security interest. Based upon current market conditions and foreseeable investment opportunities, it is anticipated that no more than 25% of the Fund's proceeds will be invested in Junior Mortgage Loans (excluding Temporary Mortgage Loans and "phase-in" loans). In addition, NTS Guaranty Corporation, an Affiliate of the Sponsor, has agreed to guarantee repayment of the principal of all Junior Mortgage Loans and Temporary Mortgage Loans made to Affiliated Borrowers. Although the Fund has reserved the right to make Real Estate Investments, it only intends to do so if such an investment would be in the best interest of the Fund and assist it in achieving its primary objectives. For example, the Fund may find it in its best interest to make a Real Estate Investment which will generate non-cash deductions from taxable income thereby allowing the Fund to make Mortgage Loans providing for the accrual of deferred interest without causing difficulties in meeting the distribution requirements of the Code.
Transactions entered into between the Fund and the Advisor and its Affiliates are subject to an inherent conflict of interest. The Directors of the Fund and the Advisor may face certain conflicts of interest in enforcing the rights of the Fund against any Affiliated Borrower.
The Directors would consider the following factors in resolving certain inherent conflicts of interest:
(1) When considering an advance of additional funds to an Affiliated Borrower, factors such as projections for the development and operation of the property, market value and market conditions generally and for the type of property anticipated to be developed by the Affiliated Borrower, the credit worthiness and equity interest of the Affiliated Borrower, the current value of the property, the security and the availability of additional collateral.
(2) In deciding whether to waive a default by an Affiliated Borrower, foreclose on a Mortgage Loan or remedy a default on senior indebtedness, the Directors will consider the nature of the default, its materiality, the anticipated time and expense of pursuing the foreclosure as well as the cost of waiving the default, the anticipated viability of the Affiliated Borrower and the likelihood of the Affiliated Borrower remedying the default within a reasonable time. When considering enforcing a due-on-sale clause, the Directors will review the Fund's anticipated investments and the need for additional funds, as well as market conditions, focusing on the specific intended use of the property and the credit worthiness of the purchaser.
- 4 -
Item 1. Business - Continued --------------------
(3) In establishing the amount of the Interest Reserve to be funded, the Directors will review the expected return on the reserve, the variability of the interest rate on the Mortgage Loan, the outstanding indebtedness, the Affiliated Borrower's anticipated cash flow, the operating history and the appraised value and potential appreciation of the property.
(4) In determining whether to vary the terms of Mortgage Loans from the anticipated terms specified in the Prospectus, the Directors will review economic and market conditions and focus upon the locale of the property, the availability of additional security to collateralize the loan and the equity that the Affiliated Borrower has invested in the property.
(5) In considering whether to refinance a property, factors relating to the value of the property compared to the Affiliated Borrower's total debt, the terms of the proposed financing and the Affiliated Borrower's ability to service the total debt, the Fund's participation in the potential appreciation of the property, as well as other investment opportunities available to the Fund will be considered. If the Affiliated Borrower seeks to refinance to prevent a default and subsequent foreclosure, the Directors would consider the factors set forth in (2) above.
In connection with the making of any Mortgage Loan to an Affiliated Borrower the Independent Directors are required to obtain on opinion from an Independent Advisor that the proposed Mortgage Loan is as fair and at least as favorable to the Fund as a Mortgage Loan to a Non-Affiliated Borrower in similar circumstances. The Independent Advisor's fees will generally be paid by the Affiliated Borrower. An Independent Advisor may face certain conflicts of interest in rendering its opinion due to the fact that its fees may be paid by the Affiliated Borrower. However, the opinion of the Independent Advisor will be requested by and rendered to the Fund.
Generally the Fund's Mortgage Loans will have maturities of between one and seven years, subject to extension. The Fund's Mortgage Loans to Affiliated Borrowers will generally provide for two-year extensions of the loan term at the option of the Borrower upon the payment of an extension fee.
Affiliated Borrowers will generally pay Points upon the initial funding of a Mortgage Loan equal to 1% of the maximum amount of the Mortgage Loan committed to by the Fund.
Affiliated Borrowers will generally be required to pay Regular Interest on a quarterly basis during the term of the Mortgage Loan. Affiliated Borrowers will have the option to choose a fixed or floating interest rate on Mortgage Loans at the time of initial funding. The floating rate is adjusted monthly based on the average of the applicable rate during the previous month. Affiliated Borrowers will generally be provided the option to convert from a fixed rate Mortgage Loan to a floating rate Mortgage Loan, or a floating rate Mortgage Loan to a fixed rate Mortgage Loan, once during the term of the Mortgage Loan and once during the extension period.
In the case of Residential or Commercial Land Development Loans and other loans secured by properties not held for investment, the Fund will ordinarily receive Gross Receipts Interest. Generally, Gross Receipts Interest will be an amount equal to 5% of the Affiliated Borrower's Gross Receipts derived from the sale, during the term of the Mortgage Loan, of all or a portion of the property which serves as collateral of the Mortgage Loan, although this amount may be varied in the discretion of the Board of Directors.
The Fund will obtain an MAI Appraisal prepared by an independent MAI appraiser and a mortgagee's title insurance policy or commitment in connection with obtaining each Mortgage Loan.
- 5 -
Item 1. Business - Continued ---------------------
Generally, Residential or Commercial Land Development Loans will be repaid from proceeds from the sale of parcels of the property, or from refinancing of the property. Temporary Mortgage Loans are expected to be repaid from permanent financing (including a Permanent Mortgage Loan from the Fund) or from the sale or refinancing of the property.
Mortgage Loans to Affiliated Borrowers are generally non-recourse and have the customary provision in the market for condemnation, events-of-default, acceleration and other remedies.
The Fund's investments at December 31, 1996 were as follows:
A Mortgage Loan to NTS/Lake Forest II Residential Corporation, an Affiliated Borrower, to fund the development of Lake Forest North, a specified investment. The loan bears interest at an annualized rate equal to the greater of 17% of Gross Receipts from the sale of residential lots or 4.42% of the average outstanding loan balance and matures July 1, 1997. It is secured by a first mortgage on approximately 532 acres of residential land located in Louisville, Kentucky. The Fund has subordinated its first mortgage on approximately 180 acres to unaffiliated lenders who provided construction financing in the amount of $5,840,000 (with an outstanding balance of $4,166,187 as of December 31, 1996) for the development of those acres. The Fund's loan balance was $25,857,472 at December 31, 1996.
A Mortgage Loan to NTS/Virginia Development Company, an Affiliated Borrower, to fund the development of Fawn Lake, a specified investment. The loan bears interest at an annualized rate equal to the greater of 17% of Gross Receipts from the sale of residential lots or 4.42% of the average outstanding loan balance and matures July 1, 1997. It is secured by a first mortgage on approximately 2,207 acres of residential land and improvements thereon located in Fredericksburg, Virginia. The Fund has subordinated its first mortgage on approximately 22 acres to an unaffiliated lender who provided construction financing in the amount of $325,000 (with an outstanding balance of $243,393 as of December 31, 1996) for the development of those acres. The Fund's loan balance was $28,966,245 at December 31, 1996.
A Temporary Mortgage Loan to NTS/Virginia Development Company, an Affiliated Borrower, to fund the construction of the Fawn Lake Golf Course. The loan bears interest at the Prime Rate plus 3/4%, payable monthly, and matures July 31, 1997. The loan is secured by a first mortgage on approximately 187 acres of residential land and improvements thereon. The principal balance is guaranteed by NTS Guaranty Corporation. The Fund's loan balance was $1,998,850 at December 31, 1996.
A Mortgage Loan to Orlando Lake Forest Joint Venture, an Affiliated Borrower, to fund the development of Orlando Lake Forest, a specified investment. The loan bears interest at an annualized rate equal to the greater of 17% of Gross Receipts from the sale of residential lots or 6.46% of the average outstanding loan balance and matures January 31, 1998. It is secured by a participation interest in a first mortgage on approximately 398 acres of residential land located in Orlando, Florida. An Affiliate of the Fund's Sponsor participates with the Fund regarding this Mortgage Loan. As of December 31, 1996, the Fund's ownership percentage was approximately 63% and the Fund's share of the outstanding loan balance was $7,126,366, which is net of an unaccreted discount of $1,127,407.
A Temporary Mortgage Loan to Orlando Lake Forest Joint Venture, an Affiliated Borrower, the proceeds of which were used to partially fund the Orlando Lake Forest Project, a specified investment. The loan bears
- 6 -
Item 1. Business - Continued ---------------------
interest at the Prime Rate plus 2%, payable quarterly, and is a demand loan. It is secured by the partnership interests of both general partners in the Orlando Lake Forest Joint Venture and a pledge of 390 shares of the Class A common stock in NTS/Virginia Development Company by J. D. Nichols, Chairman of the Board of Directors of the Sponsor. The principal balance is guaranteed by NTS Guaranty Corporation. Effective July 1, 1992, the Fund discontinued accruing interest income on the Temporary Loan and classified the loan as non-earning. The Fund has entered into a forbearance agreement with the Joint Venture whereby, effective April 1, 1995, no interest will be due on this loan until January 31, 1998. In addition, the Fund has established a loan loss reserve of $1,500,000 as of December 31, 1996 regarding this loan. In October 1993, NTS/Virginia Development Company (Fawn Lake) and NTS/Lake Forest II Residential Corporation (Lake Forest) entered into a participation agreement with the Fund whereby they were each assigned an interest in the Fund's Temporary Mortgage Loan with the Orlando Lake Forest Joint Venture in consideration for reducing the amount of Supplemental Interest credit then due to them by the Fund. As of December 31, 1996, the interest assigned to Fawn Lake and Lake Forest was 17.651% and 19.125%, respectively. The Fund's ownership percentage was 63.224% and the Fund's share of the loan balance was $3,838,831 at December 31, 1996.
On February 12, 1997, the Fund entered into a letter of intent (the Letter of Intent) with NTS Corporation and its Affiliates, NTS Development Company, Fawn Lake, and Lake Forest regarding the Fund's loans to Fawn Lake and Lake Forest. The Letter of Intent provided for, among other things, a restructuring of the Fund's loans to Fawn Lake and Lake Forest. The Letter of Intent contemplates that ownership of the properties will be transferred to the Fund, which expects to continue the development to completion of such properties and ultimately, their orderly sale.
The parties to the Letter of Intent agreed to consider a general restructuring of the relationship among the Fund, NTS Corporation and its various Affiliates. The Fund has not yet determined the method by which it will acquire control of the projects.
Generally Accepted Accounting Principles require that transactions as contemplated by the Letter of Intent be recorded at fair market value. Management can not determine at this time whether or not such transactions, if completed, will result in a loss. In addition, in connection with the ongoing development of the projects, it is likely that the Fund will be required to change its tax status from a Real Estate Investment Trust to a conventional corporation.
The Fund, as owner of the Fawn Lake and Lake Forest projects, expects that it will continue development of the projects and the orderly sale of lots, golf course memberships and ancillary services through sell-out, as well as the sale of the Fawn Lake Country Club, when appropriate. As owner, the Fund will be responsible for continuing development, operations and marketing costs through the remaining lives of the projects and it may be necessary for the Fund to borrow additional funds to complete the development. While the Fund believes that such funds will be more readily available if it owns the projects, it is not certain that the Fund will be able to borrow the funds necessary to complete the projects.
The Letter of Intent also contemplates that NTS Development Company, or another subsidiary or affiliate of NTS Corporation (the "Manager"), will enter into a management agreement ( the "Management Agreement") with the Fund pursuant to which the Manager will, as authorized agent for the Fund, provide exclusive management, development, marketing and sales efforts and personnel to the Fund, and take all other actions necessary to manage the
- 7 -
Item 1. Business - Continued --------------------
development of the projects to completion and the sale of lots, golf memberships, ancillary services and the Fawn Lake Country Club. The terms of the Management Agreement have not yet been finalized. The parties to the Letter of Intent are presently negotiating the definitive agreements contemplated by the Letter of Intent but have not yet agreed on final terms.
Item 2.
Item 2. Properties -----------
The Fund makes loans which are secured or collateralized by an interest in real property. See Item 1 of this Form 10-K and Note 4 of the Fund's Notes to Financial Statements for information pertaining to the properties which collateralize the Fund's mortgage loans.
Item 3.
Item 3. Legal Proceedings -----------------
In July 1994, the Fund was named as a defendant in a complaint originally filed by Jeno Paulucci & Silver Lakes I, Inc. in August 1992 against NTS Corporation (the Fund's Sponsor) and various Affiliates of the Fund's Sponsor. The terms of the settlement agreement are confidential. However, as no monetary awards were assessed against or are payable by the Fund under the agreement, it is not anticipated that the settlement will have a material impact on the Fund's financial position or results of operations.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders ----------------------------------------------------
The Fund did not submit any matters to a vote of its security holders during the quarter ended December 31, 1996.
- 8 -
PART II
Item 5.
Item 5. Market for the Registrant's Shares and Related Stockholder Matters ------------------------------------------------------------------
The selling price of the Shares was $20 per Share. The Fund's Shares are freely transferable but are not listed or included for quotation on a national securities exchange. As of March 1, 1997, there were 4,021 record holders of the Fund's Shares. Cash dividends declared varied based upon the date of Stockholder admittance. Dividends in 1996, 1995 and 1994 represent a return on invested capital of 0.95%, 1.01% and 2.30%, respectively. The amount of dividends declared was based on net taxable income earned per year.
Dividends per share for the year ended December 31, 1996 were declared as follows:
First Quarter $ .045 Second Quarter .045 Third Quarter .045 Fourth Quarter .055 ----
$ .190 ====
Dividends per share for each of the two years in the period ended December 31, 1995 were declared as follows:
1995 1994 ---- ---- January $.03 $.06 February .03 .06 March .03 .06 April .03 .03 May .01 .03 June .01 .03 July .01 .03 August .01 .03 September .01 .03 October .01 .03 November .01 .03 December .01 .04 --- --- $.20 $.46 === ===
- 9 -
Item 5.Market for the Registrant's Shares and Related Stockholder Matters - -------------------------------------------------------------------- Continued ---------
The following table presents that portion of the Fund's dividends that represent a return of capital under Generally Accepted Accounting Principals (GAAP) for each of the three years in the period ended December 31, 1996.
1996 1995 1994 ---------- ---------- ---------- Net Income $ 850,309 $ 858,334 $1,782,171 ======== ========= ========= Dividends Declared $ 605,601 $ 643,841 $1,466,166 ======== ========= ========= Return of Capital (GAAP Basis) $ -- $ -- $ -- ========= ========= =========
The Fund uses tax-reporting accounting in applying the REIT-qualifying test that requires 95% of taxable income to be paid out in dividends.
The following table presents that portion of the Fund's dividends that represent a return of capital under tax-reporting accounting.
1996 1995 1994 ---------- ---------- ----------- Net Taxable Income $ 631,114 $ 672,098 $1,540,323 ========= ========= ========== Dividends Declared $ 605,601 $ 643,841 $1,466,166 ========= ========= ========== Return of Capital (TAX Basis) $ -- $ -- $ -- ========= ========= ==========
See Note 1C to Notes to Financial Statements and the Results of Operations under Management's Discussion for a detailed discussion of the differences between GAAP net income and net taxable income.
The continued needs of the projects to which the Fund has outstanding loans may significantly reduce the Fund's cash flows. Therefore, the Fund's Board of Directors has determined to terminate the Fund's quarterly distribution for the foreseeable future effective as of the first quarter of 1997.
- 10 -
Item 6.
Item 6. Selected Financial Data -----------------------
Years ended December 31, 1996, 1995, 1994, 1993 and 1992.
(1) The above selected financial data should be read in conjunction with the financial statements and related notes appearing elsewhere in this Form 10-K report. (2) Represents the carrying amount of the mortgage loans, which is equal to their face amount less unamortized commitment fees and unaccreted discounts. The 1996, 1995, 1994, 1993, and 1992 balances are net of an allowance for loan losses of $1,500,000, $1,553,397, $1,638,855, $1,730,000 and $230,000, respectively. (3) See Note 1C of the Notes to Financial Statements for an explanation of differences between net income and taxable income. (4) Cash dividends declared during 1996, 1995, 1994, 1993 and 1992 varied based upon the date of Stockholder admittance.
- 11 -
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and --------------------------------------------------------------- Results of Operations ---------------------
The Fund commenced an offering to the public on March 31, 1989 and was authorized to sell up to 2,500,000 shares of common stock at $20.00 per share (subject to an increase to 5,000,000 shares at the option of the Fund). Approximately 3,187,000 shares were sold representing approximately $64 million in sales and approximately $9.5 million in selling expenses and other offering costs. The net offering proceeds remaining, after payment of brokerage commissions, organizational expenses and other costs, have been used to make Mortgage Loans and Temporary Investments and such other investments as permitted by the Fund's Prospectus.
Liquidity and Capital Resources - -------------------------------
The Fund's primary investment strategy is to make investments in Mortgage Loans. As of December 31, 1996 and 1995 the Fund had commitments outstanding for Mortgage Loans aggregating $67,168,000 and $64,315,000 of which approximately $61,950,000 and $59,177,000 had been funded, respectively. The balance of these commitments will be drawn over a period of years in a series of advances as the borrowers develop the projects. Also, the Fund has invested in Temporary Investments totalling approximately $5,838,000 and $6,032,000 as of December 31, 1996 and 1995, respectively. Reference is made to Note 4 of the Notes to Financial Statements for further information regarding the Fund's investments as of December 31, 1996.
The Orlando Lake Forest Project (the "Orlando Project") is a single-family residential community owned by the Orlando Lake Forest Joint Venture, an Affiliated Borrower. Until August 30, 1995, the partners of the Joint Venture were Orlando Lake Forest, Inc., an Affiliate of the Fund's Sponsor, and PR Partners, an unaffiliated third party. On August 30, 1995, the interests of PR Partners were acquired by NTS/Orlando Development Company, an Affiliate of the Fund's Sponsor, due to the failure of PR Partners to make required capital contributions to the Joint Venture. The Orlando Project is encumbered by the following loans.
The Orlando Project is encumbered by a loan in the amount of $14,000,000 (with an outstanding balance of $13,086,004 as of December 31, 1996) from the Fund and an Affiliate of the Fund's Sponsor. The loan is secured by a first mortgage on the Project, approximately 398 acres of residential land and improvements thereon located in Orlando, Florida. On February 17, 1995, an agreement was reached with the bank which held the first mortgage on the majority of the Orlando Project. As a result of negotiations between the Fund and the unaffiliated bank, the bank sold its interest in the loan to the Fund at a substantial discount. The Fund and the Affiliate of the Fund's Sponsor, which holds the remaining interest in the first mortgage, entered into a participation agreement (the Master Loan Participation Agreement) whereby the Fund and the Affiliate will own a proportionate share of the first mortgage. The initial ownership percentages were 50% to the Fund and 50% to the Affiliate, however, the percentage ownership will fluctuate as additional principal is advanced to the Orlando Project by the Fund and as principal payments are received. Ownership percentage is determined in accordance with the ratio of each participant's share of the outstanding loan balance to the total outstanding loan balance. The Fund's ownership percentage was approximately 63% as of December 31, 1996. Upon the Fund's purchase of an interest in the loan, it was
- 12 -
Liquidity and Capital Resources - Continued - -------------------------------------------
converted to a cash flow mortgage loan which bears interest at an annualized rate equal to the greater of 17% of Gross Receipts or 6.46% of the average outstanding loan balance and matures January 31, 1998. The Fund's share of the loan balance was $7,126,366, as of December 31, 1996, which is net of an unaccreted discount of $1,127,407.
The Orlando Project is encumbered by a Temporary Mortgage Loan in the amount of $7,818,000 (with an overall outstanding balance by the Orlando Project of $6,071,752 as of December 31, 1996) to partially fund the Orlando Lake Forest Project. The loan is secured by the partnership interests of both general partners in the Orlando Lake Forest Joint Venture and 390 shares of the Class A common stock of NTS/Virginia Development Company (Fawn Lake). The Temporary Mortgage Loan is classified as non-earning and is on a demand basis. The Principal balance outstanding of the Temporary Mortgage Loan is guaranteed by NTS Guaranty Corporation pursuant to the Fund's Junior Mortgage Loan Guaranty. In October 1993, Fawn Lake and NTS/Lake Forest II Residential Corporation (Lake Forest) entered into a participation agreement with the Fund (the Temporary Mortgage Loan Participation Agreement) whereby they were each assigned an interest in the Fund's Temporary Mortgage Loan with the Orlando Lake Forest Joint Venture in consideration for reducing the amount of Supplemental Interest credit then due to them by the Fund. As of December 31, 1996, the interest assigned to Fawn Lake and Lake Forest was 17.651% and 19.125%, respectively. The Fund's ownership percentage was 63.224% and the Fund's share of the loan balance was $3,838,831 at December 31, 1996.
On October 19, 1992, the Fund notified the Orlando Lake Forest Joint Venture (the "Joint Venture") that the Joint Venture is in default regarding the Fund's Temporary Mortgage Loan to the Joint Venture. The defaults occurred when the Joint Venture failed to pay the Fund the interest that was due on the Temporary Mortgage Loan as of October 1, 1992. The default gives the Fund the right to accelerate the indebtedness and foreclose its security interest in the partnership interests pledged against the Temporary Mortgage Loan. Also, the Fund has the right to pursue the NTS Guaranty Corporation for its guaranty of the Principal balance outstanding on the Temporary Mortgage Loan. The ability of the Guarantor to honor its guaranty on the Temporary Mortgage Loan is expressly limited to its assets and its ability to draw upon a $10 million demand note receivable from Mr. J. D. Nichols, Chairman of the Board of Directors of the Fund's Sponsor. Mr. Nichols has contingent liabilities which exist in connection with debt on properties held by himself or his affiliates. There can be no assurance that Mr. Nichols will, if called upon, be able to honor his obligation to the Guarantor. The Fund's Board of Directors continues to evaluate the collectability of the guaranty. The Board is also concerned about the possible detrimental effects that the collection proceedings may have on the Fund's other loans to other Affiliated Borrowers. As a result, the Board has concluded that it is in the best interest of the Fund and its Stockholders to pursue a work-out plan to both preserve the assets of the Fund and support the viability of the projects to which it has outstanding loans. On March 24, 1993 the first part of this plan was implemented whereby the Fund received additional collateral in the form of a pledge of 390 shares of the Class A common stock in NTS/Virginia Development Company by J. D. Nichols to support the collectability of the Temporary Mortgage Loan to the Orlando Lake Forest Joint Venture.
The Fund discontinued the recognition of interest income from the Temporary Mortgage Loan to the Orlando Lake Forest Joint Venture beginning July 1, 1992, until the principal and interest have been received. The Fund intends to pursue collection of all amounts due. The Fund has entered into a forbearance agreement with the Orlando Lake
- 13 -
Liquidity and Capital Resources - Continued - -------------------------------------------
Forest Joint Venture whereby, effective April 1, 1995, no interest will be due on this loan through January 31, 1998. The Fund will reevaluate the status of the Orlando Project at that time to determine what, if any, additional courses of action to pursue and whether to extend the forbearance of interest. As of December 31, 1996, approximately $1,553,000 of interest remains due the Fund on this loan.
As discussed above, the Fund and an Affiliate of the Fund's Sponsor now are the first mortgage holders on the Orlando Project. As with the other Residential Land Development Loans, the Fund will be providing the funds needed by the Orlando Project to allow it to continue its development plan. Principal and interest payments will be allocated proportionately between the Fund and the Affiliate based upon their respective ownership percentage.
In June of 1995, the Fund's Board of Directors approved a change to the terms of the Master Loan Participation Agreement and the Temporary Mortgage Loan Participation Agreement. Effective April 1, 1995, the Affiliate of the Fund's Sponsor agreed that the Fund may retain all payments of principal which the Affiliate would be entitled to receive on the first Mortgage Loan. The Fund is applying such sums as payment by the Orlando Lake Forest Joint Venture of the Fund's share of the principal balance outstanding on the Temporary Mortgage Loan. This will continue until such time as the Fund's share of the outstanding principal of the Temporary Mortgage Loan has been repaid in full. The Fund has received $1,139,394 and $541,899 for the years ended December 31, 1996 and 1995, respectively, which was applied to the principal balance outstanding on the Temporary Mortgage Loan via this agreement.
The completion and marketing of the Orlando Project as planned should allow the Orlando Lake Forest Joint Venture to repay both the first mortgage and the outstanding principal balance of the Fund's Temporary Mortgage Loan.
The Fund has established a $1,500,000 loan loss reserve regarding the Temporary Mortgage Loan. The amount of the reserve is based on the requirements by GAAP that the mortgage loans be carried at the lower of the carrying value of the asset or fair value. Given the likelihood that it will be some time in the future before the Fund can collect the principal balance outstanding, GAAP requires that the stream of estimated future cash flows be discounted to determine the fair value at the balance sheet date even though this loan is guaranteed by NTS Guaranty Corporation. This calculation does not lessen the Fund's ability or expectation that the entire principal balance outstanding will be collected in full.
The Orlando Project had been encumbered by a Phase-In Mortgage Loan from the Fund to the Orlando Lake Forest Joint Venture for the development of Section II of the Orlando Project. In October 1996, the last lot in Section II of the Orlando Project was sold and the proceeds therefrom were transferred to the Fund. These proceeds were applied to the outstanding balance of the Fund's $3,000,000 Phase-In Mortgage Loan to the Orlando Lake Forest Joint Venture. The loan was non-recourse, thus, the remaining $53,397 still due the Fund after the application of the lot proceeds was written off as an amount deemed uncollectible. The Fund has no further course of action to pursue collection.
In July 1994, the Fund was named as a defendant in a complaint originally filed by Jeno Paulucci & Silver Lakes I, Inc. in August 1992 against NTS Corporation (the Fund's Sponsor) and various Affiliates of the Fund's Sponsor. The terms of the settlement agreement are confidential. However, as no monetary awards were assessed against or are payable by the Fund under the agreement, it is not anticipated that the settlement will have a material impact on the Fund's financial position or results of operations.
- 14 -
Liquidity and Capital Resources - Continued - -------------------------------------------
The Fawn Lake project is a single-family residential community owned by NTS/Virginia Development Company, an Affiliated Borrower. Fawn Lake is encumbered by the following notes:
A note payable in the amount of $325,000 (with an outstanding balance of $ 243,393 as of December 31, 1996) from an unaffiliated lender which is secured by a first mortgage on 14 residential lots (approximately 22 acres of residential land and improvements thereon). The purpose of the loan was to provide construction financing to develop approximately 44 lots of the Fawn Lake project (30 of which have been sold and released from the mortgage). The Fund's Board of Directors agreed to subordinate the Fund's Mortgage Loan regarding the 44 lots until the unaffiliated lender note is paid in full. The note bears interest at the Prime Rate plus 1%, payable monthly, and matures September 15, 1997.
A Mortgage Loan from the Fund in the amount of $30,000,000 (with an outstanding balance of $28,966,245 as of December 31, 1996) to fund the development of the Fawn Lake project, a specified investment. The loan is secured by a first mortgage on approximately 2,207 acres of residential land and improvements thereon located in Fredericksburg, Virginia. The Fund has subordinated its first mortgage on approximately 22 acres regarding the loan discussed above. The loan bears interest at an annualized rate equal to the greater of 17% of Gross Receipts or 4.42% of the average outstanding loan balance and matures July 1, 1997.
A Temporary Mortgage Loan from the Fund in the amount of $2,500,000 (with an outstanding balance of $1,998,850 as of December 31, 1996) to fund the construction of the Fawn Lake Golf Course. The loan bears interest at the Prime Rate plus 3/4%, payable monthly, and matures July 31, 1997. The loan is secured by a first mortgage on approximately 187 acres of residential land and improvements thereon. The Principal balance outstanding of the Temporary Mortgage Loan is guaranteed by NTS Guaranty Corporation pursuant to the Fund's Junior Mortgage Loan Guaranty.
The Lake Forest project is a single-family residential community owned by NTS/Lake Forest II Residential Corporation, an Affiliated Borrower. Lake Forest is encumbered by the following notes:
A note payable with an unaffiliated lender in the amount of $875,000 (with an outstanding balance of $258,060 as of December 31, 1996) which is secured by a first mortgage on 10 residential lots (approximately 3 acres of residential land and improvements thereon). The purpose of the loan was to provide construction financing to develop 25 lots in the Lake Forest project (15 of which have been sold and released from the mortgage). The Fund has subordinated its Mortgage Loan regarding the 25 lots until the unaffiliated lender note is paid in full. The note bears interest at the Prime Rate plus 1%, payable monthly, and matured November 24, 1996, an extension is being negotiated.
A note payable with an unaffiliated bank in the amount of $4,965,000 (with an outstanding balance of $3,908,127 as of December 31, 1996) which is secured by a first mortgage on the Lake Forest Country Club golf course (approximately 176 acres of residential land and improvements thereon). The purpose of the loan was to provide construction financing to construct the clubhouse building for the Country Club. The Fund has subordinated its Mortgage Loan regarding the 176 acres until the unaffiliated bank note is paid in full. The note bears interest at the Prime Rate plus 1%, payable monthly, and matures July 31, 1999.
- 15 -
Liquidity and Capital Resources - Continued - --------------------------------------------
A Mortgage Loan from the Fund in the amount of $28,000,000 (with an outstanding balance of $25,857,472 as of December 31, 1996) to fund the development of the Lake Forest project, a specified investment. The loan bears interest at an annualized rate equal to the greater of 17% of Gross Receipts or 4.42% of the average outstanding loan balance and matures July 1, 1997. The loan is secured by a first mortgage on approximately 532 acres of residential land and improvements thereon located in Louisville, Kentucky of which approximately 180 acres have been subordinated regarding the loans discussed above.
On October 11, 1994, following an extended review of operations of the residential development borrowers, the Fund's Board of Directors agreed that it was necessary to revise the structure of the Fund's Mortgage Loans to Fawn Lake and Lake Forest (the "Affiliated Borrowers") in order to protect the capital of the Fund. After reviewing possible alternatives, it was determined that it was necessary to change the structure of the loans to cash flow mortgage loans which would relate the debt service to sales volumes, thereby allowing the Affiliated Borrowers to develop the elements essential for successful completion of the projects. It was judged by the Fund's Board of Directors to be the approach most likely to effectively work out the current situation and protect the Fund's capital. At the same time, the Board required that 1) the owners of the Affiliated Borrowers receive no distributions from the projects until their loan is fully repaid, 2) NTS Advisory Corporation will pay $100,000 annually towards the expenses of the Fund beginning in 1995 until the maturity of the loans, and 3) the Affiliated Borrowers will be required to pay to the Fund 100% of the Gross Receipts from the sale of the underlying real estate (residential lots) which secures the mortgage after paying closing costs. Effective July 1, 1994, the Affiliated Borrowers will pay interest at an annualized rate equal to the greater of 15% (subsequently revised to 17%) of Gross Receipts or 4.42% of the average outstanding loan balance. The Fund will no longer receive Regular Interest, Gross Receipts Interest or other fees previously charged. Interest will be due and payable monthly as lots are sold. Any shortfall to meet the minimum rate of 4.42% will be due and payable December 31 of the calendar year.
On December 1, 1994, the Fund's Board of Directors approved an increase in the loan commitment amount to Lake Forest from $25,000,000 to $28,000,000 and approved an increase in the loan commitment amount to Fawn Lake from $20,000,000 to $28,000,000. The purpose of the increases was to enable the projects to refinance certain obligations superior in priority to the Fund's Mortgage Loans as well as to enable the projects to pay ongoing development costs. In addition, the monthly interest rate was increased from 15% of Gross Receipts to 17% of Gross Receipts from lot sales effective July 1, 1994. This will allow the monthly interest payments to more closely approximate the minimum required interest rate of 4.42% of the outstanding loan balance.
On March 21, 1996, the Fund's Board of Directors approved an increase in the loan commitment amount to Fawn Lake from $28,000,000 to $30,000,000. The purpose of the increase is to pay ongoing development costs.
On September 27, 1996, the Fund's Board of Directors approved an increase in the loan commitment amount to Orlando Lake Forest from $13,000,000 to $14,000,000. The purpose of the increase is to pay ongoing development costs.
On February 12, 1997, the Fund entered into a letter of intent (the Letter of Intent) with NTS Corporation and its Affiliates, NTS Development Company,
- 16 -
Liquidity and Capital Resources - Continued - --------------------------------------------
Fawn Lake and Lake Forest, regarding the Fund's loans to Fawn Lake and Lake Forest. The Letter of Intent provides for a restructuring of the Fund's loans to Fawn Lake and Lake Forest. The Letter of Intent contemplates that the ownership of the properties will be transferred to the Fund, which plans to continue the development to completion of such properties and, ultimately, their orderly sale.
The parties to the Letter of Intent agreed to consider a general restructuring of the relationships among the Fund, NTS Corporation and its various Affiliates. The Fund has not yet determined the method by which it will acquire control of the projects.
Generally Accepted Accounting Principles require that transactions as contemplated by the Letter of Intent be recorded at fair market value. Management can not determine at this time whether or not such transactions, if completed, will result in a loss. In addition, in connection with the ongoing development of the projects, it is likely that the Fund will be required to change its tax status from a Real Estate Investment Trust to a conventional corporation.
The Fund, as owner of the Fawn Lake and Lake Forest projects, expects to continue development of the projects and the orderly sale of lots, golf course memberships and ancillary services through sell-out, as well as the sale of the Fawn Lake Country Club, when appropriate. As owner, the Fund will be responsible for continuing development, operations and marketing costs through the remaining lives of the projects and it may be necessary for the Fund to borrow additional funds to complete the development. While the Fund believes that such funds will be more readily available if it owns the projects, it is not certain that the Fund will be able to borrow the funds necessary to complete the projects.
The Letter of Intent contemplates that NTS Development Company, or another subsidiary or affiliate of NTS Corporation (the "Manager"), will enter into a management agreement ( the "Management Agreement") with the Fund pursuant to which the Manager will, as authorized agent for the Fund, provide exclusive management, development, marketing and sales efforts and personnel to the Fund, and take all other actions necessary to manage the development of the projects to completion and the sale of lots, golf memberships, ancillary services and the Fawn Lake Country Club. The terms of the Management Agreement have not yet been finalized. The parties to the Letter of Intent are presently negotiating the definitive agreements contemplated by the Letter of Intent but have not yet agreed on final terms.
On January 24, 1992, the Fund entered into a loan agreement with an unaffiliated bank providing for a credit facility of up to $2.8 million secured by a collateral assignment of the Fund's mortgage to Lake Forest. On August 3, 1993, the credit limit was raised to $4 million. The loan was paid in full on January 10, 1995.
On January 10, 1995, the Fund entered into a loan agreement with an unaffiliated bank providing for a credit facility of up to $13.8 million secured by a collateral assignment of the Fund's mortgages to Lake Forest and Fawn Lake. The purpose of the loan is to refinance the Fund's existing credit facility, increase the Fund's investment portfolio and provide additional operating capital for the Fund. The loan bears interest at the Prime Rate plus 1%, payable monthly and matures December 27, 1997. The Fund made principal payments on the loan equal to $12,000 per lot from lot sales at Lake Forest and $1,000 per lot from lot sales at Fawn Lake during 1995 and $13,500 per lot from lot sales at Lake Forest and $1,000 per lot from lot sales at Fawn Lake during 1996. The Fund will make principal payments on the loan equal to $27,500 per lot from lot sales at Lake Forest and $1,000 per lot from lot sales at Fawn Lake during 1997. The loan is guaranteed by Mr. J. D. Nichols, Chairman of the Board of the Fund's Sponsor.
- 17 -
Liquidity and Capital Resources - Continued - -------------------------------------------
In the fourth quarter of 1995, the Fund entered into a loan agreement with an unaffiliated bank for $2,000,000 secured by a collateral assignment of the Fund's mortgage to Fawn Lake regarding approximately 187 acres of residential land and improvements known as the Fawn Lake Golf Course. The purpose of the loan is to fund the remaining construction of the Fawn Lake Golf Course. The loan bears interest at the Prime Rate plus 3/4%, payable monthly. In February 1997, the loan balance was increased to $2,500,000 and the maturity date was extended to July 31, 1997.
The Fund has received advances from Affiliates of the Fund's Sponsor, net of repayments, totalling $4,524,667 and $1,885,000 as of December 31, 1996 and 1995, respectively. The advances had been at various rates averaging approximately 5.75% when they matured April 15, 1996. On April 15, 1996 the interest rate on all borrowings from Affiliates of the Fund's Sponsor increased to the Prime Rate. The maturity date on $2,320,000 of the borrowings is March 31, 1999 and $2,204,667 is due on demand. In February 1997, the maturity date on $1,054,667 of the borrowings due on demand was extended to May 1, 1999. In addition, the Fund is making principal payments on the advances equal to $3,000 per lot from lot sales at Fawn Lake, Lake Forest and the Orlando Project from April 15, 1996 through March 31, 1997; $5,000 per lot from April 1, 1997 through March 31, 1998; and $7,500 per lot from April 1, 1998 through March 31, 1999. Additional principal payments will be made to the Affiliates as cash flow permits. Interest paid to the Affiliates was $258,191 and $82,050 for the years ended December 31, 1996 and 1995, respectively. No interest was due to Affiliates in 1994. The advances were made to meet the development plans of the projects to which the Fund has outstanding loans.
During the year ended December 31, 1996, the Fund received repayment on four mortgage loans and two temporary investments in the aggregate principal amount of $8,099,364. The repayments on mortgage loans were generally equal to approximately 83% of the Gross Receipts received on lot sales less closing costs. The Fund made investments in three mortgage loans and one temporary investment in the aggregate principal amount of $10,562,950.
During the year ended December 31, 1995, the Fund received repayment on four mortgage loans and two temporary investments in the aggregate principal amount of $8,219,874. The repayments on mortgage loans were generally equal to approximately 83% of the Gross Receipts received on lot sales less closing costs. The Fund made investments in three mortgage loans and one temporary investment in the aggregate principal amount of $21,187,154.
During the year ended December 31, 1994, the Fund received repayment on three mortgage loans and one temporary investment in the aggregate principal amount of $4,310,554. The repayments of mortgage loans through June 30, 1994 were based on Scheduled Principal Payments of (i) 80% of the Gross Receipts received on sales of lots to builders and (ii) 70% of the Gross Receipts received on sales of lots to individuals. Effective July 1, 1994, repayments on mortgage loans were generally equal to approximately 83% of the Gross Receipts received on lot sales less closing costs. The Fund made investments in two mortgage loans in the aggregate principal amount of $4,056,326.
During the year ended December 31, 1996, the Fund borrowed $1,201,999 from its various lenders. The Fund repaid $1,075,022 of its borrowings primarily from loan repayments made by NTS/Lake Forest II Residential Corporation. In addition, the Fund borrowed $4,077,457 from an Affiliate of the Fund's Sponsor. The Fund repaid $1,437,790 of these affiliated borrowings primarily from loan repayments make by the Orlando Lake Forest Joint Venture.
- 18 -
Liquidity and Capital Resources - Continued - --------------------------------------------
During the year ended December 31, 1995, the Fund borrowed $15,186,873 from its various lenders. The Fund repaid $1,991,528 of its borrowings using proceeds from a $13.8 million credit facility and repaid $268,000 of its borrowings using proceeds from a $2,000,000 mortgage loan. The remaining $714,000 reduction in debt came primarily from loan repayments made by NTS/Lake Forest II Residential Corporation. The Fund also borrowed $1,885,000 from Affiliates of the Fund's Sponsor.
During the year ended December 31, 1994, the Fund borrowed $554,691 on its credit facility. The Fund repaid $1,006,151 of its borrowings using proceeds from loan payments made by NTS/Lake Forest II Residential Corporation.
The Fund intends to maintain a working capital reserve equal to 1% of the gross proceeds received. The Fund may alter the percentage of such reserves if deemed necessary. As of December 31, 1996, the Fund had cash and equivalents of approximately $716,000.
The Fund's primary source of liquidity has been from the interest earned on the Mortgage Loans on the Temporary Investments. It is expected that this will continue to be a primary source of future liquidity until the consumation of the transactions contemplated in the Letter of Intent, as discussed on page 17, if such transactions are completed. The ability of the Fund to receive interest on the Mortgage Loans depends on the level of residential lot closings achieved by the properties which collateralize the loans. In addition, the Fund is continuing to focus on cash management and is pursuing financing sources to provide sufficient resources to fund the needs of the projects to which it has outstanding loans. The Fund's Sponsor is also working with several lenders including the Fund's existing creditors, to refinance the Fund's debt which will mature within the next twelve months. While management can provide no assurance that these negotiations will be successful, it is their belief that, based upon discussions with the various lenders, such financing will be accomplished prior to the respective maturity dates.
The continued cash needs of the projects to which the Fund has outstanding loans may significantly reduce the Fund's cash flows. Therefore, the Fund's Board of Directors has determined to terminate the Fund's quarterly distribution for the foreseeable future effective as of the first quarter of 1997. However, the Fund's cash and cash equivalents are expected to be sufficient to meet its anticipated needs for liquidity and capital resources.
Results of Operations - ---------------------
Net income using generally accepted accounting principles (GAAP) was $850,309, $858,334 and $1,782,171 and using tax-reporting accounting (TRA) was $631,114, $672,098 and $1,540,323 for the years ended December 31, 1996, 1995 and 1994, respectively. The difference between GAAP income and TRA income was due primarily to the treatment of loan discount accretion, loan commitment fee income, letters of credit income, Supplemental Interest income and provision for loan losses. GAAP requires that discounts on mortgage loan receivables be recognized as an adjustment to yield over the estimated life of the loan; for tax purposes the discount is recognized as income when the proceeds are received. GAAP requires that loan commitment fee income be recognized as income over the term of the related loans; for tax purposes the fees are recognized as income when received. GAAP requires that income received from letters of credit be recognized on a straight-line basis over the term of the letter of credit (typically one year); for tax purposes, this income is recognized as income when received. For GAAP purposes, Gross Receipts Interest is reported as earned on the accrual basis of accounting; for tax purposes 50% of the amount of Gross Receipts Interest earned is credited against Supplemental Interest Income paid in prior years.
- 19 -
Results of Operations - Continued - ---------------------------------
For GAAP purposes, a provision for loan losses is recognized when the fair value of the asset is less than the carrying value of the asset; for tax purposes, a provision for loan losses is allowed when the debt becomes worthless within the taxable year. TRA income is used in applying the REIT-qualifying test that requires 95% of taxable income to be paid out in dividends. (See Note 1C to Notes to Financial Statements).
Cash provided by operations was $392,077, $59,772 and $1,503,393 during the years ended December 31, 1996, 1995 and 1994, respectively. The Fund declared dividends of $605,601 (1996), $643,841 (1995) and $1,466,166 (1994). Total dividends declared provided Stockholders with an annualized return of 0.95%, 1.01% and 2.30% for the years ended December 31, 1996, 1995 and 1994, respectively.
On October 11, 1994, the Fund's Board of Directors approved a change in the structure of the Fund's Mortgage Loans to NTS/Virginia Development Company and NTS/Lake Forest II Residential Corporation (the "Affiliated Borrowers") from fixed rate mortgage loans to cash flow mortgage loans. Effective July 1, 1994, these Affiliated Borrowers will pay interest at an annualized rate equal to the greater of 15% (subsequently revised to 17%) of Gross Receipts from the sale of the underlying real estate (residential lots) which secures the mortgage or 4.42% of the average outstanding loan balance. Interest will be due and payable monthly as lots are sold. Any shortfall to meet the minimum rate of 4.42% will be due and payable December 31 of the calendar year. The Fund will no longer receive Regular Interest, Gross Receipts Interest or other fees previously charged. In February 1995, the Fund purchased a 50% interest in a $13 million first mortgage loan to the Orlando Lake Forest Joint Venture. The loan bears interest at the greater of 17% of Gross Receipts or 6.46% of the average outstanding loan balance. The increases in interest income on mortgage loans receivable between years are due to an increase in the average outstanding balances of the earning loans. The average outstanding balances of the earning loans increased from $46,299,000 (1994) to $57,668,000 (1995) to $62,878,000 (1996). The average interest rate earned by the Fund for the years ended December 31, 1996, 1995 and 1994 was approximately 5.1%, 4.9% and 5.9%, respectively, of the average outstanding loan balances.
Effective July 1, 1992, the Fund discontinued accruing interest income from the Temporary Mortgage Loan to the Orlando Lake Forest Joint Venture until the principal and interest have been received. As of December 31, 1996 and 1995, approximately $1,553,000 of interest was due on this loan but not accrued in the Fund's financial statements. The Fund has entered into a forbearance agreement with the Orlando Lake Forest Joint Venture whereby, effective April 1, 1995, no interest will be due on the loan through January 31, 1998. The Fund will reevaluate the status of the Orlando Project at that time to determine what, if any, additional courses of action to pursue, and whether to extend the forbearance of interest.
Commitment fees paid at loan closings are amortized over the life of the loan using the interest method. Letter of credit fees are amortized over the term of the letter of credit. Fee income on mortgage loans and financial services is the amount of commitment fees and letter of credit fees being amortized for the period. There was no commitment fee income recognized in 1995.
Gross Receipts Interest represents 5% of the Affiliated Borrowers' Gross Receipts from the sale of the underlying real estate (residential lots) during the period. Supplemental Interest is an amount in excess of Points, Regular Interest, and either Gross Receipts Interest or Incentive Interest that certain Affiliated Borrowers paid to the Fund. Payments of Supplemental Interest were credited against 50% of the amount of Gross Receipts Interest or Incentive Interest which the Fund received from
- 20 -
Results of Operations - Continued - ----------------------------------
Affiliated Borrowers in later years. The Fund earned Gross Receipts Interest of $129,338 for the year ended December 31, 1994. These amounts were generated from the Fund's Mortgage Loans to NTS/Virginia Development Company, NTS/Lake Forest II Residential Corporation and the Phase-In Mortgage Loan to the Orlando Lake Forest Joint Venture. Effective July 1, 1994, none of the Fund's Mortgage Loans provide for Gross Receipts Interest.
In addition to Points, Regular Interest and Supplemental Interest, the Fund may receive Incentive Interest in connection with Mortgage Loans made to Affiliated Borrowers secured by properties not held for sale in the ordinary course of the Affiliated Borrower's business; except that in certain cases the Fund may forego Incentive Interest in order to maintain compliance with REIT qualification requirements and may instead either seek additional Points or Regular Interest or will seek to obtain Gross Receipts Interest. The Fund does not anticipate receiving Incentive Interest and Gross Receipts Interest on the same Mortgage Loan. The amount of Incentive Interest which the Fund will receive from Affiliated Borrowers will be equal to a specified percentage of the "Increase in Value" of the underlying property securing the Mortgage Loan, which Increase in Value occurred during the period beginning from the date that the Mortgage Loan was funded and ending upon the repayment of the Mortgage Loan at maturity or upon the Sale or Refinancing of the underlying property excluding a sale or transfer to an Affiliate, so long as the Fund retains an interest in the property subsequent to the sale or transfer. No Incentive Interest has been included in revenues for any of the three years ended December 31, 1996.
The Fund's by-laws provide that annual operating expenses of the Fund may not exceed in any year the greater of (i) 2% of the Funds average invested assets during such year or (ii) 25% of the Fund's taxable income during such year. The Advisor must reimburse the Fund within 60 days after the end of the year the amount by which the aggregate annual Operating Expenses paid or incurred by the Fund exceed the foregoing limitations, unless the Board of Directors approves expenses in excess of such limitations. No reimbursement was required for any of the three years ended December 31, 1996 as operating expenses did not exceed the limit.
Operating expenses of the Fund include a Management Expense Allowance (Advisory Fee) of 1% of the Fund's Net Assets, per annum, which may be increased annually by an amount corresponding to the percentage increase in the Consumer Price Index. The Advisory Fee is paid to the Advisor (NTS Advisory Corporation) or its affiliate. Effective July 1, 1994, the Fund's Mortgage Loans to Fawn Lake and Lake Forest were converted to cash flow mortgage loans. As part of the consideration for this restructuring, the Fund's Board of Directors required, among other things, that beginning in 1995, NTS Advisory Corporation pay $100,000 annually towards the expenses of the Fund until the maturity of the Mortgage Loans. As such, the Advisory Fee has been reduced $100,000 for each of the years ended December 31, 1995 and 1996. The Advisory Fee for the years ended December 31, 1996, 1995 and 1994 was $544,776, $528,973 and $614,100, respectively. Increases and decreases in the Advisory Fee generally correspond directly to increases and decreases in the Fund's Net Assets.
Increase and decreases in interest expense generally correspond directly to increase and decreases in the outstanding balances of the Fund's borrowings. The average interest rate paid by the Fund for the years ended December 31, 1996, 1995 and 1994 was 8.9%, 9.7% and 8.2%, respectively.
Professional and administrative expenses include primarily directors' fees, legal, outside accounting and investor processing fees, and printing costs for financial reports. The increase in expenses for the year ended December 31, 1996 is due to the fees associated with the addition of an Independent Director and increased professional fees related to the lawsuit discussed in Part 1, Item 3 of this Form 10-K.
- 21 -
Results of Operations - Continued - ----------------------------------
Income tax expense is the Fund's estimated liability for Federal, state, and local income taxes due on the amount of earnings which are in excess of dividends for the period.
The Fund's net income declined 52% from 1994 to 1996 and 19% from 1995 to 1996. The disproportionate declines in net income compared to the increases in revenues is due to the fact that the sales volumes at the residential projects and the corresponding interest income earned by the Fund have not been sufficient to offset the increase in the Fund's cost of debt service.
The Fund has invested in Mortgage Loans totaling approximately $67,168,000 and $59,177,000 as of December 31, 1996 and 1995, respectively. Also, the Fund has invested in Temporary Investments totaling approximately $5,837,681 and $6,032,000 as of December 31, 1996 and 1995, respectively. The balance of funds were invested in short-term cash equivalents. The Temporary Investments were funded as an alternative to other short-term investments in order to obtain higher interest rates.
The Fund's investments at December 31, 1996 were as follows:
A Mortgage Loan to NTS/Lake Forest II Residential Corporation, an Affiliated Borrower, to fund the development of Lake Forest North, a specified investment. The loan balance was $25,857,472 at December 31, 1996.
A Mortgage Loan to NTS/Virginia Development Company, an Affiliated Borrower, to fund the development of Fawn Lake, a specified investment. The loan balance was $28,966,245 at December 31, 1996.
A Temporary Mortgage Loan to NTS/Virginia Development Company, an Affiliated Borrower, to fund the construction of the Fawn Lake Golf Course. The loan balance was $1,998,850 at December 31, 1996.
A Mortgage Loan to Orlando Lake Forest Joint Venture, an Affiliated Borrower, to fund the development of Orlando Lake Forest, a specified investment. The loan balance was $7,126,366 at December 31, 1996, which is net of an unaccreted discount of $1,127,407.
A Temporary Mortgage Loan to Orlando Lake Forest Joint Venture, an Affiliated Borrower, to partially fund the Orlando Lake Forest Loan, a specified investment. Effective July 1, 1992, the Fund discontinued accruing interest income on the Temporary Mortgage Loan and classified the loan as non-earning. In addition, the Fund has established a loan loss reserve of $1,500,000 as of December 31, 1996 regarding this loan. The loan balance was $3,838,831 at December 31, 1996.
The Fund's investment of $25,857,472 in NTS/Lake Forest II Residential Corporation represents approximately 38% of the Fund's portfolio and the Fund's commitment of $28,000,000 represents approximately 41% of the Fund's portfolio. The Fund's investment of $28,966,245 in NTS/Virginia Development Company represents approximately 42% of the Fund's portfolio and the Fund's commitment of $30,000,000 represents approximately 44% of the Fund's portfolio. Both loans are current in their interest payments to the Fund.
In addition, the Fund's Mortgage Loan to the Orlando Lake Forest Joint Venture and the Temporary Mortgage Loan to NTS/Virginia Development Company are current in interest payments to the Fund. The Fund's Temporary Mortgage Loan to the Orlando Lake Forest Joint Venture is not current in interest payments to the Fund. Approximately $1,553,000 of interest remains due on this loan but is not accrued in the Fund's financial statements.
- 22 -
Results of Operations - Continued - ----------------------------------
Any forward-looking statements included in Management's Discussion and Analysis of Financial Condition and Results of Operations, or elsewhere in this report, which reflect management's best judgement based on factors known, involve risks and uncertainties. Readers are cautioned not to place undue reliance on any forward-looking statements, which reflect management's analysis only as of the date hereof. The Fund undertakes no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date hereof. Actual results could differ materially from those anticipated in any forward-looking statements as a result of a number of factors, including but not limited to those discussed below. Any forward-looking information provided by the Fund pursuant to the safe harbor established by recent securities legislation should be evaluated in the context of these factors.
- - The Fund's principal activity is the investment in Mortgage Loans to Affiliated Borrowers. Mortgage Loans are inherently subject to the risk of default. If the Borrower defaults on a Mortgage Loan which is not guaranteed, the Board of Directors may foreclose which could result in considerable delays and expenses. A Borrower's ability to make payments due under the Mortgage Loan and the amount the Fund may realize upon foreclosure are subject to risks generally associated with real estate investments, many of which are beyond the control to the Fund, including general or local economic conditions, competition, interest rates, real state tax rates, other operating expenses, the supply of and demand for properties, zoning laws, other governmental rules and fiscal policies, and acts of God.
- - The Affiliated Borrowers are engaged in the development and sale of residential subdivision building lots, the pricing of which are subject to risks generally associated with real estate development and applicable market forces beyond the control of the Affiliated Borrowers and/or the Fund, including economic conditions, competition, interest rates, real estate tax rates, other operating expenses, the supply of and demand for properties, zoning laws, other governmental rules and fiscal policies, and acts of God.
- - There is the potential for occurrences which could affect the Fund's ability to reduce, or limit the increase in, its professional and administrative expenses. Furthermore, the debt service regarding the Fund's borrowings is variable based on current interest rates, any fluctuations in which are beyond the control of the fund. These variances could, for example, impact the Fund's projected cash and cash requirements as well as projected returns.
- 23 -
Item 8.
Item 8. Financial Statements and Supplementary Data --------------------------------------------
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of the NTS Mortgage Income Fund:
We have audited the accompanying balance sheets of the NTS Mortgage Income Fund (a Delaware corporation) as of December 31, 1996 and 1995, and the related statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the NTS Mortgage Income Fund as of December 31, 1996 and 1995, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Louisville, Kentucky March 24, 1997
- 24 -
The accompanying notes are an integral part of these financial statements.
- 25 -
The accompanying notes are an integral part of these financial statements.
- 26 -
The accompanying notes are an integral part of these financial statements.
- 27-
The accompanying notes are an integral part of these financial statements.
- 28-
NTS MORTGAGE INCOME FUND
NOTES TO FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies ------------------------------------------
A) Organization ------------
NTS Mortgage Income Fund (the "Fund"), a Delaware corporation, was formed on September 26, 1988. The Fund operates as a real estate investment trust (REIT) under the Internal Revenue Code of 1986 (the "Code"), as amended. NTS Corporation is the sponsor of the Fund (the "Sponsor") and its affiliate, NTS Advisory Corporation, is the advisor to the Fund (the "Advisor").
The Fund has made permanent mortgage loans to Affiliated Borrowers consisting principally of first, and to a lesser extent, junior mortgage loans. Each mortgage loan is secured by a lien on the property, by an interest in the borrower or by a similar security interest.
The Fund is required to terminate and liquidate its assets by December 31, 2008.
These financial statements do not reflect the impact, if any, of the proposed transactions discussed in Note 12.
B) Basis of Accounting -------------------
The Fund's records are maintained on the accrual basis of accounting in accordance with generally accepted accounting principles (GAAP).
C) Income Taxes ------------
The Fund has elected and is qualified to be treated as a REIT under Internal Revenue Code Sections 856-860. In order to qualify, the Fund is required to distribute at least 95% of its taxable income to Stockholders and meet certain other requirements. The Fund intends to continue to qualify as a REIT for Federal income tax purposes. A reconciliation of net income for financial statement purposes versus that for income tax reporting at December 31 is as follows:
1996 1995 1994 ----------- ----------- ----------
Net income (GAAP) $ 850,309 $ 858,334 $ 1,782,171 Accretion of note discount (148,472) (125,029) -- Loan commitment fee income (20,000) 20,000 (102,930) Letters of credit income (2,326) (1,032) (3,105) Supplemental interest income -- (1,717) (64,668) Federal income tax expense 5,000 7,000 20,000 Provision for loan losses (53,397) (85,458) (91,145) ----------- ----------- ----------- Taxable income before dividends paid deduction $ 631,114 $ 672,098 $ 1,540,323 =========== =========== ===========
Dividends declared $ 605,601 $ 643,841 $ 1,466,166 =========== =========== ===========
Distribution percentage 96% 96% 95% =========== =========== ============
- 29 -
1. Summary of Significant Accounting Policies - Continued ------------------------------------------------------
D) Use of Estimates in Preparation of Financial Statements -------------------------------------------------------
The preparation of financial statements in conformity with GAAP 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.
E) Revenue Recognition and Reserves for Loan Losses ------------------------------------------------
Interest income from mortgage loans is reported as earned on the accrual basis of accounting. If the Fund has any reason to doubt the collectability of any principal or interest amounts due pursuant to the terms of the mortgage loans appropriate reserves would be established for any principal and accrued interest amounts deemed unrealizable (see Note 5). Statements of Financial Accounting Standards Nos. 114 and 118 require that impaired loans be measured based on the present value of expected future cash flows discounted at each loan's effective interest rate, at each loan's observable market price or at the fair value of the collateral if the loan is collateral dependent.
Commitment fees paid at loan closing are amortized over the life of the loan using the interest method. Letter of credit income is amortized over the term of the letter of credit using the straight-line method. Gross Receipts Interest is recognized with respect to a mortgage loan secured by real estate held for sale in the ordinary course of the borrower's business. Gross Receipts Interest is an amount equal to 5% of the borrower's Gross Receipts, as defined in the Fund's Prospectus, from the sale of the underlying real estate during the term of the mortgage loan. Gross Receipts Interest is reported as earned on the accrual basis of accounting.
F) Statement of Cash Flows -----------------------
For purposes of reporting cash flows, cash and equivalents include cash on hand and short-term, highly liquid investments with an original maturity of three (3) months or less that are readily convertible to cash.
G) Operating Expense Limitations -----------------------------
The annual Operating Expenses of the Fund, based upon guidelines promulgated by the North American Securities Administrators Association, Inc., are prohibited from exceeding in any fiscal year the greater of (i) 2% of the Fund's Average Invested Assets during such fiscal year or (ii) 25% of the Fund's Net Income during such fiscal year. In the event the Fund's annual Operating Expenses exceed this limitation, the Advisor must reimburse the Fund within 60 days after the end of the fiscal year, the amount by which the aggregate annual Operating Expenses paid or incurred by the Fund exceed the foregoing limitations. The Fund did not exceed this limitation for the years ended December 31, 1996, 1995 and 1994.
Operating Expenses are defined as operating, general and administrative expenses of the Fund as determined under generally accepted accounting principles, including but not limited to rent, utilities, capital equipment, salaries, fringe benefits, travel expenses, the Management Expense Allowance, expenses paid by third
- 30 -
1. Summary of Significant Accounting Policies - Continued ------------------------------------------------------
G) Operatings Expense Limitations - Continued ------------------------------------------
parties to the Advisor and its Affiliates based upon its relationship with the Fund (e.g. loan administration, servicing, engineering and inspection expenses) and other administrative items, but excluding the expenses of raising capital, interest payments, taxes, non-cash expenditures (e.g., depreciation, amortization, bad debt reserves), the Subordinated Advisory Fee, and the costs related directly to a specific Mortgage Loan investment or Real Estate Investment by the Fund, such as expenses for originating, acquiring, servicing or disposing of said specific Mortgage Loan or Real Estate Investment.
2. Affiliations -------------
The Fund operates under the direction of its Board of Directors who have retained the Advisor to manage the Fund's operations and to make recommendations concerning investments. The Advisory Agreement automatically renews for successive one year periods unless terminated by the Fund's Independent Directors upon sixty days notice. The Advisor has delegated substantially all of its duties to the Sponsor (see Note 3). The Chairman of the Board of Directors of the Fund is also the majority shareholder of NTS Corporation (the Fund's Sponsor), NTS/Virginia Development Company, an Affiliated Borrower, NTS/Lake Forest II Residential Corporation, an Affiliated Borrower, and is a majority shareholder of the managing general partner in the Orlando Lake Forest Joint Venture, an Affiliated Borrower.
3. Related Party Transactions --------------------------
In addition to the Affiliated Mortgage Loans discussed in Note 4 to the Fund's Financial Statements, the Fund had the following related party transactions.
As of December 31, 1996, the Sponsor or an Affiliate owned 96,468 shares of the Fund.
Pursuant to the Advisory Agreement, the Fund will pay the Advisor (NTS Advisory Corporation) a Management Expense Allowance (Advisory Fee) relating to services performed for the Fund in an amount equal to 1% of the Fund's Net Assets, per annum, which amount may be increased annually by an amount corresponding to the percentage increase in the Consumer Price Index. Effective July 1, 1994, the Fund's Mortgage Loans to Fawn Lake and Lake Forest were converted to cash flow mortgage loans. As part of the consideration for this restructuring, the Fund's Board of Directors required, among other things, that beginning in 1995, NTS Advisory Corporation pay $100,000 annually towards the expenses of the Fund until the maturity of the Mortgage Loans. As such, the Advisory Fee has been reduced $100,000 for each of the years ended December 31, 1996 and 1995. For the years ended December 31, 1996, 1995 and 1994, $544,776, $528,973 and $614,100, respectively, has been incurred as an Advisory Fee.
On February 17, 1995, the Fund purchased from an unaffiliated bank an interest in a $13 million first mortgage (with an outstanding balance of $9,664,465 as of February 17, 1995) to the Orlando Lake Forest Joint Venture. An Affiliate of the Sponsor owns the remaining interest via a participation agreement. The initial ownership percentages were 50% to the Fund and 50% to the Affiliate, however, the percentage ownership will fluctuate as additional principal is advanced to the Joint Venture by the Fund. Ownership percentages will be determined in accordance
- 31 -
3. Related Party Transactions - Continued --------------------------------------
with the ratio of each participant's share of the outstanding loan balance to the total outstanding loan balance. As of December 31, 1996, the outstanding balance on the first mortgage was $13,086,004, and the Fund's ownership percentage was approximately 63%.
The Fund has received advances from Affiliates of the Fund's Sponsor, net of repayments, totalling $4,524,667 and $1,885,000 as of December 31, 1996 and 1995, respectively. As of December 31, 1996, the advances bear interest at the Prime Rate and mature as follows: $2,320,000 on March 31, 1999 and $2,204,667 is due on demand. Subsequent to year end, the maturity date of $1,054,667 of the borrowings due on demand was extended to May 1, 1999. Interest expense to the Affiliates was $258,191 and $82,050 for the years ended December 31, 1996 and 1995, respectively. No interest was due to Affiliates in 1994.
4. Affiliated Mortgage Loans Receivable, net -----------------------------------------
The following tables outline the Fund's mortgage loan portfolio at December 31, 1996. There is currently no readily determinable market value for the portfolio given its unique and affiliated nature.
Property Pledged Interest Maturity Borrower as Collateral Rate Date -------- ------------- ---- ----
1) Earning Loans: ---------------
Temporary Mortgage - ------------------ Loans: - ------
NTS/Virginia First mortgage on approximately Prime 07/31/97 Development Company 187 acres of residential land + 3/4% and improvements thereon located in Fredericksburg, Virginia, known as the Fawn Lake Golf Course; NTS Guaranty Corporation guarantees the loan Mortgage Loans: - --------------- NTS/Virginia First mortgage on approximately 17% of 07/01/97 Development Company 2,207 acres of residential land Gross and improvements thereon Receipts located in Fredericksburg, (a)(b) Virginia, known as Fawn Lake
NTS/Lake Forest First mortgage on approximately 17% of 07/31/97 II Residential 532 acres of residential land Gross Corporation in Louisville, Kentucky, known Receipts as Lake Forest (a)(b)
Orlando Lake First mortgage on approximately 17% of 01/31/98 Forest Joint 398 acres of residential land Gross Venture in Orlando, Florida known as Receipts Orlando Lake Forest (c)
(a) Effective July 1, 1994, these Mortgage Loans are paying interest at the greater of 17% of Gross Receipts or 4.42% of the average outstanding loan balance. (b) These Mortgage Loans included a provision for Gross Receipts Interest through June 30, 1994. (c) This Mortgage Loan pays interest at the greater of 17% of Gross Receipts or 6.46% of the average outstanding loan balance.
- 32 -
4. Mortgage Loans Receivable, net - Continued --------------------------------------------
Total Balance Interest Senior Outstanding Commitment Receivable Liens At Face Amount At Fees At 12/31/96 At 12/31/96 12/31/96(j) Received 12/31/96 -------- ----------- ----------- -------- --------
1) Earning ------- Loans: - ------
Temporary - --------- Mortgage Loan: - --------------
NTS/Virginia $1,998,850 $ 2,500,000 $ 1,998,850 $ 20,000 $ 30,466 Development Company
Mortgage Loans: - ---------------
NTS/Virginia 243,393 30,000,000 28,966,245 200,000 819,803 Development (d) (f) Company
NTS/Lake Forest 4,166,187 28,000,000 25,857,472 250,000 607,885 II Residential (e) (g) Corporation
Orlando Lake -- 14,000,000 7,126,366 -- 131,344 Forest Joint (h) (i) Venture ___________ __________ _________ ___________
Total Earning Loans $74,500,000 $63,948,933 $ 470,000 $1,589,498 ========== ========== ========= =========
(d) Senior lien applies to approximately 22 acres securing the first mortgage which are subordinated to an unaffiliated lender. (e) Senior liens apply to approximately 180 acres securing the first mortgage which are subordinated to unaffiliated lenders. (f) NTS Guaranty Corporation guarantees up to $2 million of outstanding debt exceeding $18 million. (g) NTS Guaranty Corporation guarantees up to $2,416,500 of outstanding debt exceeding $22 million. (h) An Affiliate of the Fund's Sponsor participates with the Fund regarding this Mortgage Loan. As of December 31, 1996, the Fund's ownership percentage was approximately 63%. (i) The carrying amount of this Mortgage Loan is net of an unaccreted discount of approximately $1,127,407. (j) The carrying amount of the mortgage loans receivable at December 31, 1996 is net of any unamortized commitment fees.
- 33 -
4. Affiliated Mortgage Loans Receivable, net - Continued -----------------------------------------------------
Property Pledged Interest Maturity Borrower as Collateral Rate Date -------- ------------- ---- ----
2) Non-Earning Loans: - --------------------- Temporary Mortgage - ------------------ Loans: - ------
Orlando Lake Pledge by both general partners Prime Demand Forest Joint of their partnership interests + 2% Venture in Orlando Lake Forest Joint (k) Venture located in Orlando, Florida; a pledge of 390 shares of the Class A common stock in NTS/Virginia Development Company, NTS Guaranty Corporation guarantees the loan
Total Balance Interest Senior Outstanding Commitment Receivable Liens At Face Amount At Fees At 12/31/96 At 12/31/96 12/31/96 Received 12/31/96 -------- ----------- -------- -------- --------
Temporary - --------- Mortgage Loan: - --------------
Orlando Lake $13,086,004 $ 7,818,000 $ 3,838,831 $ 150,000 $ -- Forest Joint (l) (m) (n) (k) Venture
Total Non Earning Loans $ 7,818,000 $ 3,838,831 $ 150,000 $ -- ========== ========== ======== =========
(k) The Orlando Lake Forest Joint Venture has entered into a forbearance agreement with the Fund whereby, effective April 1, 1995, no interest will be due on these loans through January 31, 1998. The Fund has discontinued accruing interest from the Temporary Mortgage Loan to the Orlando Lake Forest Joint Venture until the interest payment is received. Approximately $1,553,000 of interest remains due to the Fund on this loan but is not accrued in the Fund's financial statements. (l) Total senior liens include the Fund's 63% interest in the lien. (m) NTS/Virginia Development Company (Fawn Lake) and NTS/Lake Forest II Residential Corporation (Lake Forest) participate with the Fund regarding the Temporary Mortgage Loan. Their percentage ownership as of December 31, 1996 is 17.651% and 19.125%, respectively. (n) The Fund has established a $1,500,000 loan loss reserve as of December 31, 1996. The Fund has discontinued accruing interest from the Temporary Mortgage Loan to the Orlando Lake Forest Joint Venture until the interest payment is received. Approximately $1,553,000 of interest remains due to the Fund on this loan but is not accrued in the Fund's financial statements.
- 34 -
4. Affiliated Mortgage Loans Receivable, net - Continued ---------------------------------------------------
Reconciliation of Affiliated Mortgage Loans Receivable for the year ended: --------------------------------------------------------------------------
Balance at December 31, 1993 $52,614,695
Additions: Mortgage Loans $ 4,056,326 Temporary Mortgage Loans -- Amortization of loan fees 117,930 4,174,256 -----------
Reductions: Mortgage Loans (4,305,330) Temporary Mortgage Loans (5,224) Mortgage Loan written-off (241,145) Loan fees received (15,000) (4,566,699) ----------- -----------
Balance at December 31, 1994 $52,222,252
Additions: Mortgage Loans $ 20,113,201 Temporary Mortgage Loans 1,073,953 Accretion of discount 125,029 Amortization of loan fees -- 21,312,183 ----------
Reductions: Mortgage Loans (6,177,976) Temporary Mortgage Loans (2,041,898) Mortgage Loan written-off (85,458) Loan fees received (20,000) (8,325,332) ----------- ------------
Balance at December 31, 1995 $65,209,103
Additions: Mortgage Loans $ 9,371,032 Temporary Mortgage Loans 1,191,918 Accretion of discount 148,472 Amortization of loan fees 20,000 10,731,422 -----------
Reductions: Mortgage Loans (6,692,948) Temporary Mortgage Loans (1,406,416) Mortgage Loan written-off (53,397) Loan fees received -- (8,152,761) ---------- -----------
Balance at December 31, 1996 $67,787,764 ==========
Reserves for Loan Losses:
Balance at December 31, 1993 $ 1,730,000 Additions charged to Expenses $ 150,000 Deduction for Mortgage Loan written-off (241,145) (91,145) ---------- ---------
Balance at December 31, 1994 $ 1,638,855 Additions charged to Expenses $ -- Deduction for Mortgage Loan written-off (85,458) (85,458) ---------- -----------
Balance at December 31, 1995 $ 1,553,397 Additions charged to Expenses $ -- Deduction for Mortgage Loan written-off (53,397) (53,397) --------- -----------
Balance at December 31, 1996 $ 1,500,000 ==========
- 35 -
5. Reserves for Loan Losses ------------------------
Reserves for loan losses are based on management's evaluation of the borrower's ability to meet its obligation by comparing the mortgage note receivable balance with the discounted value of estimated future cash flows as well as considering current and future economic conditions. Reserves are based on estimates and ultimate losses could differ materially from the amounts assumed in arriving at the reserve for possible loan losses reported in the financial statements. These estimates are reviewed periodically and, as adjustments become necessary, they are reported in earnings in the period in which they become known. On a regular basis, management reviews each mortgage loan in the Fund's portfolio including an assessment of the recoverability of the individual mortgage loans. As of December 31, 1996, the Fund has a loan loss reserve regarding the Temporary Mortgage Loan to the Orlando Lake Forest Joint Venture (with an outstanding balance of $3,838,831 as of December 31, 1996) amounting to $1,500,000. Certain of the Fund's mortgage loans are guaranteed by NTS Guaranty Corporation, an Affiliate of the Fund's Sponsor (see Note 9). The Fund has not considered this guarantee when determining future cash flows and the loan loss reserve.
6. Notes Payable -------------
Notes payable consist of the following:
1996 1995 --------- ---------
Note payable to a bank in the amount of $13,800,000, bearing interest at the Prime Rate plus 1%, payable monthly due December 27, 1997, secured by a collateral assignment of the Fund's mortgages on Lake Forest and Fawn Lake, guaranteed by Mr. J. D. Nichols, Chairman of the Board of the Fund's Sponsor $12,278,000 $13,086,000
Note payable to a bank in the amount of $2,500,000, bearing interest at the Prime Rate plus 3/4%, payable monthly, due July 31, 1997, secured by approximately 187 acres of residential land and improvements thereon 1,998,850 1,063,873 ---------- ---------- $14,276,850 $14,149,873 ========== ==========
The Prime Rate was 8 1/4% and 8 1/2% at December 31, 1996 and 1995, respectively.
Based on the borrowing rates currently available to the Fund for bank loans with similar terms and average maturities, the fair value of the above debt instruments approximates the carrying value.
The Fund's Sponsor is working with several lenders, including the Fund's existing creditors, to refinance the Fund's debt which will mature within the next twelve months. While management can provide no assurance that these negotiations will be successful, it is their belief that, based upon discussions with the various lenders, such refinancing will be accomplished prior to the respective maturity dates.
- 36 -
7. Gross Receipts and Supplemental Interest Income -----------------------------------------------
Gross Receipts Interest is recognized with respect to a Mortgage Loan secured by real estate held for sale in the ordinary course of the borrower's business. Gross Receipts Interest is an amount equal to 5% of the borrower's Gross Receipts, as defined in the Fund's Prospectus, from the sale of the underlying real estate during the term of the mortgage loan. Gross Receipts Interest is reported as earned on the accrual basis of accounting. Effective July 1, 1994, none of the Fund's Mortgage Loans provided for Gross Receipts Interest.
8. Commitments and Contingencies -----------------------------
The Fund has commitments to extend credit made in the normal course of business that are not reflected in the financial statements. At December 31, 1996, the Fund had outstanding funding commitments under standby letters of credit aggregating $296,597: Orlando Lake Forest Joint Venture $91,921; NTS/Virginia Development Co. $204,676. These outstanding funding commitments are part of the maximum funding amount of the mortgage loans. Committed undisbursed loans were approximately $4,591,000 at December 31, 1996.
In July 1994, the Fund was named as a defendant in a complaint originally filed by Jeno Paulucci & Silver Lakes I, Inc.in August 1992 against NTS Corporation (the Fund's Sponsor) and various Affiliates of the Fund's Sponsor. The terms of the settlement agreement are confidential. However, as no monetary awards were assessed against or are payable by the Fund under the agreement, it is not anticipated that the settlement will have a material impact on the Fund's financial position or results of operations.
9. Guaranties to the Fund ----------------------
NTS Guaranty Corporation (the "Guarantor"), an Affiliate of the Sponsor, has agreed to provide the following guaranties to the Fund:
Junior Mortgage Loan Guaranty -----------------------------
The Guarantor guarantees the payment to the Fund, on a timely basis, of the Principal (as defined in the Prospectus) of all Junior Mortgage Loans and Temporary Mortgage Loans made by the Fund to Affiliated Borrowers. The Guarantor's obligation is limited to the Principal balance outstanding on the Junior Mortgage Loan or Temporary Mortgage Loan and does not include the Interest Reserve, as defined in the Prospectus. This guaranty will not apply to Junior Mortgage Loans or Temporary Mortgage Loans made to Non-Affiliated Borrowers.
On October 19, 1992, the Fund notified the Orlando Lake Forest Joint Venture (the "Joint Venture") that the Joint Venture is in payment default regarding the Fund's Temporary Mortgage Loan to the Joint Venture. This default gives the Fund the right to pursue the Guarantor for its guaranty. The Fund's Board of Directors continues to evaluate the collectability of the guaranty. The Board is also concerned about the possible detrimental effects that the collection proceedings may have on the Fund's other loans to other Affiliated Borrowers. The Board has concluded that it is in the best interest of the Fund and its Stockholders to continued to pursue the work-out plan to both preserve the assets of the Fund and support the viability of the projects to which it has outstanding loans.
- 37 -
9. Guaranties to the Fund - Continued ----------------------------------
Purchase Price Guaranty -----------------------
The Guarantor has guaranteed that investors of the Fund will receive, over the life of the Fund, aggregate distributions from the Fund (from all sources) in an amount at least equal to their Original Capital Contributions, as defined in the Fund's Prospectus.
The liability of the Guarantor under the above guaranties is expressly limited to its assets and its ability to draw upon a $10 million demand note receivable from Mr. J.D. Nichols, Chairman of the Board of Directors of the Sponsor. There can be no assurance that Mr. Nichols will, if called upon, be able to honor his obligation to the Guarantor. The total amounts guaranteed by the Guarantor are in excess of its net worth, and there is no assurance that the Guarantor will be able to satisfy its obligation under these guaranties. The Guarantor may in the future provide guaranties for other Affiliates of the Fund.
- 38 -
10. Dividends Paid and Payable --------------------------
Dividends declared for the periods ended December 31, 1994, 1995 and 1996 were as follows:
Average Date Date of Date Outstanding Amount Declared Record (1) Paid Shares Per Share Amount -------- ---------- -------- ----------- --------- --------
01/28/94 01/31/94 02/28/94 3,187,333 $ .06 $ 191,240 01/28/94 02/28/94 03/28/94 3,187,333 .06 191,239 01/28/94 03/31/94 04/28/94 3,187,333 .06 191,240 01/28/94 04/20/94 05/28/94 3,187,333 .03 95,618 01/28/94 05/31/94 06/28/94 3,187,333 .03 95,619 01/28/94 06/30/94 07/28/94 3,187,333 .03 95,619 01/28/94 07/31/94 08/29/94 3,187,333 .03 95,619 01/28/94 08/31/94 09/29/94 3,187,333 .03 95,619 01/28/94 09/30/94 10/28/94 3,187,333 .03 95,620 01/28/94 10/31/94 11/29/94 3,187,333 .03 95,620 01/28/94 11/30/94 12/29/94 3,187,333 .03 95,620 01/28/94 12/31/94 01/27/95 3,187,333 .04 127,493 ----- ---------
Total dividends declared in 1994 $ .46 $1,466,166 ====== =========
03/09/95 01/31/95 02/27/95 3,187,333 $ .03 $ 95,620 03/09/95 02/28/95 03/28/95 3,187,333 .03 95,620 03/09/95 03/31/95 04/27/95 3,187,333 .03 95,620 03/09/95 04/30/95 05/26/95 3,187,333 .03 95,620 03/09/95 05/31/95 06/27/95 3,187,333 .01 31,873 03/09/95 06/30/95 07/27/95 3,187,333 .01 31,873 03/09/95 07/31/95 08/25/95 3,187,333 .01 31,873 03/09/95 08/31/95 09/26/95 3,187,333 .01 31,873 03/09/95 09/30/95 10/26/95 3,187,333 .01 31,873 03/09/95 10/31/95 11/29/95 3,187,333 .01 31,873 03/09/95 11/30/95 12/26/95 3,187,333 .01 31,873 03/09/95 12/31/95 01/26/96 3,187,333 .01 38,250 ----- ---------
Total dividends declared in 1995 $ .20 $ 643,841 ===== =========
03/12/96 03/31/96 04/15/96 3,187,333 $ .045 $ 143,432 03/12/96 06/30/96 07/19/96 3,187,333 .045 143,432 06/27/96 09/30/96 10/18/96 3,187,333 .045 143,432 06/27/96 12/31/96 01/27/97 3,187,333 .055 175,305 ----- ------- Total dividends declared in 1996 $ .190 $ 605,601 ==== ========
It is the Fund's policy to distribute to its Stockholders an amount equal to at least 95% of taxable income. A portion of the dividends paid during a subsequent year may be allocable to taxable income earned in the prior year. For 1993, 1994 and 1995, dividends to Stockholders represent ordinary income.
The continued needs of the projects to which the Fund has outstanding loans may significantly reduce the Fund's cash flows. Therefore, the Fund's Board of Directors has determined to terminate the Fund's quarterly distribution for the foreseeable future effective as of the first quarter of 1997.
(1) Cash dividends vary based upon the date of stockholder admittance.
- 39 -
11. Unaudited Quarterly Financial Data ----------------------------------
Quarters Ended --------------------
1996 March 31 June 30 September 30 December 31 Total ---- ---------- ---------- ---------- ----------- ----------
Total revenues $ 768,848 $ 847,287 $ 843,784 $ 845,076 $3,304,995
Total expenses 556,974 661,440 645,275 633,597 2,447,286 ---------- ---------- ---------- ---------- ----------
Income before income taxes 211,874 235,847 198,509 211,479 857,709
Income tax expense 1,850 1,850 1,850 1,850 7,400 ---------- ---------- ---------- ---------- ----------
Net income $ 210,024 $ 233,997 $ 196,659 $ 209,629 $ 850,309 ========== ========== ========== ========== ==========
Net income per share of common stock $ .07 $ .07 $ .06 $ .07 $ .27 ========== ========== ========== ========== ==========
1995 March 31 June 30 September 30 December 31 Total - ------ ---------- ---------- ---------- ---------- ----------
Total revenues $ 640,705 $ 751,340 $ 741,441 $ 751,166 $2,884,652
Total expenses 418,094 520,429 522,330 555,465 2,016,318 ---------- ---------- ---------- ---------- ----------
Income before income taxes 222,611 230,911 219,111 195,701 868,334
Income tax expense 2,500 2,500 2,500 2,500 10,000 ---------- ---------- ---------- ---------- ----------
Net income $ 220,111 $ 228,411 $ 216,611 $ 193,201 $ 858,334 ========== ========== ========== ========== ==========
Net income per share of common stock $ .07 $ .07 $ .07 $ .06 $ .27 ========== ========== ========== ========== ==========
- 40 -
12. Subsequent Events -----------------
On February 12, 1997, the Fund entered into a letter of intent (the Letter of Intent) with NTS Corporation and its Affiliates, NTS Development Company, Fawn Lake, and Lake Forest regarding the Fund's loans to Fawn Lake and Lake Forest. The Letter of Intent provided for, among other things, a restructuring of the Fund's loans to Fawn Lake and Lake Forest. The Letter of Intent contemplates that ownership of the properties will be transferred to the Fund, which expects to continue the development to completion of such properties and ultimately, their orderly sale.
The parties to the Letter of Intent agreed to consider a general restructuring of the relationship among the Fund, NTS Corporation and its various Affiliates. The Fund has not yet determined the method by which it will acquire control of the projects.
Generally Accepted Accounting Principles require that transactions as contemplated by the Letter of Intent be recorded at fair market value. Management can not determine at this time whether or not such transactions, if completed, will result in a loss. In addition, in connection with the ongoing development of the projects, it is likely that the Fund will be required to change its tax status from a Real Estate Investment Trust to a conventional corporation.
The Fund, as owner of the Fawn Lake and Lake Forest projects, expects that it will continue development of the projects and the orderly sale of lots, golf course memberships and ancillary services through sell-out, as well as the sale of the Fawn Lake Country Club, when appropriate. As owner, the Fund will be responsible for continuing development, operations and marketing costs through the remaining lives of the projects and it may be necessary for the Fund to borrow additional funds to complete the development. While the Fund believes that such funds will be more readily available if it owns the projects, it is not certain that the Fund will be able to borrow the funds necessary to complete the projects.
The Letter of Intent also contemplates that NTS Development Company, or another subsidiary or affiliate of NTS Corporation (the "Manager"), will enter into a management agreement (the "Management Agreement") with the Fund pursuant to which the Manager will, as authorized agent for the Fund, provide exclusive management, development, marketing and sales efforts and personnel to the Fund, and take all other actions necessary to manage the development of the projects to completion and the sale of lots, golf memberships, ancillary services and the Fawn Lake Country Club. The terms of the Management Agreement have not yet been finalized. The parties to the Letter of Intent are presently negotiating the definitive agreements contemplated by the Letter of Intent but have not yet agreed on final terms.
- 41 -
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholder of NTS Guaranty Corporation:
We have audited the accompanying balance sheets of NTS Guaranty Corporation (a Kentucky corporation) as of December 31, 1996 and 1995. These balance sheets are the responsibility of NTS Guaranty Corporation's management. Our responsibility is to express an opinion on these balance sheets based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the balance sheets are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the balance sheets. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the balance sheets referred to above present fairly, in all material respects, the financial position of NTS Guaranty Corporation as of December 31, 1996, and 1995, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Louisville, Kentucky March 24, 1997
- 42 -
NTS GUARANTY CORPORATION (A KENTUCKY CORPORATION) BALANCE SHEETS AS OF DECEMBER 31, 1996 AND 1995
ASSETS
1996 1995 ------------ -----------
Cash $ 100 $ 100 ------------ ------------
$ 100 $ 100 ============ ===========
STOCKHOLDER'S EQUITY
Common stock, no par value; 100 shares issued and outstanding $ 10 $ 10 Additional paid-in capital 10,000,090 10,000,090 ------------ -----------
10,000,100 10,000,100
Less non-interest bearing demand note receivable from a majority stockholder of NTS Corporation (10,000,000) (10,000,000) ------------ ------------
$ 100 $ 100 ============ ===========
NOTES TO BALANCE SHEETS -----------------------
1. Significant Accounting Policies -------------------------------
A. Organization ------------
NTS Guaranty Corporation (the "Guarantor"), a Kentucky corporation, was formed in February 1987 and is an affiliate of NTS Corporation. NTS Corporation is the Sponsor of the NTS Mortgage Income Fund (the "Fund"). The balance sheets include only those assets and liabilities which relate to the Guarantor. The Guarantor is authorized to issue up to 2,000 shares of common stock with no par value. There are 100 shares issued and outstanding which were purchased by Mr. J. D. Nichols, Chairman of the Board of Directors of the Sponsor and of the Fund. In addition, Mr. Nichols has given the Guarantor a non-interest bearing demand note receivable for $10,000,000, the receipt of which is included in additional paid-in capital. Expenses (consisting mostly of state taxes and licenses) of the Guarantor totalling approximately $15 and $45 for the years ended December 31, 1996 and 1995, respectively, were paid by an affiliate of the Sponsor and therefore no income statement is presented. These expenses will not be reimbursed to the affiliate.
B. Use of Estimates in Preparation of Finanacial Statements -----------------------------------------------------------
The preparation of financial statements in conformity with generally accepted accounting principles 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.
- 43 -
2. Commitments -----------
The Guarantor has made commitments to the Fund as follows:
A. Junior Mortgage Loan Guaranty -----------------------------
The Guarantor guarantees the payment to the Fund, on a timely basis, of the Principal (as defined in the Fund's Prospectus) of all Junior Mortgage and Temporary Mortgage Loans made by the Fund to Affiliated Borrowers. The Guarantor's obligation is limited to the Principal balance outstanding on the Junior Mortgage Loan or Temporary Mortgage Loan and does not include the Interest Reserve as defined in the Fund's Prospectus. This guaranty will not apply to Junior Mortgage Loans or Temporary Mortgage Loans made to Non-Affiliated Borrowers. As of December 31, 1996, the Principal balance outstanding on Junior Mortgage Loans and Temporary Mortgage Loans guaranteed by the Guarantor was $8,070,602.
The Temporary Mortgage Loan to the Orlando Lake Forest Joint Venture (with an overall outstanding balance of $6,071,752 as of December 31, 1996) is in default. The Fund's Board of Directors has not called upon the guaranty at this time. Based on current facts, management believes that the Fund will continue to pursue the workout plan regarding the default.
B. Purchase Price Guaranty -----------------------
The Guarantor has guaranteed that Investors of the Fund will receive, over the life of the Fund, aggregate distributions from the Fund (from all sources) in an amount at least equal to their Original Capital Contributions, as defined in the Fund's Prospectus. As of December 31, 1996, the Fund has raised approximately $63,690,000 and has paid distributions of approximately $23,141,000.
C. Mortgage Loan Guaranties ------------------------
The Guarantor has guaranteed the payment, up to $2,000,000, of the outstanding principal amount of the Mortgage Loan to NTS/Virginia Development Company which exceeds $18,000,000. The Guarantor has guaranteed the payment, up to $2,416,500, of the outstanding principal amount of the Mortgage Loan to NTS/Lake Forest II Residential Corporation which exceeds $22,000,000. As of December 31, 1996, the outstanding principal balances of the NTS/Virginia Development Company Mortgage Loan and the NTS/Lake Forest II Residential Corporation Mortgage Loan were $28,966,245 and $25,857,472, respectively.
The liability of the Guarantor under the above guaranties and obligations is expressly limited to its assets and its ability to draw upon a $10 million demand note receivable from Mr. J. D. Nichols. Mr. Nichols has contingent liabilities which have arisen in connection with the acquisition of properties by himself or his affiliates. There can be no assurance that Mr. Nichols will, if called upon, be able to honor his obligation to the Guarantor. The total amounts guaranteed by the Guarantor are in excess of its net worth, and there is no assurance that the Guarantor will be able to satisfy its obligation under these commitments. The Guarantor may in the future provide guaranties to other Affiliates of the Fund.
- 44 -
3. Subsequent Event ----------------
On February 12, 1997, the Fund entered into a letter of intent (the Letter of Intent) with NTS Corporation and its Affiliates, NTS Development Company, Fawn Lake and Lake Forest regarding the Fund's loans to Fawn Lake and Lake Forest. The Letter of Intent provided for, among other things, a restructuring of the Fund's loans to Fawn Lake and Lake Forest. The Letter of Intent contemplates that ownership of the properties will be transferred to the Fund, which expects to continue the development to completion of such properties and ultimately, their oderly sale.
The parties of the Letter of Intent agreed to consider a general restructuring of the relationship among the Fund, NTS Corporation and its various Affiliates. The Fund has not yet determined the method by which it will acquire control of the projects.
- 45 -
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of NTS/Lake Forest II Residential Corporation:
We have audited the accompanying balance sheets of NTS/Lake Forest II Residential Corporation (a Kentucky corporation) as of December 31, 1996 and 1995, and the related statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996. 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 in accordance with generally accepted auditing standards. 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of NTS/Lake Forest II Residential Corporation as of December 31, 1996 and 1995 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Louisville, Kentucky March 24, 1997
- 46 -
The accompanying notes to financial statements are an integral part of these balance sheets.
- 47 -
The accompanying notes to financial statements are an integral part of these statements.
- 48 -
The accompanying notes to financial statements are an integral part of these statements.
- 49 -
The accompanying notes to financial statements are an integral part of these statements.
- 50 -
NTS/LAKE FOREST II RESIDENTIAL CORPORATION ------------------------------------------ NOTES TO FINANCIAL STATEMENTS -----------------------------
1. Significant Accounting Policies -------------------------------
A) Organization ------------
NTS/Lake Forest II Residential Corporation (Lake Forest) was organized on July 6, 1988 as a Kentucky corporation. Lake Forest is an Affiliate under common control with NTS Corporation, the Sponsor of the NTS Mortgage Income Fund. The NTS Mortgage Income Fund (the Fund) is the primary creditor of Lake Forest. Lake Forest is in the process of developing approximately 726 acres of land located in Louisville, Kentucky into a single-family residential community and a country club with a championship golf course for the purpose of selling such residential lots and country club memberships. Lake Forest will have amenities consisting of a clubhouse, pools, tennis courts, recreation fields and several lakes. As of December 31, 1996, approximately 480 acres have been developed.
These financial statements do not reflect the impact, if any, of the proposed transaction discussed in Note 8.
B) Revenue Recognition -------------------
Lake Forest recognizes revenue and related costs from lot sales using the accrual method in accordance with generally accepted accounting principles, which is when payment has been received and title, possession and other attributes of ownership have been transferred to the buyer, and Lake Forest is not obligated to perform significant activities after the sale. Lake Forest generally requires a minimum down payment of at least 10% of the sales price of the lot.
C) Reserves for Loan Losses ------------------------
Interest income is reported as earned on the accrual basis of accounting. If Lake Forest has any reason to doubt the collectability of any principal and interest amounts due pursuant to the terms of the notes and accounts receivable, appropriate reserves are established for any principal and accrued interest amounts deemed unrealizable. Notes receivable in the accompanying balance sheets are presented at lower of cost or market. The amounts Lake Forest will ultimately realize could differ from the amounts assumed in arriving at the reserve for loan losses reported in the financial statements.
D) Inventory ---------
Inventory is stated at the lower of cost or net realizable value. Inventory includes all direct costs of land, land development, and amenities, including interest, real estate taxes, and certain other costs incurred during the development period, less amounts charged to cost of sales. Inventory costs are allocated to individual lots sold using the relative sales values. The use of the relative sales value method to record cost of sales requires the use of estimates of sales values, development costs and absorption periods over the life of the project. Given the long-term nature of the project and inherent economic volatility of residential real estate, it is reasonably possible that such estimates could change in the near term. Any changes in estimates would be accounted for prospectively over the life of the project.
- 51 -
1. Significant Accounting Policies - Continued -------------------------------------------
E) Tax Status ----------
Lake Forest has elected, for income tax purposes, to include its income with that of its stockholders, an S-Corporation election. Accordingly, no provision for income taxes is included in the accompanying financial statements.
F) Use of Estimates in the Preparation of Financial Statements -----------------------------------------------------------
The preparation of financial statements in conformity with generally accepted accounting principles 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.
G) New Accounting Pronouncement ----------------------------
Statement of Financial Accounting Standards (SFAS) No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, specifies circumstances in which certain long-lived assets must be reviewed for impairment. If such review indicates that the carrying amount of an asset exceeds the sum of its expected future cash flows, the asset's carrying value must be written down to fair market value. Application of this standard during the year ended December 31, 1996 did not result in an impairment loss.
H) Advertising -----------
Lake Forest expenses advertising-type costs as incurred. Advertising expense, a component of Cost Reimbursements (see Note 6), was approximately $75,000 and $85,000 during the years ended December 31, 1996 and 1995, respectively. Advertising expense for the year ended December 31, 1994 is a component of the Marketing and Development Fee (see Note 6) and is not separately determinable.
I) Reclassification of 1995 Financial Statements ---------------------------------------------
Certain reclassifications have been made to the December 31, 1995 financial statements to conform with December 31, 1996 classifications. These classifications have no effect on previously reported operations.
2. Member Initiation Fees and Other Accounts Receivable ----------------------------------------------------
Lake Forest Country Club (the "Country Club") membership initiation fees receivable totalled approximately $870,000 and $1,530,000 as of December 31, 1996 and 1995, respectively. The receivable is net of a discount recorded to allow for the present value of the receivables considering the estimated timing of collections.
3. Notes Receivable ----------------
Notes receivable are secured by a first mortgage on lots sold to individuals. The notes bear interest at the prevailing market rates at the time the lots were sold. The majority of the notes are due between five to seven years, monthly payments are based on a 30-year amortization and the balance is due at the maturity date. As of December 31, 1996, notes totalling $772,065 are pledged as security for notes payable to banks under
- 52 -
3. Notes Receivable - Continued ----------------------------
certain Warehouse Line of Credit Agreements. There are also $17,238 of notes held by Lake Forest that are not pledged. Approximately $121,889, $208,073, $68,617, $324,619 and $48,867 of the notes receivable balance as of December 31, 1996 are due for the years ended December 1997 through 2001, respectively, with $17,238 due thereafter.
4. Inventory ---------
Inventory consists of the following as of December 31:
1996 1995 ----------- ----------
Land held for future development, under development and completed lots $12,608,256 $11,674,237 Country club (net of membership initiation fees) 10,568,113 7,648,039 Amenities 6,694,256 6,426,336 ----------- -----------
$29,870,625 $25,748,612 =========== ===========
Lake Forest capitalized in inventory $1,184,137 and $1,123,366 of interest and real estate taxes in 1996 and 1995, respectively. Interest and real estate taxes incurred were $1,772,550 and $1,514,674 for the years ended December 31, 1996 and 1995, respectively.
Inventory as reflected above includes $15,477,112, net of $4,908,999 of Country Club membership initiation fees, of costs incurred to date for the development of the Country Club. Pursuant to an agreement between the Country Club and Lake Forest regarding the cost to develop the Country Club, Lake Forest is to receive all initiation fees from membership sales for a period not to exceed 12 years from the date of the agreement (ending 2003). The remaining cost to be incurred for the current projected Country Club operating deficit for the period covered by the agreement is approximately $2,200,000 which is expected to be offset by member initiation fees. During 1996, the Country Club operating deficit was approximately $380,000 and was capitalized as a cost of inventory.
5. Notes and Mortgage Loans Payable (See Note 8) ---------------------------------------------
Notes and mortgage loans payable consist of the following as of December 31:
1996 1995 ----------- ---------- Mortgage loan payable to the Fund in the amount of $28,000,000 bearing interest equal to the greater of 17% of Gross Receipts or 4.42% of the outstanding loan balance, due July 1, 1997, secured by inventory and a subordinated first mortgage on approximately 180 acres of land, advances are made as needed for project costs, generally principal payments consist of approximately 83% of the Gross Receipts of lot sales $25,857,472 $25,935,987
(Continued next page)
- 53-
5. Notes and Mortgage Loans Payable (See Note 8) - Continued ---------------------------------------------------------
1996 1995 ----------- --------- Warehouse Line of Credit Agreements with three banks bearing interest at the Prime Rate + 1%, the Prime Rate + 3/4% and the Prime Rate + 1/2%, due December 15, 1997 ($259,910), September 30, 1997 ($240,569) and February 28, 1997 ($815,956), secured by notes receivable (see Note 3), principal payments consist of payments received from notes receivable securing the obligation $ 1,316,437 $ 2,108,249
Mortgage loan payable in the amount of $4,965,000, bearing interest at the Prime Rate + 1%, due July 31, 1999, secured by the Lake Forest Country Club golf course, 10 acres of land upon which the clubhouse was constructed and inventory, advances are made as needed for project costs, principal payments consist of 100% of the Club's net membership fees prior to the loan closing (September 1, 1995) and 95% of the Club's net memberships after the loan closing 3,908,127 438,960
Mortgage loan payable in the amount of $875,000, bearing interest at the Prime Rate + 1%, due November 24, 1996, secured by inventory, advances are made as needed for project costs, principal payments consist of 85% of gross proceeds of lot sales to builders and 75% of the gross proceeds of the lot sales to individuals 258,060 123,913
Equipment loan in the amount of $38,961, bearing interest of 10.5%, due October 1, 1997, secured by equipment purchased for use at the Country Club 9,870 21,878 ---------- ---------- $31,349,964 $28,628,987 ========== ==========
As of December 31, 1996, substantially all of the assets of Lake Forest secure the above notes and mortgage loans payable.
The Prime Rate was 8 1/4% and 8 1/2% at December 31, 1996 and 1995 respectively.
The $259,910 Warehouse Line of Credit Agreement is guaranteed by NTS Corporation.
- 54 -
5. Notes and Mortgage Loans Payable (See Note 8) - Continued ---------------------------------------------------------
There is currently no readily determinable market value for the $28,000,000 mortgage loan payable to the Fund given its unique and affiliated nature. Based on the borrowing rates currently available to Lake Forest for bank loans with similar terms and average maturities, the fair value of all other debt instruments approximates the carrying value for these debt instruments.
Lake Forest is working with several lenders, including existing creditors, to refinance the debt which matures within the next twelve months. While management can provide no assurance that these negotiations will be successful, it is their belief that such financing will be accomplished during fiscal 1997 or prior to the respective maturity dates.
6. Related Party Transactions --------------------------
Development and marketing activities in Kentucky, which include accounting, are managed by NTS Residential Properties, Inc., a Kentucky corporation (Residential), a wholly-owned subsidiary of NTS Development Company. NTS Development Company is a Kentucky corporation and a wholly-owned subsidiary of NTS Corporation, the Sponsor of the Fund. These entities are under common control with Lake Forest. During fiscal 1994, pursuant to an agreement, Residential received 25% of the gross proceeds of lot sales to individuals and 15% of the gross proceeds of lot sales to builders as a fee for its service. The fee amounted to $382,789 for the year ended December 31, 1994. Subsequent to June 30, 1994, the fee was no longer charged by Residential.
Lake Forest incurred expenditures with various affiliates for preliminary planning, start-up, and construction overhead costs and has recorded these expenditures as a cost of inventory. The amounts charged were approximately $ 360,000, $459,000 and $112,500 for each of the three years ended December 31, 1996, 1995 and 1994, respectively. In addition, for 1996 and 1995, pursuant to an agreement effective July 1, 1994 with an affiliate, reimbursements were made to Residential for actual personnel, marketing and administrative costs as they relate to Lake Forest of approximately $654,000 and $835,000, respectively. These reimbursements are reflected as Cost Reimbursements in the accompanying Statements of Operations.
In addition to the mortgage loan with the Fund, Lake Forest had the following transactions with the Fund:
1996 1995 1994 -------- -------- -------
Regular interest - capitalized $893,864 $916,922 $859,745 Regular interest - expensed $264,788 $299,067 $325,578 Gross receipts interest $ -- $ -- $ 52,124 Letters of credit fees $ -- $ -- $ 3,295
Lake Forest has made advances in 1993 and 1992 to an affiliate in connection with the expansion of the sewage treatment plant servicing the project which is owned and operated by the affiliate. The advances are due December 27, 1997 and bear interest at 6.74%. The amount outstanding, including interest, at December 31, 1996 and 1995 was $562,826 and $1,734,518, respectively. Interest income earned on the advances was $76,807, $116,371 and $109,112 for the years ended December 31, 1996, 1995 and 1994, respectively.
- 55 -
6. Related Party Transactions - Continued --------------------------------------
As of December 31, 1995, Lake Forest had received advances from an affiliate totalling $1,669,346. The advances bear interest at a rate approximating the Prime Rate. Interest paid to the affiliate for the years ended December 31,1996, 1995 and 1994 totalled $60,077, $146,976, and $131,940 respectively. The advances were repaid during 1996.
As of December 31, 1996, Lake Forest has a participation agreement with the Fund whereby Lake Forest has been assigned an interest in the Fund's Temporary Mortgage Loan with the Orlando Lake Forest Joint Venture (the "Joint Venture"). The loan is on a demand basis and is in default due to the failure of the Joint Venture to pay the interest due on the loan. Based on management's evaluation of the Joint Venture's future cash flows, Lake Forest increased the loan loss reserve by $395,275 during 1996. The loan loss reserve is equal to the note amount. Reserves for loan losses are based on management's evaluation of the borrower's ability to meet its obligation as well as current and future economic conditions. Reserves are based on estimates and ultimate losses may vary. These estimates are reviewed periodically and, as adjustments become necessary, they are reported in earnings in the period in which they become known.
7. Commitments and Contingencies -----------------------------
It is estimated that development of the remaining homeowners association amenities will be substantially completed by December 2000. Based on engineering studies and projections, Lake Forest will incur additional costs, excluding interest, of approximately $420,000 during 2000 to complete the homeowners association amenities.
Lake Forest has various letters of credit outstanding to governmental agencies and utility companies totalling approximately $158,000.
8. Subsequent Event ----------------
On February 12, 1997, Lake Forest entered into a letter of intent (the Letter of Intent) with the Fund and NTS Corporation and its Affiliates, NTS Development Company and NTS/Virginia Development Company (Fawn Lake) regarding the Fund's loans to Lake Forest and Fawn Lake. The Letter of Intent provided for, among other things, a restructuring of the Fund's loans to Fawn Lake and Lake Forest. The Letter of Intent contemplates that ownership of the properties will be transferred to the Fund, which expects to continue the development to completion of such properties and ultimately, their orderly sale.
The parties of the Letter of Intent agreed to consider a general restructuring of the relationship among the Fund, NTS Corporation and its various Affiliates. The method by which the Fund will acquire control of Lake Forest has not yet been determined.
Generally Accepted Accounting Principles require that transactions as contemplated by the Letter of Intent be recorded at fair market value. Management can not determine at this time whether or not such transactions, if completed, will result in a loss.
The Fund, as owner of the Lake Forest project, expects that it will continue development of the project and the orderly sale of lots, golf course memberships and ancillary services through sell-out. As owner, the Fund will be responsible for continuing development, operations and marketing costs through the remaining life of the project and it may be necessary for the Fund to borrow additional funds to complete the development. While the Fund believes that such funds will be more readily available if it owns the project, it is not certain that the Fund will be able to borrow the funds necessary to complete the project.
- 56 -
8. Subsequent Event - Continued ----------------------------
The Letter of Intent contemplates that NTS Development Company or another subsidiary or affiliate of NTS Corporation (the "Manager"), will enter into a management agreement (the "Management Agreement") with the Fund pursuant to which the Manager will, as authorized agent for the Fund, provide exclusive management, development, marketing and sales efforts and personnel to the Fund, and take all other actions necessary to manage the development of the project to completion and the sale of lots, golf memberships and ancillary services. The terms of the Management Agreement have not yet been finalized.
- 57 -
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ----------------------------------------
To the Stockholders of NTS/Virginia Development Company:
We have audited the accompanying balance sheets of NTS/Virginia Development Company (a Virginia corporation) as of December 31, 1996 and 1995, and the related statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996. 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 in accordance with generally accepted auditing standards. 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of NTS/Virginia Development Company as of December 31, 1996 and 1995 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Louisville, Kentucky March 24, 1997
- 58 -
=========== ===========
The accompanying notes to financial statements are an integral part of these balance sheets.
- 59 -
=========== =========== ===========
The accompanying notes to financial statements are an integral part of these statements.
- 60 -
The accompanying notes to financial statements are an integral part of these statements.
- 61 -
The accompanying notes to financial statements are an integral part of these statements.
- 62 -
NTS/VIRGINIA DEVELOPMENT COMPANY -------------------------------- NOTES TO FINANCIAL STATEMENTS -----------------------------
1. Significant Accounting Policies -------------------------------
A) Organization ------------
NTS/Virginia Development Company (Fawn Lake) was organized on December 8, 1987 as a Virginia corporation. Fawn Lake is an Affiliate under common control with NTS Corporation, the Sponsor of the NTS Mortgage Income Fund. The NTS Mortgage Income Fund (the Fund) is the primary creditor of Fawn Lake. Fawn Lake is in the process of developing approximately 2,825 acres of land located in the Chancellor district of Spotsylvania County, Virginia, approximately 60 miles south of Washington D.C., into a single-family residential community and a country club with a championship golf course for the purpose of selling such residential lots and country club memberships. Included on the property is a 285 acre lake. Fawn Lake will have amenities consisting of a clubhouse, pool, tennis courts and boat docks. As of December 31, 1996, approximately 1,200 acres have been developed.
These financial statements do not reflect the impact, if any, of the proposed transaction discussed in Note 8.
B) Revenue Recognition -------------------
Fawn Lake recognizes revenue and related costs from lot sales using the accrual method in accordance with generally accepted accounting principles, which is when payment has been received and title, possession and other attributes of ownership have been transferred to the buyer, and Fawn Lake is not obligated to perform significant activities after the sale. Fawn Lake generally requires a minimum down payment of at least 10% of the sales price of the lot.
C) Reserves for Loan Losses ------------------------
Interest income from notes receivable is reported as earned on the accrual basis of accounting. If Fawn Lake has any reason to doubt the collectability of any principal and interest amounts due pursuant to the terms of the notes and accounts receivable, appropriate reserves are established for any principal and accrued interest amounts deemed unrealizable. Notes receivable in the accompanying balance sheets are presented at lower of cost or fair value. The amounts Fawn Lake will ultimately realize could differ from the amounts assumed in arriving at the reserve for loan losses reported in the financial statements.
D) Inventory ---------
Inventory is stated at the lower of cost or net realizable value. Inventory includes all direct costs of land, land development, and amenities, including interest, real estate taxes, and certain other costs incurred during the development period, less amounts charged to cost of sales. Inventory costs are allocated to individual lots sold using the relative sales values. The use of the relative sales value method to record cost of sales requires the use of estimates of sales values, development costs and absorption periods over the life of the project. Given the long-term nature of the project and inherent economic volatility of residential real estate, it is reasonably possible that such estimates could change in the near term. Any changes in estimates would be accounted for prospectively over the life of the project.
- 63 -
1. Significant Accounting Policies - Continued -------------------------------------------
E) Tax Status ----------
Fawn Lake has elected, for income tax purposes, to include its income with that of its stockholders, an S-Corporation election. Accordingly, no provision for income taxes is included in the accompanying financial statements.
F) Use of Estimates in the Preparation of Financial Statements -----------------------------------------------------------
The preparation of financial statements in conformity with generally accepted accounting principles 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.
G) New Accounting Pronouncement ----------------------------
Statement of Financial Accounting Standards (SFAS) No. 121, Accounting for the Impairment of Long-Lived Assets and for Long- Lived Assets to be Disposed Of, specifies circumstances in which certain long-lived assets must be reviewed for impairment. If such review indicates that the carrying amount of an asset exceeds the sum of its expected future cash flows, the asset's carrying value must be written down to fair value. Application of this standard during the year ended December 31, 1996 did not result in an impairment loss.
H) Advertising -----------
Fawn Lake expenses advertising-type costs as incurred. Advertising expense, a component of Cost Reimbursement (See Note 6), was approximately $410,000 and $310,000 during the years ended December 31, 1996 and 1995, respectively. Advertising expense for the year ended December 31, 1994 is a component of the Marketing and Development Fee (See Note 6) and is not separately determinable.
I) Reclassification of 1995 and 1994 Financial Statements ------------------------------------------------------
Certain reclassifications have been made to the December 31, 1995 and 1994 financial statements to conform with December 31, 1996 classifications. These classifications have no effect on previously reported operations.
2. Member Initiation Fees and Other Accounts Receivable ----------------------------------------------------
Fawn Lake Country Club membership initiation fees receivable totalled approximately $460,000 and $660,000 as of December 31, 1996 and 1995, respectively. The receivable is net of a discount recorded to allow for the present value of the membership initiation fee receivables considering the estimated timing of collections.
3. Notes Receivable ----------------
Notes receivable are secured by a first mortgage on lots sold to individuals. The notes bear interest at the prevailing market rates at the time the lots were sold. The majority of the notes are due between five to seven years, monthly payments are based on a 30-year amortization and the balance is due at the maturity date. As of
- 64 -
3. Notes Receivable - Continued ---------------- -----------
December 31, 1996, notes totalling $3,946,565 are pledged as security for notes payable to banks under certain Warehouse Line of Credit Agreements. There are also $203,950 of notes held by Fawn Lake that are not pledged. Approximately $1,041,296, $1,464,463, $701,746, $527,628 and $222,614 of the notes receivable balance as of December 31, 1996 are due for the years ended December 1997 through 2001, respectively, with $192,768 due thereafter.
4. Inventory ---------
Inventory consists of the following as of December 31:
1996 1995 ----------- ----------
Land held for future development, under development and completed lots $21,633,702 $20,714,958 Country club (net of membership initiation fees) 6,749,630 5,198,132 Amenities 4,384,896 4,889,574 ----------- -----------
$32,768,228 $30,802,664 =========== ===========
Fawn Lake capitalized in inventory approximately $1,407,284 and $1,216,410 of interest and real estate taxes in 1996 and 1995, respectively. Interest and real estate taxes incurred was approximately $2,017,650 and $1,838,322 as of December 31, 1996 and 1995, respectively.
Inventory for 1996 as reflected above includes $8,025,573, net of $1,275,943 of country club membership initiation fees, of costs incurred to date for the development of Fawn Lake Country Club.
5. Notes and Mortgage Loans Payable (See Note 8) ---------------------------------------------
Notes and mortgage loans payable consist of the following as of December 31:
1996 1995 ----------- ----------- Mortgage loan payable to the Fund in the amount of $30,000,000, bearing interest equal to the greater of 17% of Gross Receipts or 4.42% of the outstanding loan balance, due July 1, 1997, secured by inventory and a subordinated first mortgage on 22 acres of land, generally principal payments consist of approximately 83% of the Gross Receipts of lot sales $28,966,245 $27,459,598
Mortgage payable to the Fund in the amount of $2,500,000, bearing interest at the Prime Rate + 3/4%, due July 31, 1997 secured by the Fawn Lake Golf Course 1,998,850 1,073,953 (Continued next page)
- 65 -
5. Notes and Mortgage Loans Payable - Continued --------------------------------------------
1996 1995 ----------- ----------- Warehouse Line of Credit Agreements with two banks bearing interest at the Prime Rate + 1% and Prime Rate + 3/4%, due December 15, 1997 ($613,718) and September 30, 1997 ($3,203,442), secured by notes receivable (See Note 3), principal payments consist of payments received from notes receivable securing the obligation $ 3,817,160 $ 5,118,702
Mortgage loan payable in the amount of $325,000 bearing interest at the Prime Rate + 1% and gross receipts interest of 2% of the gross proceeds from lot sales, due September 15, 1997, secured by a first mortgage on 14 lots in Fawn Lake, principal payments consist of 85% of the gross proceeds of lot sales to builders and 75% of the gross proceeds of lot sales to individuals 243,393 502,936
Bank note payable in the amount of $165,276, bearing interest at the rate of 8.75%, due January 14, 1999, secured by golf course maintenance equipment 115,028 165,276
Bank note payable in the amount of $42,435, bearing interest at the rate of 10.5%, due October 15, 1999, secured by golf course maintenance equipment 36,421 --
Bank note payable in the amount of $34,505, bearing interest at the rate of 10.5%, due October 15, 1999, secured by golf course maintenance equipment 30,366 --
Bank note payable in the amount of $79,545, bearing interest at the rate of 7.99%, due October 1, 1997, secured by golf course maintenance equipment 21,680 48,667
Bank note payable in the amount of $19,144, bearing interest at the rate of 10.5%, due October 15, 1999, secured by golf course maintenance equipment 16,450 -- ---------- ---------- $35,245,593 $34,369,132
As of December 31, 1996, substantially all of the assets of Fawn Lake secure the above notes and mortgage loans payable.
The Prime Rate was 8 1/4% and 8 1/2% at December 31, 1996 and 1995, respectively.
The $613,718 Warehouse Line of Credit Agreement is guaranteed by NTS Corporation.
- 66 -
5. Notes and Mortgage Loans Payable - Continued --------------------------------------------
There is currently no readily determinable market value for the $30,000,000 loan payable to the Fund given its unique and affiliated nature. Based on the borrowing rates currently available to Fawn Lake for bank loans with similar terms and average maturities, the fair value of all other debt instruments approximates the carrying value for these debt instruments.
Fawn Lake is working with several lenders, including existing creditors to refinance the debt which will mature within the next twelve months. While management can provide no assurance that these negotiations will be successful, it is their belief that such financing will be accomplished prior to the respective maturity dates.
6. Related Party Transactions --------------------------
Development and marketing activities in Virginia, which include accounting, are managed by NTS Residential Properties, Inc. - Virginia (Residential),a Virginia corporation and a wholly-owned subsidiary of NTS Development Company. NTS Development Company is a wholly-owned subsidiary of NTS Corporation, the Sponsor of the Fund. These entities are under common control with Fawn Lake. During fiscal 1994, pursuant to an agreement, Residential received 25% of the gross proceeds of lot sales to individuals and 15% of the gross proceeds of lot sales to builders as a fee for its service. The fee amounted to $505,950 for the year ended December 31, 1994. Subsequent to June 30, 1994, the fee is no longer being charged by Residential.
Fawn Lake incurred expenditures with various affiliates for acquisition, preliminary planning, start-up and construction overhead costs and has recorded these expenditures as a cost of inventory. The amounts charged were approximately $260,000, $206,000 and $811,900 for each of the three years ended December 31, 1996, 1995 and 1994 respectively. In addition, for 1996 and 1995, pursuant to an agreement effective July 1, 1994 with Residential, reimbursements were made to Residential for actual personnel, marketing and administrative costs as they relate to Fawn Lake of approximately $1,035,000 and $985,000 respectively. These reimbursements are reflected as Cost Reimbursements in the accompanying Statements of Operations.
In addition to the mortgage loans with the Fund, Fawn Lake had the following additional transactions with the Fund:
1996 1995 ----------- ----------
Regular interest - capitalized $1,310,224 $1,074,591 Regular interest - expensed $ 123,216 $ 82,261 Letters of credit fees $ 1,933 $ 4,679
Fawn Lake has received non-interest bearing advances from an affiliate totalling $583,700 as of December 31, 1996. The advances were used to fund development costs and will be repaid to the affiliate as cash flow permits.
As of December 31, 1996, Fawn Lake has a participation agreement with the Fund whereby Fawn Lake has been assigned an interest in the Fund's Temporary Mortgage Loan with the Orlando Lake Forest Joint Venture (the "Joint Venture"). The loan is on a demand basis and is in default due to the failure of the Joint Venture to pay the interest due on the loan. Based on managements's evaluation of the Joint Venture's future cash flows, Fawn Lake increased the loan loss reserve by $364,974 during 1996. The loan loss reserve is equal to the note amount. Reserves for loan losses are based on management's evaluation of the
- 67 -
6. Related Party Transactions - Continued --------------------------------------
borrower's ability to meet its obligation as well as current and future economic conditions. Reserves are based on estimates and ultimate losses may vary. These estimates are reviewed periodically and, as adjustments become necessary, they are reported in earnings in the period in which they become known.
7. Commitments and Contingencies -----------------------------
It is estimated that the country club and homeowners association amenities will be substantially completed by December 2002. Based on engineering studies and projections, Fawn Lake will incur additional costs, excluding interest, of approximately $4,450,000 to complete the country club and homeowners association amenities for the project. These costs are estimated to be incurred as follows: $225,000 for 1997, $2,400,000 for 1998, $1,210,000 for 1999, $210,000 for 2000, $5,000 for 2001 and $400,000 for 2002.
Fawn Lake has letters of credit outstanding to governmental agencies totalling approximately $480,000 at December 31, 1996.
8. Subsequent Event ----------------
On February 12, 1997, Fawn Lake entered into a letter of intent (the Letter of Intent) with the Fund and NTS Corporation and its Affiliates, NTS Development Company and NTS/Lake Forest II Residential Corporation (Lake Forest) regarding the Fund's loans to Fawn Lake and Lake Forest. The Letter of Intent provided for, among other things, a restructuring of the Fund's loans to Fawn Lake and Lake Forest. The Letter of Intent contemplates that ownership of the properties will be transferred to the Fund, which expects to continue the development to completion of such properties and ultimately, their orderly sale.
The parties to the Letter of Intent agreed to consider a general restructuring of the relationship among the Fund, NTS Corporation and its various Affiliates. The method by which the Fund will acquire control of Fawn Lake has not been determined.
Generally Accepted Accounting Principles require that transactions as contemplated by the Letter of Intent be recorded at fair market value. Management can not determine at this time whether or not such transactions, if completed, will result in a loss.
The Fund, as owner of the Fawn Lake project, expects that it will continue development of the project and the orderly sale of lots, golf course memberships and ancillary services through sell-out, as well as the sale of the Fawn Lake Country Club, when appropriate. As owner, the Fund will be responsible for continuing development, operations and marketing costs through the remaining life of the project and it may be necessary for the Fund to borrow additional funds to complete the development. While the Fund believes that such funds will be more readily available if it owns the projects, it is not certain that the Fund will be able to borrow the funds necessary to complete the projects.
The Letter of Intent contemplates that NTS Development, or another subsidiary or affiliate of NTS Corporation (the "Manager"), will enter into a management agreement (the "Management Agreement") with the Fund pursuant to which the Manager will, as authorized agent for the Fund,
- 68 -
8. Subsequent Event -Continued ---------------------------
provide exclusive management, development, marketing and sales efforts and personnel to the Fund, and take all other actions necessary to manage the development of the project to completion and the sale of lots, golf memberships, ancillary services and the Fawn Lake Country Club. The terms of the Management Agreement have not yet been finalized.
- 69 -
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and --------------------------------------------------------------- Financial Disclosure --------------------
There have been no changes in accountants or reported disagreements on any matter of accounting principles, practices or financial statement disclosure.
Part III
Item 10.
Item 10. Directors and Executive Officers of the Registrant --------------------------------------------------
The directors and principal officers of the Fund are as follows:
Name Office With the Fund ---- --------------------
J. D. Nichols Chairman of the Board of Directors Robert M. Day Director* Gerald B. Thomas Director* F. Everett Warren, J.D. Director* Richard L. Good President and Director John W. Hampton Secretary and Treasurer ________________________________________________________________________________ * Messrs. Day, Thomas and Warren are the Independent Directors of the Fund. Neither of them are employees, partners, officers or directors of the Sponsor or any of its Affiliates.
J. D. Nichols (age 55)is Chairman of the Board and Chief Executive Officer of NTS Corporation and its various Affiliates and is a member and Chairman of the Board of Directors of the NTS Mortgage Income Fund. He is a graduate of the University of Louisville School of Law. His undergraduate studies were at the University of Kentucky, where he concentrated in Accounting, Marketing and Business Administration. Mr. Nichols entered the real estate construction and development business in 1965 and has been involved in the development and construction of over 6,500 acres of land and over 6,500,000 square feet of office, residential, commercial and industrial space in numerous states throughout the eastern half of the United States. He is a member of both the Louisville and National Homebuilders Associations, and has served as Vice President and Director of the Louisville and National Apartment Associations. Mr. Nichols is also lifetime member of the President's Society of Bellarmine College, Louisville, Kentucky and a past member of the Board of Overseers and Board of Trustee of the University of Louisville, the Governors Council for Education Technology and the Board of Directors of the Louisville Chamber of Commerce. Mr. Nichols is currently a member of the Board of Directors of the Regional Airport Authority of Louisville and Jefferson County and is a member of the Board of Directors of the Greater Louisville Economic Development Partnership.
Robert M. Day (age 44) has been Managing Director of Lambert, Smith & Hampton and its predecessor companies, Atlanta, Georgia, a commercial and industrial real estate brokerage firm since 1985. Mr. Day received a Bachelor of Business Administration degree from Georgia State University and holds an MAI designation from the Appraisal Institute. Mr. Day is a member of the Atlanta Board of Realtors, the Urban Land Institute and is on the operating committee of the Atlanta Chapter of Young Life.
Gerald B. Thomas (age 58) has 24 years experience in Commercial Real Estate lending. Formerly a Senior Vice President with Mid-American Bank of Louisville, Mr. Thomas joined Citizens Bank of Kentucky in February 1996 as Vice President, with responsibility of developing real estate portfolios for four Kentucky affiliate banks of CNB Bancshares, Inc., Evansville, Indiana. Mr. Thomas has attended Eastern Kentucky University, National School of Real Estate Finance (Ohio State University) and National Institute of Real Estate Appraisers (University of Louisville). He is a board member of Big Brothers/Big Sisters, Louisville and Co-chairman of the Programs, Planning and Evaluation Committee.
- 70 -
Item 10. Directors and Executive Officers of the Registrant - Continued --------------------------------------------------------------
F. Everett Warren, J.D. (age 73) retired in 1985 from Citizens Fidelity Mortgage Company, Louisville, Kentucky, a division of Citizens Fidelity Bank Corporation and Pittsburgh National Corporation. From 1972 to 1985, Mr. Warren served as Chairman, President and Chief Executive Officer of Citizens Fidelity Mortgage Company. Mr. Warren attended both the University of Kentucky and University of Louisville and received a Bachelor of Law degree and a Juris Doctorate degree. He serves on the Board of Directors of Louisville Mortgage Bankers Association, National Mortgage Bankers Association, United Cerebral Palsy and Louisville Deaf Oral School. Mr. Warren is a member of both the Kentucky and Louisville Bar Associations.
Richard L. Good (age 57) is President and Chief Operating Officer of NTS Corporation, and Chairman of the Board of NTS Securities, Inc. As such, Mr. Good oversees all operations of NTS Corporation and its various subsidiaries and is responsible for residential developments, commercial properties, property management, securities, finance and corporate administration. From 1981 to 1984, Mr. Good was Executive Vice President of Jacques-Miller, Inc., a real estate syndication, property management and financial planning firm, and was responsible for corporate systems, marketing and planning. Prior to 1981, Mr. Good held sales, marketing and management positions, including sixteen years with IBM Corporation, where he served as Branch Manager of the Data Processing Division in Nashville. Mr. Good attended Stanford University and Case Western Reserve University and holds a Bachelor of Science degree in Management Science from Case. He is a registered securities principal and member of the International Association for Financial Planning and the Real Estate Securities and Syndication Institute and is past President of the Hurstbourne Corridor Business Association in Louisville. In addition, he has served on the Board of Directors of Junior Achievement, the Boy Scouts and Christ Church United Methodist and is a member of the Leadership Louisville Class of 1990.
John W. Hampton (age 47) is Senior Vice President of NTS Corporation with responsibility for all accounting operations. Before joining NTS in March 1991, Mr. Hampton was Vice President - Finance and Chief Financial Officer of the Sturgeon-Thornton-Marrett Development Company in Louisville, Kentucky for nine years. Prior to that he was with Alexander Grant & Company CPA's. Mr. Hampton is a Certified Public Accountant and a graduate of the University of Louisville with a Bachelor of Science degree in Commerce. He is a member of the American Institute of CPA's and the Kentucky Society of CPA's.
The Directors are not required to devote all of their time to the Fund, they are only required to devote such of their time to the affairs of the Fund as their duties require, and will meet quarterly or more frequently if necessary. It is not expected that the Directors will be required to devote substantial portions of their time to discharge their duties as Directors. For a description of provisions concerning indemnification, see "Fiduciary Responsibility" on page 14 of the Fund's Prospectus, which description is filed herewith and incorporated herein by reference.
The Directors, although not precluded from engaging in activities similar to the Fund's, are required to disclose any interest held directly or indirectly by them, or an Affiliate in an investment presented to the Fund. Furthermore, Affiliated Directors must offer the Fund the right to engage in an investment opportunity, which is within the Fund's objectives and policies, prior to entering into such transaction themselves. The Fund will not pay a commission to an Affiliate of any Director for presenting or disposing of the Fund's investments.
- 71 -
Item 10. Directors and Executive Officers of the Registrant - Continued --------------------------------------------------------------
The Fund will initially pay to each Independent Director a fee of $1,000 per month (which amount may be increased or decreased in the discretion of the Directors) and will reimburse such persons and Affiliated Directors for travel expenses and other out-of-pocket disbursements incurred in connection with attending any meetings. Affiliated Directors will not receive any compensation from the Fund for their services as Directors or Officers of the Fund.
The Directors have retained NTS Advisory Corporation (the Advisor) to manage the Fund's day-to-day affairs, and recommend investments suitable for the Fund. The Advisor has delegated substantially all of its duties to NTS Corporation (NTS), an affiliate of the Advisor. NTS has substantial experience in all phases of real estate activities, including acquisition, financing, property management and disposition.
The following persons are the executive officers and key employees of NTS and/or an affiliate and will provide services to the Advisor and the Fund:
Name Office ---- ------
J. D. Nichols Chairman and Chief Executive Officer Richard L. Good President and Chief Operating Officer H. L. Heiner Executive Vice President, NTS Development Company B. J. DeVries President, NTS Residential Properties, Inc. and President, NTS/Residential Properties, Inc.- Virginia Margaret O. Templeton President, NTS/Residential Properties, Inc. - Florida David G. Williams President, NTS Securities, Inc. John W. Hampton, CPA Senior Vice President, NTS Corporation Gary D. Adams Senior Vice President, NTS Development Company Gregory A. Compton Senior Vice President, NTS Corporation Sally A. Judah Senior Vice President, NTS Corporation
The following provides additional information regarding the above-mentioned persons. Information regarding Messrs. Nichols, Good and Hampton is provided in the section entitled "Directors and Officers of the Fund."
H. L. Heiner (age 45) is Executive Vice President of NTS Development Company with responsibility for development, leasing and property management activities for commercial and retail properties. Mr. Heiner attended Purdue University and received his Master's degree in Engineering, magna cum laude, from the University of Louisville. From 1974 until joining NTS in 1985, Mr. Heiner was a consultant responsible for the successful planning of development projects in South Carolina, Florida, Kentucky and Indiana, many of which were planned for NTS. During this period, Mr. Heiner held the position of Vice President and partner of Sabak, Wilson, Heiner & Lingo, Inc., a development planning and consulting firm in Louisville. Mr. Heiner is registered as a professional engineer in several states.
B. J. DeVries (age 36) is President of NTS Residential Properties, Inc. in Kentucky and President of NTS/ Residential Properties, Inc. - Virginia with responsibility for single-family residential development, marketing and operations, in the states of Kentucky and Virginia. Mr. DeVries' experience with NTS includes the positions of Residential Sales Representative, Builder Sales Representative, Residential Sales Manager and Vice President - Sales and Marketing. Prior to joining NTS in June 1992, Mr. DeVries served eight years as a United States Marine Corps officer. Mr. DeVries was a pilot with additional management experience in operations, maintenance and logistics. Mr. DeVries received his Bachelor of Arts degree from Centre College.
- 72 -
Item 10. Directors and Executive Officers of the Registrant - Continued --------------------------------------------------------------
Margaret O. Templeton (age 47) is President of NTS/Residential Properties, Inc. - - Florida with responsibility for single family residential development, marketing and operations in the state of Florida. Prior to joining NTS in November 1994, Ms. Templeton was President of Templeton Development Corporation, a real estate development firm in Tampa, Florida from 1992 to November 1994. She has extensive experience in marketing, construction and land development including seven years (1985 to 1992) as Vice President of Tampa Palms and Gulfstream Land and Development Company, whose holdings included 30,000 acres in Florida, Georgia and Virginia. Ms. Templeton received a Bachelor of Arts degree from the University of Florida. Ms. Templeton is a member and Director of the National Association of Homebuilders, Florida Homebuilders Association as well as Director and Vice President of the Builders Association of Greater Tampa and Orlando. Ms. Templeton is also a member of the Florida Board of Realtors and the Urban Land Institute.
David G. Williams (age 62) is President of NTS Securities, Inc. and serves as the General Securities Principal with responsibilities for managing NTS's securities operations. Mr. Williams is also Senior Vice President of NTS Corporation and is responsible for Management Information Systems and Corporate Administration of NTS Corporation and NTS Development Company. Prior to joining NTS in March 1989, Mr. Williams served as President of Systemedics, Inc., a physicians claim processing company in Princeton, New Jersey. Mr. Williams has a Bachelor of Science degree from Tufts University, Medford, Massachusetts and attended graduate school at Harvard University.
Gary D. Adams (age 51) is Senior Vice President of NTS Development Company with responsibility for single-family residential development, multi-family operations and commercial properties in the state of Florida. Since joining the NTS organization in May 1977, Mr. Adams has been involved in the development, construction and management of numerous apartment, office, industrial and commercial developments in the southeastern portion of the United States. Mr. Adams received his undergraduate degree in Engineering from the University of Cincinnati, and he holds a Master of Business Administration from Xavier University. He is a member of the Building Owners and Managers Association and is a licensed general contractor in the State of Florida.
Gregory A. Compton (age 36) is Senior Vice President, Secretary and General Counsel of NTS Corporation. Prior to joining NTS in March 1992, Mr. Compton was a senior associate in the Real Estate and Finance Department of Greenebaum, Doll & McDonald for seven years, where he was responsible for many of NTS's corporate real estate transactions. He is a member of the Board of Directors of and is General Counsel for Goodwill Industries of Kentucky. He received a B.B.A. in Finance from the University of Kentucky and a J. D. from the University of Cincinnati College of Law.
Sally A. Judah (age 38) is Senior Vice President of NTS Corporation with responsibility for multi-family property management of NTS's apartment communities in Kentucky and Indiana and the Human Resources area of Corporate Administration of NTS Development Company. From July 1991 to 1994, Ms. Judah was Vice President of NTS Corporation with responsibility for Corporate Marketing, Human Resources and the Graphics Division. From June of 1987 when she joined NTS until July 1991, Ms. Judah was responsible for leasing activities for commercial properties in Louisville, Kentucky. Ms. Judah is a member of the Louisville Board of Realtors and is a Certified Commercial Investment Member (CCIM) Candidate and is a member of the national and Kentucky CCIM chapters. Ms. Judah is also a member of the Louisville Apartment Association and is a member of the Leadership Louisville Class of 1993. Ms. Judah holds a Bachelor of Arts degree from the University of Kentucky.
- 73 -
Item 11.
Item 11. Executive Compensation ----------------------
(a, b, c & d) The Fund will pay each Independent Director a fee of $12,000 per year and will reimburse such persons and Affiliated Directors for travel expenses and other out-of-pocket disbursements incurred in connection with attending any meetings of the Board of Directors. During the years ended December 31, 1996, 1995 and 1994, the Fund paid directors fees of $34,000, $24,000 and $24,000, respectively, representing annual compensation. The Affiliated Directors will not receive any compensation from the Fund for their services to the Fund. The present officers of the Fund receive compensation from the Advisor or its affiliates which indirectly relates to services to the Fund (see Item 13).
The Fund is entitled to engage in various transactions involving the Advisor and its affiliates, as described under captions "Compensation Table" at pages 9 and 10 of the Prospectus and "Conflicts of Interest" on pages 11 to 14 of the Prospectus, which descriptions are filed herewith and incorporated herein by reference. Reference is made to Note 3 to Notes to the Fund's Financial Statements filed with this report for various transactions with affiliates.
(e) There are no compensatory plans or arrangements resulting from resignation or retirement of the Directors and executive officers which require payments to be received from the Fund.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management ---------------------------------------------------------------
(a) As of the date hereof, no person owns of record or is known by the Fund to own beneficially more than five percent (5%) of the outstanding shares of common stock of the Fund.
(b) The following table sets forth the ownership of shares owned directly or indirectly by the Directors and principal officers of the Fund as of the date hereof:
Amount of Percent Name of Beneficial of Title of Class Beneficial Owner Ownership Interest -------------- ---------------- --------- --------
Shares of Common J. D. Nichols 96,468 * 3.0% Stock, $0.001 Shares Par Shares
* These shares are owned of record by NTS Corporation or an Affiliate of which Mr. Nichols directly or beneficially holds voting and investment authority.
(c) There are no known arrangements which may at a subsequent date result in change in control of the Fund.
Item 13.
Item 13. Certain Relationships and Related Transactions ----------------------------------------------
Pursuant to the Advisory Agreement, the Fund will pay the Advisor a Management Expense Allowance relating to services performed for the Fund in an amount equal to 1% of the Fund's Net Assets, per annum, which amount may be increased annually by an amount corresponding to the percentage increase in the Consumer Price Index. Effective July 1, 1994, the Fund's Mortgage Loans to Fawn Lake and Lake Forest were converted to cash flow mortgage loans. As part of the consideration for this restructuring, the Fund's Board of Directors required, among other things, that beginning in 1995, NTS Advisory Corporation pay $100,000 annually towards the expenses of the Fund until the maturity of the Mortgage Loans. As such, the Management Expense Allowance for each of the years ended December 31, 1996 and 1995 has been
- 74 -
Item 13. Certain Relationships and Related Transactions - Continued ------------------------------------------------------------
reduced by $100,000. For the years ended December 31, 1996, 1995 and 1994, $544,776, $528,973 and $614,100, respectively, has been incurred as a Management Expense Allowance.
Neither the Certificate of Incorporation, By-Laws nor the Advisory Agreement restricts the Affiliated Directors, the Advisor or its affiliates from engaging in other business activities which may give rise to conflicts of interest with the Fund. One of the three Directors is an Affiliated Director. This individual holds a position with the Advisor and is affiliated with other related entities, including partnerships that borrow money from the Fund. In such cases, this individual will have fiduciary obligations to such other entities which may conflict with his fiduciary obligations to the Fund. Transactions between the Fund and any affiliates will be subject to potential conflicts of interest. With respect to the conflicts of interest described herein, the Advisor and its affiliates will endeavor to balance the interests of the Fund with the interests of the Advisor and its affiliates in making any determinations.
- 75 -
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules, and Reports on ------------------------------------------------------- Form 8-K --------
1. Financial statements
The financial statements for the NTS Mortgage Income Fund, NTS Guaranty Corporation, NTS/Lake Forest II Residential Corporation and NTS/Virginia Development Company together with the reports of Arthur Andersen LLP dated March 24, 1997.
2. Financial statement schedules
All schedules have been omitted because they are not applicable, are not required, or because the required information is included in the financial statements or notes thereto.
3. Exhibits
The following exhibits are incorporated by reference from the Fund's Registration Statement on Form S-11, referencing the exhibit number used in such Registration Statement.
Exhibit Number Description -------------- -----------
3 (a)(2) Restated Certificate of Incorporation 3 (b) By-Laws 10 (c) Form of Advisory Agreement 10 (b) Form of Guaranty Agreement
The following are additional exhibits filed with the Form 10-K Report.
Exhibit Number Description -------------- -----------
27 Financial Data Schedule
99 Additional Exhibits - Pages from the Fund's prospectus which have been specifically incorporated by reference and copies of which are attached hereto which include pages 9 to 14 and pages 75 to 81.
4. Reports on Form 8-K.
None.
- 76 -
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities exchange Act of 1934, NTS Mortgage Income Fund has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
NTS MORTGAGE INCOME FUND
/s/ Richard L. Good Date: March 27, 1997 - ----------------------------------------- Richard L. Good President and Director of the NTS Mortgage Income Fund
Pursuant to the requirements of the Securities and Exchange Act of 1934, this Form 10-K has been signed below by the following persons on behalf of the registrant in their capacities and on the date indicated.
/s/ J. D. Nichols Date: March 27, 1997 - ----------------------------------------- J. D. Nichols Chairman of the Board of Directors of the NTS Mortgage Income Fund
/s/ F. Everett Warren J.D. Date: March 27, 1997 F. Everett Warren J.D. Director of the NTS Mortgage Income Fund
/s/ Robert M. Day Date: March 27, 1997 - ----------------------------------------- Robert M. Day Director of the NTS Mortgage Income Fund
/s/ Gerald B. Thomas Date: March 27, 1997 - ----------------------------------------- Gerald B. Thomas Director of the NTS Mortgage Income Fund
/s/ Richard L. Good Date: March 27, 1997 - ----------------------------------------- Richard L. Good President and Director of the NTS Mortgage Income Fund
/s/ John W. Hampton Date: March 27, 1997 - ----------------------------------------- John W. Hampton Secretary and Treasurer (principal financial and chief accounting officer)
- 77 -